National Policy Interests in the Duty Free Market


In 1999 the EU abolished duty-free on intra-EU travel. Other European countries and many countries outside Europe still retain duty-free shopping for international travellers, as does the EU in relation to external travel. This paper looks at national policy interests in the retention, or further abolition, of duty-free. We note that these will relate closely to the structure of competition in the duty-free market, and to the tax levels on high-street sales in different countries. The existence of duty-free trade requires that countries have reasons both to admit duty-free goods and to permit their sale to departing passengers. We argue that low-tax countries might be more likely to perceive gains from unilateral abolition of duty-free sales to departing passengers, while high-tax countries would only benefit from concerted action to abolish duty-free.     See below for more details of key conclusions.

Reference:  Vidar Christiansen and Stephen Smith (2004) "National Policy Interests in the Duty Free Market", CESifo Economic Studies, vol 50, 2/2004, 351-375. ISSN 1610-241X

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Other papers on the economics of duty-free shopping

Vidar Christiansen and Stephen Smith (2001) "The Economics of Duty-Free Shopping" CESifo Working Paper No 595, ISSN 1617-9595, October 2001. Munich: CESifo.

Vidar Christiansen and Stephen Smith (2008) "Optimal Commodity Taxation with Duty-Free Shopping", International Tax and Public Finance, 15(3), pp 274-296. ISSN 0927-5940. DOI: 10.1007/s10797-007-9034-z.

Key conclusions: National Policy Interests in the Duty Free Market

The ending of duty-free on intra-EU travel in 1999 focussed attention on this distinctive fiscal phenomenon, and prompts the question whether further abolition might be desirable. Globally, duty-free involves clear deadweight losses (as discussed in Christiansen and Smith 2001). For individual countries, however, the case for abolishing duty-free, either unilaterally or in a co-ordinated action by a group of countries (without side payments), is less clear cut. In this paper we identify the factors determining the pattern of country interests in duty-free, and the nature of the gains and losses to countries that would arise from extending the abolition of duty-free beyond intra-EU travel.

An important recognition is that national policy interests in duty-free are closely bound up with the international pattern of duty rates, and with price-setting behaviour in the duty-free market. In particular, we suggest that there are important differences between the interests of high-tax and low-tax countries. For a high-tax country the primary competition in the market for duty-free goods comes from the shops of the foreign high street. Prices in the lower-tax high street govern the prices at which duty-free goods must be sold, and the goods sold duty-free by the high-tax country would otherwise be purchased abroad. For low-tax countries, on the other hand duty-free sales will mainly be at the expense of sales made in their own high street. We have argued that, even though duty-free may involve additional resource costs and inefficiencies, it may nonetheless provide a mechanism by which high-tax countries can earn rents from foreign citizens, in the form of super-normal profits or fiscal revenues.

The opportunity for appropriating a rent from foreigners raises issues of price-setting, and of rent appropriation. Rents will generally be maximised by restricting competition in the duty-free market to avoid prices being driven down to cost. A monopoly duty-free shop will maximise the rent that can be earned at the expense of foreign residents. The rent will accrue to the duty-free retailer as profit, unless the government takes action to appropriate (at least a share of) the rent, for example by auctioning off the duty-free franchise. From this perspective, duty-free may be seen as a way of offering goods to foreign residents at what is, in effect, a low, rather than zero, tax rate.

From the perspective of an individual country, co-ordinated (mutual) abolition of duty-free will be more attractive the smaller the loss of revenue or rents from tax exporting and the larger the gains from reducing the resource transfer to foreign countries. Since from a global perspective there is a deadweight loss from duty-free, a clear-cut result is that, if countries are sufficiently similar, they will individually gain from mutual abolition. However, if tax rates are very dissimilar, mutual abolition is unlikely to happen. Low-tax countries may benefit from collective abolition, because they can continue tax exporting through taxed high-street sales, but the high-tax country has no such opportunity, and needs the duty-free trade in order to extract rents from sales to foreigners. Not only would high-tax countries lose by abolishing duty-free unilaterally, but, in the absence of appropriate side payments it may not be in their interests to support coordinated abolition either. In contrast to the popular perception that the duty-free trade is particularly damaging to high-tax countries, we suggest that it is these countries that would have the most to lose from its abolition.