In recent years, there has been a great deal of interest in cutting taxes at all levels of government. While tax cuts can serve many different purposes-from increasing economic competitiveness to making the tax system more progressive-much of the recent interest has been stimulated by the claim that tax cuts pay for themselves over time by boosting economic activity and thus government revenues.

At the local level, the surge in tourism and hotel occupancy tax revenues that accompanied New York City's December 1994 cut in its hotel occupancy tax has been used to make the case for cuts in other taxes. However, it is not appropriate to generalize from one tax cut to the next; even cuts in the same tax will have very different revenue impacts under different circumstances.

But it is instructive to take a close look at the City's reduction in hotel occupancy taxes to determine the extent to which recent increases in hotel occupancy and other tax receipts are attributable to economic activity specifically generated by the tax cut. The purpose of this fiscal brief is not to determine whether the City should have reduced the rate on its hotel occupancy tax in 1994-tax cuts do not necessarily have to pay for themselves to be desirable. The much narrower goal is simply to determine how much of the direct revenue loss attributable to cutting the City's hotel occupancy tax was offset by revenue gains from increased economic activity.

A look at the hotel occupancy and room rate data reveals that demand for hotel rooms was increasing strongly and thereby boosting hotel tax receipts well before the City cut its tax on hotel occupancy. Clearly other factors beyond changes in the tax rate influence tourism and City revenues from the hotel occupancy tax. Using sophisticated econometric techniques to distinguish among the different factors underlying the increase in hotel occupancy and room rates, IBO finds that while the City's 1994 reduction in its hotel occupancy tax rate did generate significant increases in economic activity and tax revenues, the tax cut did not pay for itself:

• Increased receipts from New York City's hotel occupancy tax and general sales tax on hotel rooms offset as much as 20 percent of the tax revenue lost due to the cut in the City's hotel occupancy tax rate.
• Adding in secondary fiscal benefits from all City tax sources attributable to the tax reduction's stimulus to the local economy, in the long run the City can expect to regain slightly more than half of forgone hotel occupancy tax revenues.

This study begins with an overview of recent changes in hotel occupancy tax rates and revenues. In the next section, an econometric model is used to estimate the direct fiscal impact of the 1994 City tax cuts, highlighting the extent to which the rate reduction boosted tax revenues through increased hotel occupancy and room rates. The secondary fiscal effects of additional economic activity stimulated by increased hotel stays are examined in the following section. The study concludes with a summary of IBO's major findings and discusses why the City's experience in cutting its tax on hotel occupancy cannot be generalized to cuts in other City taxes. (An appendix detailing the econometric model and its results is available on request.)

An Overview of the Data

The pattern of recent changes in hotel occupancy tax rates, City hotel revenues, hotel occupancy, and nightly room rates suggests that demand for hotel rooms-and tourism in general-began to rise well before the hotel tax reductions.

Hotel Occupancy Tax Rates

Hotel rooms located in New York City are subject to hotel occupancy taxes, which are levied in addition to the State and City's general sales taxes of 8.25 percent. Before July 1986, New York City taxed hotel rooms renting for $40 or more at a flat rate of $2 per night, with lower amounts for less expensive rooms.¹ In July 1986, the City added a variable component to its hotel occupancy tax; although the rate was initially 5 percent of room charges, it was increased to 6 percent in September 1990. (See Figure 1.) In June 1990, New York State imposed its own hotel occupancy tax of 5 percent on hotel rooms renting for $100 or more per night-a statewide tax that primarily affected New York City.

By September 1990, a New York City hotel room renting for $100 was subject to taxes totaling 21.25 percent-the highest rate in the country and over twice the average rate for major U.S. cities (de Seve, 1992). Moreover, taxes on hotels had increased precipitously, rising from 15.25 percent in May 1990 to 21.25 percent in September of the same year.

The difficulties associated with high hotel tax rates were compounded by laws requiring that the taxes be itemized on four separate lines of guests' hotel bills. This requirement made visitors and events organizers keenly aware of the many taxes being levied on their hotel stays, and it is likely that this fueled resentment among visitors. The most formal adverse response to the 1990 State and City tax increases came from meeting and convention planners, who soon began an unofficial boycott of New York City as a location for their events.

