Quality standards versus taxation in a dynamic environmental model of a tourism economy

The paper constructs a dynamic general equilibrium model for a small economy that specializes in tourism to explore the long term effects of environmental and tourism policies. The model assumes that tourists obtain satisfaction from private services provided by tourism firms, goods and services provided by the public sector and environmental quality. Satisfaction from private services depends on the quality of those services, which is represented by the amount of capital per unit of accommodation. It is also assumed that goods and services provided by the government suffer from congestion. Environmental quality, which is also valued by the residents, is modelled as a renewable resource that is depleted by tourism activity. Tourism firms are price takers in the international tourism market, in the sense that the amount of tourism services provided by the economy has no direct impact on international prices. The price, however, depends positively on the quality of the supplied tourism bundle and therefore tourism firms in the destination can charge higher or lower prices depending on the quality of private tourism services, congestion of public goods and environmental quality. In this setting, the long term effects of two alternative policy instruments are compared, namely an overnight stay tax and a quality standard that is imposed on tourism firms. Both instruments can be used as accommodation quality and environmental quality policy tools. However, their welfare consequences are different as they have different effects on the incentives to accumulate capital. Specifically, the overnight stay tax acts as an implicit tax on capital, reducing the incentives for investment and capital accumulation. From a long term perspective, the quality standard is always superior to the overnight stay tax, provided that the former does not cause any dynamic inefficiency.