31/10/2011 18:54 GMT | Updated 31/12/2011 05:12 GMT

The Tax Loophole That's Costing the Treasury and Impeding Economic Growth

Taking a lead from the EU is not in vogue. Ask the 81 Tory MPs who voted for a referendum on UK's future in the EU, or the Prime Minister who has been locked in discussions with his European counterparts over the planned 'haircut' in Greek bonds. It's fair to say that the social-democratic model of governance - of high tax and spend on the continent - has come under intense scrutiny since 2008. It has invariably been found wanting as Governments from all parts of the political spectrum reign in public spending to maintain credit ratings, to keep borrowing costs on the bond markets down.

But the Europeans have by no means got everything wrong. It would be tempting - as the UK embarks on a rapid retrenchment of public spending - to imagine that it is the profligate Club Med countries who should be taking a lead from us in all matters of fiscal discipline. While on the macro arguments of the day that may be true, there are one or two isolated (but significant) areas where European nations - almost unilaterally - have adopted taxation policies which stand firmly at odds with their high tax heritage. The consequence of which has been to stimulate growth and investment in those countries. One such area is tax on aviation.

Britain has the highest air ticket tax - known as Air Passenger Duty (APD) - of any country in the world. As an island nation, you can see why successive policy-makers have raised APD since its introduction in 1994. Most Brits have little choice but to pay the departure tax - and it's been a boon to the Treasury. This year it will rake-in an anticipated £2.9 bn.

European countries on the Continent however - willingly or not - have been forced by the laws of free-market economics to keep aviation taxes down, or in the vast majority of countries not levy them at all. European holiday-makers and business people in the Schengen Area have long known they can skip across a border to a neighbouring country to take a flight, instead of paying high air taxes in their home country. The consequence is that just six (including the UK) EU countries levy flight taxes. The Netherlands recognised the economic damage it was doing in 2009 and scrapped theirs.

I accept that the UK is different. The Treasury have, until recently, been able to tax outbound flights knowing full well that holiday-makers would put up and shut up. But that is changing. The economic downturn combined with the emergence of online comparison sites has helped precipitate a new phenomenon - of people flying long-haul (they pay the highest aviation taxes) hopping across from the UK to Paris Charles de Gaulle or Schipol to catch connections for long-haul flights. Indeed, for those living in the north of England, for example, it may be just as convenient (let alone cheaper) to fly to Schipol as it is getting to Heathrow or Gatwick. It means a family of four flying to the USA save around £200 - not an insignificant sum on an annual getaway.

That's not all. The effect of our high APD, combined with the high cost of obtaining visas for non-EU citizens is having another dramatic impact: we're missing out on the burgeoning Chinese tourist market. Last year 3m Chinese tourists came to Europe. Just 127,000 of them visited the UK. The reason? A family of four will pay £600 more than most other EU countries to visit the UK. Many Chinese tourists travel in package tours with stop-offs at a number of European destinations, so Chinese tour operators are now cutting out the UK to reduce costs for their travellers. We're losing out on a huge growth market at a time when the British economy would benefit immeasurably from the inbound investment tourism brings. It is for this reason that the World Economic Forum's 2011 study on international competitiveness ranked Britain 134th out of 138 countries in terms of taxation on tourists.

As the Chancellor weighs up his plans for the Autumn Statement on 29 November, we all recognise the priority the Government is giving to reducing the public debt and it would be unrealistic for the travel industry to be seeking a cut in APD at the current time [except to offset ETS which is what aviation wants and HMT have hinted at]. Similarly, it is also right that aviation should be covering its environmental costs - something that APD, by most estimates, serves to do by a factor of two. But three out of four foreign tourists come to the UK by air and total numbers of visits to Britain have fallen by two million in the last five years. The APD tax yield - forecast at around £15 billion over the next five years - is now so high that it exceeds the tax take from the Bank Levy.

If the tourism industry - the UK's third largest export earner - is to play its part in rebalancing the British economy, the Chancellor would do well to look to the example of our near European neighbours. When it comes to APD at least you have to look to the Continent to find policies that encourage growth and attract inward investment.