Journal of Economics, Business and Management, Vol. 5, No.
5, May 2017
The Impact of Tax Reform on the Hospitality Sector: Some
Evidence of the Republic of Croatia
Marinko Škare, Dean Sinković, and Tea Golja
supported by investments in tourism, government
Abstract—In this paper authors argument that the increase “collective” spending (i.e. tourism marketing,
in VAT for restaurant/catering services will have negative promotion etc. on the national level) and domestic
influence on the tourism sector and consequently slow Croatian purchases of goods and services by the sectors
economy which is heavily dependent on tourism.
dealing directly with tourists; induced contribution
This increase will negatively influence the price
competitiveness and the overall competitiveness of the tourism measures the GDP and jobs supported by the
sector. According to the latest Travel and Tourism spending of those who are directly and indirectly
Competitiveness Report 2015, Croatia has been ranked 33rd out employed by the Travel & Tourism sector.
of 141 countries (scoring 4.3 of 7). Looking at the price Tourism is a major component of Croatian economy. The
competitiveness pillar which measures how costly it is to travel number of arrivals and nights spent in tourist accommodation
and invest in the country, Croatia has been placed on 101st place.
establishments is showing an upward trend. In 2016 the
Claiming that business operating in the catering industry did
not take advantage of the preferential (lower) VAT rate of 10% number of nights spent in tourist accommodation
(01/01/2013) and 13% (01/01/2014) to increase its establishments in Croatia reached a peak of 78.04 million
competitiveness cannot be accepted. nights. In 2016 the number of arrivals reached 15.5 million
The employment cycle in the tourism sector began with the [2].
targeted VAT relief on catering services in 2013. The research According to the World Travel and Tourism's calculations
results have shown the existence of strong correlation between and projections, direct contribution of Travel and Tourism to
accommodation and catering services, particularly when it
Croatian GDP in 2015 was HRK 33,896.7mn (10.1% of
comes to the creation of new jobs and protection of existing ones.
Delving into the relationship between taxation and the profit GDP). This is forecast to rise by 2.6% to HRK34, 775.3mn in
margin, authors conclude that Croatian businesses operating in 2016. The direct contribution of Travel & Tourism to GDP is
the restaurant and catering industry do not have space to expected to grow by 4.4% pa to HRK53, 697.3mn (13.2% of
amortize shocks derived from the increase of VAT tax to 25%. GDP) by 2026. The total contribution of Travel & Tourism to
The only way to amortize shocks would be the price increase or GDP was HRK77, 918.4mn in 2015 (23.2% of GDP) and is
the decrease of product/services quality. This can only result in
expected to grow by 1.9% to HRK79, 429.1mn (23.3% of
the loss of the competitiveness of the tourism sector.
GDP) in 2016. It is forecast to rise by 4.2% pa to HRK120,
Index Terms—Economic impacts, tax reform, tourism and 329.0mn by 2026 (29.7% of GDP). Travel and Tourism
hospitality sector, the Republic of Croatia. generated 130,500 jobs directly in 2015 (9.8% of total
employment) and this is forecast to grow by 1.0% in 2016 to
132,000 (9.8% of total employment). By 2026, Travel and
I. INTRODUCTION Tourism will account for 155,000 jobs directly, an increase of
Tourism has a strong potential in boosting economic 1.6% over the next ten years [3].
development, economic growth (measures of GDP) and
TABLE I: VAT RATES IN THE TOURISM SECTOR IN EU COUNTRIES
employment. Tourism impacts on the economy can be
categorized into: direct, indirect and induced. In calculating
overall impacts of tourism sector the World Travel and
Tourism Council summarizes the following impacts [1]:
1. Direct contribution of Travel & Tourism to GDP
which reflects the “internal spending” on Travel and
Tourism total spending within a particular country
by residents and non-residents for business and
leisure purposes, followed by the government
“individual” spending on Travel and Tourism
services directly linked to visitors, such as cultural
or recreational visitors;
2. Indirect contribution includes the GDP and jobs
Manuscript received March 5, 2017; revised May 23, 2017.