SOURCE:	Independent Budget Office
* The City’s hotel occupancy tax includes both a variable component and a flat tax of $2 per night on rooms costing over $40 per night.

Pressure to reduce hotel taxes led New York State to eliminate its 5 percent hotel occupancy tax in September 1994. Three months later, New York City reduced the variable component of its hotel occupancy tax by one percentage point, to 5 percent. Thus by December 1994, a New York City hotel room renting for $100 was subject to taxes totaling 15.25 percent-the rate prevailing in early 1990.

City Hotel Occupancy Tax Revenues

Total City hotel occupancy tax receipts are the sum of revenues from the variable and flat components of the tax. Revenues from the flat tax on room occupancy are the product of the tax rate (for example, $2 per night for rooms over $40) and the number of nights rooms are occupied. Revenues from the variable portion of the tax simply equal the variable tax rate times the nightly room rate times the number of nights rooms are occupied. A decline in the tax rate, all else being equal, would cause total hotel tax revenues from the variable portion to decline.

Despite the one percentage point decline in New York City's hotel occupancy tax rate in December 1994, total City hotel occupancy tax receipts have actually increased. Figure 2 (see next page) provides some initial insight into what happened. As shown in the figure's top panel, revenues from the City's hotel occupancy tax increased substantially in the two fiscal years following the tax cut, and another solid increase in tax receipts has occurred in fiscal year 1997.

As shown in the figure's lower panel, occupancy rates in New York City hotels have been rising strongly since the early part of fiscal year 1994, both before and after the cut in State and City taxes. In spite of a net decline in the number of New York City hotel rooms during calendar year 1993, the rise in the hotel occupancy rate can be viewed as an indicator of an increase in the number of room nights booked.² Although the increase in average room rates before the tax cut was more modest than the increase in hotel occupancy, room rates have also risen sharply in the last two years (City Project, 1997). Together these increases in hotel occupancy and room rates boosted City hotel occupancy tax receipts by more than enough to compensate for the loss of revenues directly attributable to the tax cut.

It is one thing to note that hotel tax receipts rose following cuts in hotel occupancy tax rates and quite another to infer that the tax cuts themselves caused receipts to rise. Both hotel occupancy and room rates in New York City began to increase well before the tax cut, indicating that demand for hotel rooms (and tourism in general) was already rising due to factors other than the tax rate. Moreover, visitors to the City tend to reserve their hotel rooms well in advance, suggesting that the full effect of any change in the tax rate is likely to be evident only after a considerable period of time. Only 17 percent of visitors booked their rooms within three months of their stay, while large conventions often book rooms several years ahead (de Seve, 1992, p. 6).

SOURCES:	NYC Comprehensive Annual Financial Report of the Comptroller, FY 1986-1996; PKF Consulting, Trends in the Hotel Industry, various issues.
* Receipts from both the variable and flat components of New York City’s hotel occupancy tax; does not include State hotel occupancy tax receipts or City and State general sales tax receipts. ** City and State hotel occupancy tax rates on rooms renting for $100 per night. *** Nominal average room rates. Changes in inflation-adjusted room rates follow a similar pattern.

How much of the rise in City tax revenues is attributable to the reduction in the City's hotel occupancy tax rates? A simple examination of the data is not sufficient to address this question. The following section employs more sophisticated empirical analysis to provide some answers.

Estimating the Fiscal Impact

In order to determine the extent to which recent increases in New York City's revenues from its hotel occupancy tax can be attributed to the December 1994 rate reduction, and whether the tax cut on balance has increased or decreased total City revenues from all sources, IBO has estimated the net fiscal impact of the reduction in the City's hotel occupancy tax rate. The first part of the analysis focuses on the rate cut's direct impact on tax revenues derived from hotel occupancy. The calculation of this direct fiscal impact is based on IBO's econometric estimates of how hotel occupancy and room prices are affected by changes in the tax rate.³ The second part uses a local economic multiplier to examine the indirect fiscal impact of increased economic activity generated by the tax cut's stimulation of hotel occupancy and accompanying visitor spending.

