Sales Tax Holidays: Politically Expedient but Poor Tax Policy

August 26, 2009

Special Report No. 171

Executive Summary
Sales tax holidays are periods of time when selected goods are exempted from state (and sometimes local) sales taxes. Such holidays have become an annual event in many states, with exemptions for such targeted products as back-to-school supplies, clothing, computers, hur­ricane preparedness supplies, products bearing the U.S. government's Energy Star label, and even guns. High-tax New York State sparked the trend in 1997 as a way to discourage border shopping. In 2009, 16 states will conduct sales tax holidays.

At first glance, sales tax holidays seem like great policy. They enjoy broad political support, with backers arguing that holidays are a highly visible form of tax cut and provide benefits to low-income consumers. Politicians and other supporters routinely claim that sales tax holi­days improve sales for retailers, create jobs, and promote economic growth.

Despite their political popularity, sales tax holidays are based on poor tax policy and dis­tract policymakers and taxpayers from real, permanent, and economically beneficial tax reform. Sales tax holidays introduce unjustifi­able government distortions into the economy without providing any significant boost to the economy. They represent a real cost for busi­nesses without providing substantial benefits. They are also an inefficient means of help­ing low-income consumers and an ineffective means of providing savings to consumers.

Key Findings

• 16 states will hold a sales tax holiday in 2009, down from 17 states in 2008.

• Sales tax holidays do not promote economic growth or significantly increase consumer purchases; the evidence shows that they simply shift the timing of purchases. Some retailers raise prices during the holiday, reducing consumer savings.

• Sales tax holidays create complexities for tax code compliance, efficient labor allocation, and inventory management. However, free advertising for what is effectively a paltry 4 to 7 percent sale leads many larger businesses to lobby for the holidays.

• Most sales tax holidays involve politicians picking products and industries to favor with exemptions, arbitrarily discrimi­nating between products and across time, and distorting consumer decisions.

• While sales taxes are somewhat regressive, this is often exaggerated to sell the idea that sales tax holidays are an effective way of providing relief to the poor. To give a small amount of tax savings to low-income individuals, holidays give a large amount to others.

• Political gimmicks like sales tax holidays distract policymakers and taxpayers from genuine, permanent tax relief. If a state must offer a "holiday" from its tax system, it is a sign that the state's tax system is uncompetitive. If policymakers want to save money for consumers, then they should cut the sales tax rate year-round.

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