D. Sinković, M. Škare and T. Golja are with the Juraj Dobrila University
of Pula, Faculty of Economics and Tourism “Dr. Mijo Mirković”,
Preradovićeva 1, 52100 Pula, Croatia (e-mail: dsinkov@ [Link], mskare@
[Link], tgolja@ [Link]).
doi: 10.18178/joebm.2017.5.5.516 223
Journal of Economics, Business and Management, Vol. 5, No. 5, May 2017
Vellas points that tourism, as an economic stimulant, In this paper authors argument that the increase in VAT for
should be central to measures designed to revive economic catering services will have negative influence on the tourism
growth for the trade flows generated by a strong tourism sector and consequently will possibly slow Croatian
industry have a major effect on business and consumer economy which is heavily dependent on tourism. This paper
confidence. This has been proved in the research where the can serve as a context for the stronger debate about taxation
scale of the indirect economic effects of tourism in the T20 and its implications on the overall competitiveness of tourism
countries was measured [4]. There is an evident positive destination and economic development of the country.
impact of tourism on incomes (monetary and non-monetary
terms), livelihoods and poverty (especially for rural
households that participate in the sector) [5]. The taxation II. EMPIRICAL ANALYSIS
system strongly influences destination’s competitiveness. Since the reduced VAT rate of 10% for food preparation
The value added tax rate in Croatia is higher than in most of and services was applied on 1/1/2013, the number of
the Mediterranean countries. In the table below (see Table I), full-time employees in hospitality and food and beverages
authors highlight the VAT rates in the EU countries. [6] services has increased from 41,862 in 2012 to 47,246 in 2013,
13 out of 28 countries (UK included) benefit the reduced then to 51,304 in 2014, all the way to 56,170 in 2015.
VAT rate on catering service, amongst which Luxembourg In the period from 2006 to 2012 when the lowered rate of
has the lowest VAT rate of only 3%. Denmark levies the VAT was applied only for accommodation services, the
highest rate of 25%. As of 1st of January 2017 Croatia has number of employees remained mostly unchanged. The
introduced a standard VAT rate for catering services of 25%, movement of the employee’s figures indicates a strong
thus abolishing the reduced rate of 13%. Croatia will no connection between accommodation and hospitality because
longer take advantage of the reduced rate in catering sector. of the investment cycle. Thus, also the cycle of increased
The tax reform that Croatian government introduced has employment in the tourism sector has started with the very
attracted a great attention particularly in the catering services reduction in VAT for hospitality in 2013.
and tourism (hospitality) sector. Significant changes to the The number of full-time employees in 2013 increased by
tax law always create “winners and losers” but also can have as much as 11.3 %, while the growth in 2014 and 2015, when
strong economic repercussions and alter the competitive the VAT rate for accommodation and hospitality increased
landscape [7]. This is particularly true for the Croatian from 10% to 13%, was of a reduced intensity and came up to
economy where tourism constitutes a major component of the between 8% and 8.7%.
economy. Therefore, catering sector will be strongly hit by The fact stated above clearly indicates the strong
the tax reform, but tourism in general will bear consequences significance of the restaurant/catering sector in the context of
of such reform. Apart the above mentioned, the Croatian increasing the competitiveness of the entire tourism sector.
fiscal system includes an extensive list of hidden fees, and We conclude that the accommodation and hospitality sectors
neither the number of these different fees nor the way in behave according to the “Siamese twins” principle; because,
which they are calculated is fully known [8]. Bearing in mind looking through the contexts of investment impact, level of
the contribution of tourism to Croatian GDP, it is therefore, service quality and employment, they work best when
reasonable to conclude that such abolition of the reduced rate “together”, i.e., when they are afforded the condition of a
on catering services will strongly impact the Croatian privileged and equal tax treatment. In the following Fig. 1
economy, employment and GDP growth in the years to come. authors present the data on the full-time employment in
Dombrovski and Hodžić explained the reasons behind the tourism sector from 2007 to 2015 [12].
negative influence of strong taxation on tourism in Croatia
particularly emphasizing the impact of taxation on price
competitiveness of the country [9]. VAT increase in catering
sector is expected to have a negative impact on inbound
tourism whilst it will impact the general price levels of the
“tourism product”. Reducing the VAT rate in catering sector
would lower the prices, but also allow businesses to increase
investment in tourism sector because most of the catering
services are strongly connected with tourism (hospitality
sector).