Direct Fiscal Impact

The reduction in the hotel occupancy tax rate has had several direct effects on the amount of tax revenue New York City collects. In and of itself, the rate reduction led to a decrease in hotel tax receipts. Yet because a cut in the tax rate reduces the price of hotel lodging facing buyers, it can be expected to stimulate visitors' demand for rooms, thus increasing hotel occupancy (the quantity of room nights filled by hotels) and perhaps the pre-tax price of hotel rooms per night. Increases in hotel occupancy and room rates in turn cause hotels' taxable receipts to rise. To the extent that taxable receipts increase, City revenues from both the hotel occupancy tax and the general sales tax rise, directly offsetting at least in part the revenue loss from the rate reduction.⁴

Effective December 1, 1994, New York City lowered the hotel occupancy tax rate from 6 to 5 percent of visitors' hotel bills (nightly room rate multiplied by number of nights stayed), a one-sixth or 16.7 percent reduction in the tax rate. Neither the flat portion of the hotel occupancy tax, which since September 1980 has been $2 per night for rooms renting for $40 and over, nor the general sales tax rate applicable to hotel rooms was affected. As noted earlier, the City's rate reduction came on the heels of the State's September 1994 elimination of its five percent hotel occupancy tax on rooms renting for $100 or more per night.

In fiscal year 1994, the last complete fiscal year prior to the City and State hotel occupancy tax cuts, the City's hotel occupancy tax receipts (excluding audits) totaled $126.1 million. An estimated $30 million of this revenue was derived from the flat component of the hotel occupancy tax, with the remaining $96.1 million attributable to the tax's variable component.⁵ All else being equal, the one-sixth reduction in the variable portion of the hotel occupancy tax rate led to a direct revenue loss of New York City hotel occupancy tax receipts of $16.0 million per year.⁶

This econometric analysis aims to determine the degree to which the City's 1994 tax rate reduction stimulated hotel occupancy and room rates, thereby boosting tax revenues so as to offset the direct revenue loss due to the rate reduction. Revenues from both the flat ($2 per night) and variable (room charges times tax rate) component of the City's hotel occupancy tax would be increased by a rise in the number of room nights filled in New York City hotels, as would the City's receipts of the general sales tax. The total added hotel and general sales tax revenue due to an increase in hotel occupancy caused by the City's 1994 rate reduction may be termed the occupancy effect.

Any increase in nightly room rates caused by the 1994 rate reduction would affect only the variable component of the hotel tax plus, again, the general sales tax. The total of this revenue increase may be termed the room rate effect.

The combination at the end of 1994 of the State's elimination of its hotel occupancy tax and the City's reduction of its tax rate greatly lowered the aggregate tax rate-the sum of City and State hotel occupancy and general sales taxes-on hotel rooms. Thus it is highly plausible that the tax cuts played a significant role in bringing about the recent increases in hotel occupancy and room rates. But, as noted above, these increases began prior to either the State or City tax cut in 1994, indicating the likelihood that other factors also played an important role in stimulating hotel visits and the City's resulting tax collections.

The time-series model. In order to isolate the effects of tax cuts from the effects of other factors, IBO has developed and estimated an econometric, time-series model in which hotel occupancy rates and inflation-adjusted hotel room rates-the model's dependent variables-are each a function of present and past values of the aggregate tax rate and other factors affecting tourism and the hotel industry. In the model, the dependent variables also are affected by past values of each other. Assuming no changes in other variables, a decrease in the aggregate tax rate is expected to cause increases in hotel occupancy and pre-tax room rates.

