No Room at the Inn? Prospects for the Lodging Tax.

• Author: Marlowe, Justin
• Position: PERSPECTIVE

Earlier this year a version of the headline, "Hotel vacancies are up, and so are hotel room rates" appeared in newspapers around the world. This seems to defy the basic laws of economics. If demand for hotel rooms is down, we would expect room rates to decrease. This trend, although quirky, could have a major impact on state and local finance.

There are two explanations for the rising rates-failing occupancy phenomenon. One is that hotel operators are willing to take losses today to keep their workers for tomorrow. As the Great Resignation grinds on, retaining workers is paramount even though the travel economy has not returned to pre-pandemic levels. That creates an odd dynamic where higher wages for workers are passed on to customers through higher room rates, even as lots of rooms sit vacant. Most travel industry experts see this as a short-term labor market disruption rather than a permanent shift.

A different and more durable explanation is that COVID sorted the travel economy into its elastic and inelastic components. Zoom is a permanent substitute for many in-person business meetings. That does not bode well for convention centers and downtown hotels in cities like Indianapolis, Indiana, Dallas, Texas, Kansas City, Missouri, and other traditional business travel destinations. On the other hand, this past spring proved that some people vacation, no matter what. They'll put up with packed airplanes, crowded beaches, and the risk of COVID just to get away. This should be no surprise, as the line between work and home is now erased for many workers. That strong demand met a constrained supply of rooms. Tourist hot spots like Honolulu, Hawaii, Palm Springs, California, and Orlando, Florida, saw record high room rates in late 2021 and early 2022 as a result.

All this suggests a new normal of weak demand for business travel but strong and consistent demand for leisure travel. To understand what that new normal means for state and local finance, it's useful to focus on state and local "lodging taxes."

Most jurisdictions collect an ad valorem tax on overnight stays in hotels, motels, and bed and breakfasts. Many also apply that tax to short-term rentals like AirBnB and VRBO. Some apply that tax through a special hotel tax or room tax. Some include lodging in their general sales tax. Some do both. A few states and localities also impose an excise tax collected per room or per night. These incremental taxes add up. In fact, a recent analysis by...