Fig. 1. Full-time employment in tourism sector 2007-2015 (accommodation
For example, in Ireland reduced VAT rate has contributed + restaurants/catering).
significantly to strong growth in tourism over the past few
years marked by lower prices, enhanced competitiveness, The Tourism Development Strategy of the Republic of
growth of employment in the sector, increased investments in Croatia until 2020 that the government adopted in February
maintenance, refurbishment, renovation and innovation [10]. 2013 assumes that the investment cycle will last until about
Gago, Labandeira, Picos and Rodrigues analysed the effects 2025. It should be noted that this investment cycle assumed a
of tourism taxation in Spain - both economic and further reduction in the VAT for accommodation and
environmental reasons for taxation – and concluded that the hospitality services to the level of 5%, which the former
increase of VAT rates on tourism-related sectors could be government led by Mr Tihomir Oreskovic announced, and
mostly done at the costs of greater negative impact for numerous investors probably included in their business plans.
Spain’s economy [11]. The interruption of the afore-mentioned investment cycle by
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Journal of Economics, Business and Management, Vol. 5, No. 5, May 2017
raising the VAT for the restaurants/catering sector will cause Furthermore, in the period from 2013 to 2015, revenues of
very negative impacts on the tourism sector and thus the businesses in the hospitality sector increased by 28%, while
entire Croatian economy through related sectors (agriculture, wages costs grew to as much as 33%, which implies that the
construction, transport and communications, retail, etc.). hospitality business owners used the benefits of a
Considering that the estimated height of investment in the differentiated VAT rate for new employment and partial
hospitality and catering (restaurants) sector until 2020 is over wages increase.
35 billion Kunas (see: Table II), any shocks in this segment Looking at the expenditure side, where a parallel increase
would reduce the mentioned investment potential and of fixed assets is noticeable, it is clear that during the
threaten faster economic growth and the development of the afore-mentioned period, hospitality business owners chose to
Republic of Croatia. Besides, according to the Eurostat data, redirect the benefits of a lowered VAT rate to invest in the
the number of employees in the hospitality and catering new infrastructure and, consequently, to raise the quality of
(restaurants) sector in 2015 was more than 115,000, which is the existing ones. In other words, increased profits as a result
20,000 more than the estimated by the Tourism Development of reduced VAT rate were not used for payments of
Strategy. The table 2 shows that planned investments and dividends or asset stripping but for investment in
employment by 2020 in the tourism sector (hotels and infrastructure (quality) and new employment.
restaurants) [13]. Profit margins were relatively low in the years when the
restaurant/catering sector operated positively. After several
TABLE II: PLANNED INVESTMENTS AND EMPLOYMENT BY 2020 IN TOURISM years operating with a loss and upon the introduction of the
SECTOR IN CROATIA
reduced VAT rate, in 2013 profit margin spiked to 5.8%,
Year Investment Number of employees
projections (projections) while in 2014 and 2015 they amounted 2.5% and 3.5%
(u 000 kn) respectively. Such movements clearly illustrate that the
2015 3.542.354 95.000 (> 115.000)* restaurant/catering sector have very limited space to cushion
2016 4.250.825 98.800
2017 5.100.990 102.752
the blows of an increased VAT rate of 25%. Therefore, it has
2018 6.121.188 106.862 to either raise prices or reduce quality of its service. This
2019 7.345.426 111.137 scenario will result in a reduced competitiveness of the
2020 8.814.511 115.582 restaurant/catering services and entire tourism sector in the
TOTAL 2015-2020 35.175.296 Increase 20.582
moment when the investment cycle is having its full swing.
Furthermore, an increase in employment, revenue and
Analysis of the restaurant/catering sector shows that
profit in the restaurant/catering sector implies higher tax
reduction of VAT rate resulted in high growth rates of all the
revenues for the state and local government budgets via taxes
key indicators (see Table III) [14].
and surtaxes on higher income and profit. Finally, there is the
TABLE III: ECONOMIC AND FINANCIAL ASPECTS OF
significant influence of the tourism development on linked
RESTAURANT/CATERING SECTOR IN CROATIA, 2011-2015 sectors (construction, agriculture, transport and
2011 2012 2013 2014 2015 communications, and retail) which further strengthens the
[Link] 4.128 4.278 5.053 5.910 6.324 side of state and local budgets.
preneurs
No. 20.196 21.076 24.346 29.001 31.247
employe
es III. CONCLUSION
Total 4.279.2 4.469.75 6.311.55 7.301.67 8.124.49
revenues 49 4 1 3 2 Tourism has been the main driver of employment and GDP
Wage 1.091.0 1.113.73 1.379.12 1.730.36 1.846.42 growth in the Republic of Croatia with planed estimates of
costs 52 0 1 6 4 over 35 billion kn of investments in tourism sector by 2020.