Similarly, increases in both domestic and overseas economic growth are expected to stimulate tourism and increase hotel occupancy and room rates. As a measure of domestic demand, the model includes a time series of employment growth in the northeastern United States outside of New York City.⁷ The Northeast is defined as the twelve states of New England and the Mid-Atlantic regions along with the District of Columbia. The focus on the Northeast stems from a Port Authority survey which found that nearly 75 percent of domestic visitors come from within a 250-miles radius of New York City (Port Authority, 1994, p. 33).⁸

To capture the influence of foreign demand, the model includes a weighted index of gross domestic product for eight countries-Canada, France, Germany, Italy, Japan, Spain, Switzerland, and the United Kingdom. Together these countries accounted for over 70 percent of foreign visitors to the New York region in 1992 (Port Authority, 1994, p. 11).⁹

The pronounced decline in the incidence of serious crimes committed in New York City in recent years, both in terms of the absolute number of crimes and in relation to the national crime rate, has been linked to the City's attractiveness for tourists. Indeed, surveys of travelers indicate that personal safety and freedom from crime are rated among the most important factors influencing destination choice (Port Authority, 1994, pp. 38-50). A measure of serious crimes committed in New York City is included in the model; decreases in the City's per capita crime rate are expected to improve the public's perception of personal safety, thereby boosting tourism and hotel occupancy.

The cost of doing business is likely to affect the nightly room rates offered by hotels, with increased costs leading to higher real room rates and lower hotel occupancy, all other factors being equal. As a proxy for a more comprehensive measure of the costs facing hotel operators, the model includes a time series of inflation-adjusted payroll expenses per employee of New York City hotels.

Data on the average price of hotel rooms in New York City was adjusted for inflation using the regional consumer price index. The data was adjusted for inflation because real rather than nominal prices influence consumer demand, and because the analysis is interested in the degree to which increases in room prices are a function of underlying structural variables (such as the tax rate) as opposed to general inflation in the local economy. The time series on real room rates was then adjusted for seasonal variation.

Finally, New York City's seasonally adjusted hotel occupancy rate was used as a proxy for the other dependent variable, the quantity of room nights filled. Changes in the hotel occupancy rate are proportional to changes in the quantity of room nights filled for any given number of hotel rooms available, and this analysis assumes that-in the short run-the number of available rooms is not likely to vary appreciably.¹⁰

Monthly data, available for the January 1979 to September 1996 period, was used to estimate the responsiveness of hotel occupancy and real room rates to the various explanatory variables, including the aggregate tax rate measure (the sum of City and State hotel occupancy and general sales taxes levied on hotel rooms). The influence of the explanatory variables is likely to be felt over a long period of time, and up to two years' worth of past values of the variables were included in the estimating equations. Including a large number of past values is also warranted because of how far in advance a large number of hotel rooms are booked, especially by foreign visitors and those attending trade shows and conventions. Because it is likely to take time for public perceptions of crime in New York to change in response to the release of the official crime data (which is itself delayed), the crime rate variable was lagged for an additional two years, so that hotel occupancy in the model is influenced by the crime rate two to four years in the past and not by the contemporaneous value.

The goal of this analysis is to determine the greatest possible impact of the hotel tax cuts on City revenues. Because of this objective, choices in the specification and estimation of the model were made that maximized the estimate of the tax rate coefficient-the measure of the tax rate's influence on hotel occupancy and room rates-in situations where no objective, technical criterion dictated a specific choice.¹¹

Results of the model. Estimation of the model of hotel occupancy and real room rates generated strong results; about 90 percent of the variation in room rates and 66 percent of the variation in hotel occupancy rates over time were explained by changes in the independent (or explanatory) variables. More importantly, the estimated values of the coefficients-the numbers that measure the influence of the explanatory variables on the dependent variables-generally had the expected (positive or negative) signs and were statistically significant.¹² As expected, the results indicate that contemporaneous and past values of the aggregate tax rate have a negative influence on both hotel occupancy and real room rates, while indicators of domestic and foreign economic growth have a positive influence. Increases in the crime rate measure are shown to reduce hotel occupancy as predicted, and decreases in real per employee payroll costs-the measure of hotel owners' costs of doing business-are shown to increase occupancy.

