A tourist tax in a vertically segmented destination with congestion effects

Abstract We present a model of a two-segment tourist destination where there are externalities of congestion, both within and across segments. We show that when intersegment sensitivity to congestion from low to high category is sufficiently large, then a well-designed per-person tourist tax can increase local social welfare, while also increasing industry aggregate profit. In particular, it is profit maximizing to only tax the low segment, until it creates no externality on the high segment. Intervention is more likely to be optimal when the high category segment would be sufficiently more profitable (absent intersegment congestion) than the low category one. While a uniform tax on both segments may increase local welfare, it always decreases aggregate industry profits.