EBIT -198.85 -167.76 363.716 180.645 286.301
6 5
Huge spike in investments and employment in tourism has
earnings/ -4,6% -3,8% 5,8% 2,5% 3,5% been encountered since 2013 when reduced VAT rate has
revenues been imposed on both segments of tourism industry;
accommodation and restaurants/catering.
The restaurants/catering sector grew particularly well in all In a period from 2006-2013 reduced VAT rate of 13% was
aspects (number of businesses, number of employees, imposed only to accommodation while restaurants where
revenues, expenses and revenue profit shares) just after 2013, charged standard rate ranging from 23 to 25%. During this
when the VAT rate was reduced from 25% to 10%. In the period employment and investment in tourism sector mostly
period between 2006 and 2013 it operated with a loss while stagnated. Reduced VAT rate on restaurants/catering in 2013
the number of employees did not change significantly, and initiated investment cycle in tourism resulting in increase of
this trend was reversed precisely by introducing reduced employment in tourism sector of 34%, revenues of
VAT rate. Similar indicators are visible in the consolidated restaurants/catering businesses by 28%, number of
balance sheets of both accommodation and entrepreneurs in restaurant segment of 25% and nominal
restaurant/catering sectors. wage increase in hospitality industry by 33%. Finally, since
In the period from 2013 to 2015 the number of employees 2013 profit margins of restaurants/catering businesses finally
in the hospitality sector grew from 24,346 to 31,247 which turned slightly positive, yet with margins still less than 6%.
implies growth of 28.3%, more than entire period between The only viable option for hospitality sector to amortize
2006 and 2013, i.e., in the period when the lowered rate of shocks of VAT rate increase is either to increase prices or
VAT applied only on the accommodation sector. decrease delivered service quality. Such findings clearly
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Journal of Economics, Business and Management, Vol. 5, No. 5, May 2017
reflect that growth and higher competitiveness of the tourism [11] A. Gago, X. Labandeira, F. Picos, and M. Rodrí guez. Taxing tourism in
Spain: Results and recommendations. [Online]. Available:
sector in Croatia will only be achievable under reduced VAT [Link]
rate for both accommodation and restaurant/catering services. [12] Annual Financial Report of Entrepreneurs, 2007-2015.
This implies that accommodation and restaurants/catering [13] Ministry of Tourism of the Republic, “Strategy of tourism development
2013 – 2020,” Zagreb, Croatian Institute of Tourism and Eurostat,
services behave according to the principles of the Siamese
2015.
twins, i.e. they best behave when they are provided with the [14] Croatian Financial Agency, 2016.
same (tax) treatment.
Croatian economy is highly dependent on tourism sector,
perhaps more than any other Mediterranean country. With Dean Sinkovic is an assistant professor of economics,
highly inefficient agriculture sector and industry that has vice dean for Research/International Relations and
been mostly devastated through the process of economic Economic Research Journal Managing Editor at the
Faculty of Economics and Tourism “Dr. Mijo
transition, tourism has been the most propulsive segment of Mirković” Juraj Dobrila University of Pula. He served
the economy that generated increase in investments and new as an advisor to the Deputy Prime Minister of the
employment. Moreover, tourism development provided Republic of Croatia for Economy, Finance and EU
funds and held numerous visiting lectures at
enormous support for related sectors such as construction,
universities and institutions in EU, North and South
communication, retail and agriculture. Therefore, America. His academic background is in teaching and research on economic
government decision to raise VAT rate on growth, development economics, investments, financial development, public
restaurants/catering services will have deleterious impact not policy and microfinance. He authored or co-authored many research papers
and books and has coordinated several large scale investment projects in
only for restaurant business and tourism sector but also for Croatia.
entire economy. Investment and employment cycles that
began in 2013 have been put in enormous jeopardy.
Marinko Skare is a professor of economics,
economic research journal editor in Chief, Member of
REFERENCES Editorial Board of several international journals,
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economic impact research,” p. 4, March 2015. as vice dean for education and vice dean for
[2] Ministry of tourism of the republic of Croatia and Croatian bureau of international cooperation at the Faculty of Economics
statistics, Croatian tourism. [Online]. Available: & Tourism, Pula, main and team researcher on several
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[Online]. Available: a Ph.D. at the Juraj Dobrila University of Pula in the
[Link] field of general economics. Currently she holds a
[Link] position of head of Department of Interdisciplinary,
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