The results of the estimation also indicate that the relationship between room rates and hotel occupancy differs between the short run and the long run. It is interesting to note that while hotel room rates are negatively correlated with current occupancy rates (higher room rates are associated with lower hotel occupancy), prior values of the occupancy rate in total have a strong positive influence on real room rates. This relationship is not surprising considering how far in advance a large share of hotel rooms are booked. Because hotel operators are able to use computerized reservations systems to track occupancy and alter their offering prices on the basis of changing demand conditions, high occupancy rates combined with information on the number of rooms already booked may signal hotel managers to adjust room rents upward.

For the purposes of calculating the degree to which the direct revenue loss is offset by hotel occupancy and nightly room rate effects, we are interested in the responsiveness of hotel occupancy and room rates to changes in the aggregate tax rate as indicated by the estimated coefficients on that explanatory variable. The results of the estimated model indicate that a 1 percent decline in the aggregate tax rate generates: 1) a 0.34 percent increase in the hotel occupancy rate; and 2) a 0.18 percent increase in real room rates, though the room rate increase is offset in part by the interaction of hotel occupancy and room rates.

Economists would formally term these degrees of hotel occupancy and room rate responsiveness as "inelastic," since a one percent change in the explanatory variable (in this example the aggregate tax rate) leads to a less than one percent change in either of the two dependent variables. Yet the effect on City tax revenue is substantial because the near concurrent State and City hotel occupancy tax cuts in 1994 decreased the aggregate tax rate by over 20 percent.

Less than one-fourth (22.7 percent) of the revenues generated by the combined 1994 hotel occupancy tax cuts, as estimated by the econometric model, can be attributed specifically to the decline in the City's hotel occupancy tax rate. Recall that the City's hotel occupancy tax was reduced by one percentage point, from 6 to 5 percent, while the State eliminated its 5 percent tax on rooms renting for $100 or more per night. While only half of all hotel rooms were subject to the State's 5 percent hotel occupancy tax, these rooms accounted for 68.3 percent of hotel room revenue (de Seve, 1992, p. 16). This information was used to derive the share of revenue offsets attributed to the City tax cut.

Figure 3 summarizes the direct rate reduction, hotel occupancy, and room rate effects on City tax revenues as calculated from the estimated coefficients and the magnitude of the 1994 changes in the aggregate tax rate attributable to the City's rate reduction. The revenues reported in the table are annual figures, stated in terms of fiscal year 1994 hotel occupancy tax revenues. Because the model incorporates up to two years of past values of the aggregate tax rate, the reported figures represent the cumulative effect of rate reduction after two years.

While the rate reduction directly reduces City hotel occupancy tax revenues, a portion of the revenue loss is offset by increases in hotel occupancy and general sales tax revenues due to the occupancy and room rate effects.

The reduction in the City's hotel occupancy tax led to a 1.47 percent increase in hotel occupancy, which in turn generated $1.9 million in City hotel occupancy tax revenue and $1.1 million in City general sales tax revenue. It should be noted that the 1994 rate reduction did not reduce the portion of hotel occupancy tax receipts derived from the flat component of the tax. But the occupancy effect of the rate reduction did increase the number of taxable room nights, thereby boosting hotel occupancy tax revenue.

SOURCE:	Independent Budget Office
NOTES:	Annual revenues are stated in fiscal year 1994 terms. Negative signs denote a reduction in revenues.

On the basis of the econometric estimates, we calculate that pre-tax real room rates increased by 0.10 percent in response to the reduction in the City's hotel occupancy tax, once the interaction between occupancy and room rates is taken into account.¹³ Only the variable component of the hotel occupancy tax is affected by increases in real room rates, and the resulting room rate effect is to generate $0.1 million in additional City hotel occupancy tax revenue and $0.1 million in City general sales tax revenue.

Annual direct revenue offsets attributable to the City's hotel occupancy tax cut total $3.2 million, 20 percent of the direct revenue loss due to the tax rate cut itself. Almost two-thirds of these offsets comes from increases in the City's hotel occupancy while the balance comes from increases in its general sales tax.¹⁴

The results indicate that the tax rate is just one of several important determinants of hotel occupancy. Past values of the New York City crime rate in particular have an especially strong influence on hotel occupancy, with the reduction of crime in the two years prior to the 1994 tax cut causing a 6.4 percentage point increase in the occupancy rate, holding other factors constant.

