Norwegian School of Economics Bergen, Spring 2020 The Air Passenger Tax An empirical analysis of the effect of the Air Passengers Tax on air- traffic volumes for domestic routes in Norway Fabian Blandkjenn and Christoffer Wilhelmsen Supervisor: Øivind Anti Nilsen MSc in Economics and Business Administration, Finance and Economics NORWEGIAN SCHOOL OF ECONOMICS This thesis was written as a part of the Master of Science in Economics and Business Administration at NHH. Please note that neither the institution nor the examiners are responsible − through the approval of this thesis − for the theories and methods used, or results and conclusions drawn in this work. 2 Acknowledgement Firstly, we would like to thank our supervisor Professor Øivind Anti Nilsen for giving us guidance and valuable feedback. Special thanks should also be given to Torolf Holte at Avinor for giving us access to flight data and support from the beginning. Without this data material, the analyses would not have been possible. Lastly, we would also thank friends and family for supporting us throughout the process of writing this master’s thesis. Fabian Blandkjenn and Christoffer Wilhelmsen 3 Abstract This master’s thesis seeks to analyse the effect of the Air Passenger Tax, introduced by the Norwegian government in 2016 on all flights departing a Norwegian airport. The future of the Air Passenger Tax is of current political interest with potential change of the tax toward a greener agenda as a frequently discussed topic. This thesis employs panel data techniques where we have designed econometric models that are based on a dataset where we follow the development of the number of daily passengers on a route with a specific airline. The models estimate the effect of the Air Passenger Tax on the air-traffic volume in terms of number of daily passengers in the 2012 to 2019 period. To isolate the effect of the tax, we have included variables that we assume explain the variation in demand for flights. The results of the study show the effect of APT to be insignificant when evaluating the air- traffic volumes. Furthermore, when considered individually, Norwegian is shown to be the only airline with a change in passenger volume that is significantly different from zero at positive 6.87 %. This is surprising as similar studies conducted in other European countries have shown significant reductions in passenger volume following the introduction of similar taxes. This thesis explores possible explanations based on the high level of domestic competition and the heavy reliance on flying as a means of domestic transport as found in past research on adjacent topics. 4 Contents 1 Introduction ........................................................................................................................... 7 1.1 Background and motivation ............................................................................................ 7 1.2 Research question ........................................................................................................... 7 1.3 Delimitation .................................................................................................................... 8 1.3.1 Domestic air-travel ................................................................................................... 8 1.3.2 Non-PSO routes ....................................................................................................... 9 2 Institutional Background ..................................................................................................... 10 2.1 Historical development in the Norwegian Airline industry .......................................... 11 2.2 PSO routes .................................................................................................................... 15 2.3 The major participants .................................................................................................. 15 2.3.1 Avinor .................................................................................................................... 15 2.3.2 SAS – Scandinavian Airlines Systems ................................................................... 16 2.3.3 Widerøe .................................................................................................................. 17 2.3.4 Norwegian .............................................................................................................. 17 2.4 Competition and market share ...................................................................................... 18 2.5 Profitability in the airline industry ................................................................................ 20 3 The Air Passenger Tax (APT) ............................................................................................. 22 3.1 The purpose of the tax .................................................................................................. 23 3.2 Passthrough rate ............................................................................................................ 23 3.3 Other fees and taxes within the Norwegian air industry............................................... 24 4 Theoretical framework ........................................................................................................ 25 4.1 Effect of taxation on market equilibrium ...................................................................... 25 4.2 Elasticity and market competition ................................................................................ 27 4.3 Deadweight loss ............................................................................................................ 29 5 Literature Review ................................................................................................................ 30 5.1 Demand for air travel .................................................................................................... 30 5 5.2 Price elasticity of demand ............................................................................................. 31 5.3 APT in other countries .................................................................................................. 32 5.4.1 Netherlands ............................................................................................................ 33 5.4.2 Ireland .................................................................................................................... 34 6. Data and methodology ........................................................................................................ 36 6.1 Dataset .......................................................................................................................... 36 6.2 Airports ..................................................................................................................... 37 6.3 Municipalities ............................................................................................................ 37 6.4 Variables ....................................................................................................................... 38 6.4.1 Macroeconomic variables ...................................................................................... 39 6.4.2 Variables across municipalities .............................................................................. 40 6.4.3 Dummy variables ................................................................................................... 41 6.4.4 Trend variable ........................................................................................................ 42 7 Econometric specification ................................................................................................... 43 7.1 Research method ........................................................................................................... 43 7.1.1 Panel data ............................................................................................................... 43 7.2 Alternative approaches ................................................................................................. 44 7.2.1 Differences-in-Differences (DD) ........................................................................... 45 7.2.2 Regression Discontinuity ....................................................................................... 45 8 Hypotheses .......................................................................................................................... 48 8.1 Hypothesis 1: The demand for air travel ...................................................................... 48 8.1.1 Hypothesis 1: .......................................................................................................... 48 8.2 Hypothesis 2: The impact on individual carriers .......................................................... 48 8.2.1 Hypothesis 2: .......................................................................................................... 48 9 The model ............................................................................................................................ 49 9.1 Problem with simultaneous equations .......................................................................... 49 9.2 Model equation ............................................................................................................. 50 6 10 Empirical results ...............................................................................................................