How do these results compare with those of other studies? Existing research on hotel occupancy taxes, most of it focused on Hawaiian tourism, is scant and lacks consensus as to whether hotel rental receipts-the tax base for hotel occupancy taxes-are significantly affected by the tax rate.¹⁵ The sensitivity of hotel receipts to the tax rate indicated by IBO's analysis is substantially greater than those found in other studies, reflecting in part the selection among equally plausible regression results of the model in which the tax rate variable has the greatest impact. This emphasizes the need to interpret the numbers reported here as the upper limit of a plausible estimate of direct revenue offsets of the 1994 City rate reduction.

In sum, reductions in the hotel occupancy tax rates spurred increases in hotel occupancy and (to a lesser extent) room rates, which in turn directly boosted revenue from two different taxes: the hotel occupancy tax itself and the general sales tax. Thus, the structure of the taxation of New York City hotels strengthened the direct fiscal impact of the hotel tax cut.¹⁶ These direct fiscal benefits of the City's tax cut offset roughly one-fifth of the $16.0 million annual direct cost to the City of the one percentage point reduction in its hotel occupancy tax rate.

Although the tax cut did not pay for itself in terms of direct revenue offsets, it is also important to consider the indirect economic and fiscal benefits attributable to the increases in hotel occupancy generated by the cut in hotel taxes. As discussed in the following section, these indirect impacts are quite substantial.

Indirect Fiscal Benefits

To the extent that NYC hotel revenues and tourist spending are increased by rising occupancy and nightly room rates due to the 1994 tax cut, there will be positive indirect (or secondary) impacts on the local economy as a whole and, by extension, on New York City tax revenues. Additional tax receipts from two types of secondary impacts offset the initial loss of revenues due to the tax cut. The first derives from the non-hotel spending of tourists and the second from the additional purchases made by hotels and other City businesses serving tourists, and by these firms' employees.

As before, IBO has adopted a research methodology that maximizes our estimates of the indirect impacts of New York City's cut in hotel occupancy taxes on the City's economy and tax revenues. There are two major reasons why the following indirect offsets should be interpreted as high-end estimates. First, these estimates of indirect revenue offsets are based on IBO's estimates of the direct impact of the tax cut on hotel occupancy and room rates. To the extent IBO's estimate of the direct revenue offsets is overstated, the estimate of the indirect offsets will also be exaggerated.

Second, the analysis implicitly assumes that reductions in hotel occupancy taxes would not affect New York City government outlays, which themselves boost local economic activity and tax revenues. This assumption is reasonable for 1998-when the impact of the tax cut would be mitigated by the budget surplus rolled over from 1997-though in later years the tax cut would exacerbate projected City budget deficits, thereby leading to the possibility of additional gap-closing spending reductions. Declines in government spending would negatively affect income and employment, thereby counteracting some part of the economic stimulus associated with the reduction in hotel occupancy taxes.

Non-hotel spending of tourists. The econometric estimates reported above imply that after two years, revenues of City hotels increase by $30.2 million annually in response to just the City's share of the reduction in hotel occupancy taxes. Assuming that visitors who stay overnight in City hotels do not reside in the City, the increase in spending on hotel rooms is accompanied by increases in spending in other areas of the City's economy. Using information on 1995 visitor spending reported by the New York Convention and Visitors Bureau (NYCVB, 1996), IBO finds that hotel bills account for 36.2 percent of hotel guests' total spending in the City. By extension, the increase in hotel stays attributable to the City's hotel occupancy tax cut generates an additional $53.2 million in non-hotel spending each year.

These increases in tourist spending soon translate into significant additional City revenues from sales, personal income, and business income taxes. In contrast, the full impact of increases in economic activity on the City's collections of real property taxes does not occur for many years (IBO, 1997a). In order to simplify the exposition, however, IBO assumes that increases in economic activity immediately boost all revenue sources-including the City's real property tax. The NYCVB estimates that each dollar of tourist spending in New York City ultimately yields 5.4 cents in City tax revenues (1996). Thus, IBO expects increased non-hotel spending by the increase in overnight visitors attributable to the 1994 City tax cut to generate as much as $2.9 million of additional City tax revenues each year.¹⁷

The Multiplier Effect. Whether in hotels or other businesses, the spending of overnight visitors to New York City induces additional spending on locally produced goods and services. Businesses that receive tourist dollars spend a portion of their revenue on locally produced inputs. Similarly, their employees spend a portion of their earnings on local goods and services. This induced spending is less than the initial infusion of tourist dollars, since businesses and their employees spend some of their money on products made outside of the City. This spending in turn generates new but smaller rounds of spending in the City economy. The sum of all the rounds of additional spending induced by an initial infusion of dollars into the City's economy is termed the multiplier effect.

The New York Convention and Visitors Bureau reports that the sales multiplier for New York City tourism is 1.48, meaning that every $100 spent by tourists generates an additional $48 in additional or secondary spending in the local economy.¹⁸ Using this multiplier, the $83.4 million increase in visitor spending resulting from the City's hotel tax cut ($30.2 million on hotels and $53.2 million on other tourism-related purchases) is expected to generate an additional $40.0 million in spending and output in the City. Applying the NYCVB ratio of tax revenue per dollar of spending, this additional spending in turn generates a $2.2 million increase in City tax revenue.

Both indirect sources of tax revenues attributable to increased hotel occupancy are reported in Figure 4. When the impact of increases in economic activity on the City's tax collections is fully phased in, IBO projects that indirect effects of non-hotel spending and the multiplier could offset as much as 31 percent of the direct cost of the City's 1994 hotel occupancy tax cut-$5.0 million of secondary revenues offsetting the $16.0 million direct revenue loss.¹⁹

SOURCE:	Independent Budget Office
NOTES:	Annual revenues are stated in fiscal year 1994 terms. Negative signs denote a reduction in revenues.

The total indirect fiscal impact of the hotel tax cut is substantial-even larger than the direct impacts-due to the export nature of the hotel and tourism industries. The dollars injected into the local economy by overnight hotel guests would not otherwise be present, and thus any increases in hotel occupancy attributable to the tax cut (or any other source) has a substantial impact on the City's tax revenues.²⁰

Although the dollar value of these secondary impacts is expected to increase over time due to general economic growth and increases in prices, the direct cost of the reduction in the City's hotel occupancy tax-the forgone revenue attributable to the tax rate reduction-is also expected to rise. In the long run, IBO projects that secondary revenue increases will offset a smaller share of the direct costs of the hotel occupancy tax cut because City revenues as a share of GDP are projected to decline.²¹

Conclusion

To determine the degree to which the positive fiscal impacts compensate for the annual revenue loss due to the tax cut, the direct and indirect revenue offsets are added together (Figure 5). The analysis indicates that once the impact of increases in economic activity on the City's tax collections is fully phased in, as much as 51 percent of the annual revenue loss resulting from the 1994 reduction in the City's hotel occupancy tax rate could be offset by direct and indirect revenue increases attributable to the City's tax cut.²² Given IBO's methodology-one that maximizes the impact of the City tax cut in stimulating hotel occupancy, tourist spending, and general economic activity-these figures should be interpreted as a high-end estimate of the extent to which the City's tax cut will ultimately pay for itself.

SOURCE:	Independent Budget Office
NOTES:	Annual revenues are stated in fiscal year 1994 terms. Negative signs denote a reduction in revenues.

However they are interpreted, the revenue offsets reported here are quite substantial. The size of the effect is due in part to the nature of tourism and overnight hotel stays. Tourism is an export industry, and any increase in hotel stays due to a tax cut (or any other factor) brings dollars into the City's economy that otherwise would not have been locally spent. Furthermore, overnight hotel stays are complemented by spending in other areas of the City's economy, which amplifies indirect economic activity and revenue offsets. The structure of taxes the City levies on hotel bills also plays a role in boosting the revenue offsets. Because hotel occupancy is taxed under the City's hotel occupancy tax and its general sales tax, any increase in hotel stays due to a cut in one tax will generate receipts from both.

In short, the major factors behind these revenue effects are specific to the tourism industry and to the unique structure of the City's hotel taxes. As a result, New York City's experience in cutting its hotel occupancy tax cannot be generalized to cuts in other City taxes.²³ It would therefore be particularly misleading to presume that all tax cuts would be as effective as the City's 1994 hotel occupancy tax cut in stimulating economic activity and revenue growth to offset their direct revenue losses.

Finally, the econometric analysis behind IBO's estimate indicates that factors other than the tax rate also play an important role in stimulating hotel occupancy, room rates, and tax revenues. In recent years City hotels and other tourist-related businesses have benefited from the Northeast's expanding regional economy and increased consumer confidence. Foreign economic growth, another important factor, also has been favorable to tourism. Finally, declines in the City's crime rate has made the City an increasingly attractive place for visitors.

One factor affecting City tax revenues that cannot be quantified and tested empirically is the City's reputation as a place for doing business-its business climate. The local business climate has undoubtedly benefited from the continued reduction in crime. Moreover, New York City's well-publicized hotel occupancy tax cut is also likely to help improve the City's business climate, thus spurring additional economic activity and increases in tax revenues in the long run.

References

Bonham, Carl, Edwin Fujii, Eric Im, and James Mak. 1992. "The Impact of the Hotel Room Tax: An Interrupted Time Series Approach." National Tax Journal. Vol. XLV, No. 4 (December), pp. 433-41.

Bram, Jason. 1995. "Tourism and New York City's Economy." Current Issues in Economics and Finance. Vol. 1, No. 7 (October).

City Project. 1997. "Tax Cuts Swell, Job Growth Shrinks: The Mayor's Financial Plan for FYs 1997-2001." February 24.

de Seve, Charles W. 1994. "Update on the Destructive Impact of New York State's Hotel Occupancy Tax." Washington, D.C.: American Economics Group. February.

de Seve, Charles W. 1992. "The Destructive Impact of New York State's Hotel Occupancy Tax and Travel Promotion Cutbacks." Washington, D.C.: American Economics Group. December.

Im, Eric Iksoon and Marcia Sakai. 1996. "A Note on the Effects of Changes in Ad Valorem Tax Rates on Net Revenue of Firms: An Application to the Hotel Room Tax." Public Finance Quarterly. Vol. 24, No. 3 (July), pp. 397-402.

InterBank Brenner. 1996. "1995 Annual New York City Hotel Survey."

New York City Independent Budget Office. 1997a. "New York City's Fiscal Outlook." February.

New York City Independent Budget Office. 1997b. "The Economic and Fiscal Impact of the Clothing Sales Tax Exemption." June.

New York City Independent Budget Office. 1997c. "Issues in estimating the elasticities of demand and supply." Work in progress. July.

New York City Police Department. "Complaints and Arrests." Various issues.

New York Convention and Visitors Bureau. 1995. "International Travel to New York City, 1993."

New York Convention and Visitors Bureau. 1996. "Tourism's Economic Impact on New York City, 1995."

New York State Department of Labor, Research and Statistics Division. Unpublished data on total payroll and employment in the New York City hotel industry.

Organization for Economic Co-operation and Development. Main Economic Indicators. Various issues.

PKF Consulting. Trends in the Hotel Industry. Various issues.

Port Authority of New York and New Jersey. 1994. "Destination New York-New Jersey: Tourism and Travel to the Metropolitan Region." December.

U.S. Department of Commerce, Economics and Statistics Administration, Bureau of Economic Analysis. 1997. "Regional Industry Multipliers: A User Handbook for the Regional Input-Output Modeling System (RIMS II)." Third Edition. Washington, D.C. March.

U.S. Department of Justice, Federal Bureau of Investigation. "Crime in the United States." Uniform Crime Reports. Washington, D.C. Various issues.

U.S. Department of Labor, Bureau of Labor Statistics. Consumer price index and regional employment data obtained from Internet site.

Footnotes