Sales Tax Holidays: Small Gains Are Outweighed By Serious Harms

August 20, 2008

I'll be appearing on Fox Business Network at 2:00 PM to talk about sales tax holidays. These one- or two-day breaks from sales taxes for specific items are increasingly popular; 16 states had or are having one this year. The holiday in D.C. is representative: school supplies, clothing, and shoes under $100 were temporarily exempt from the 5.75% sales tax from August 2 to 10.

Everyone seems to win with these holidays. Consumers save some hard-earned money, retailers get free advertising, and politicians get to take credit for cutting taxes. What's the harm with sales tax holidays?

They put politicians in charge of deciding what qualifies for tax-free status. Tax systems should be neutral; taxes should be used to raise revenue, not encourage or discourage certain behaviors. But most sales tax holidays apply only to specific products under certain prices. Sales tax holidays essentially allow government to artificially shape what products are purchased and when. By doing so, the government places itself in the business of deciding economic winners and losers - a function that should always be the sole responsibility of the free market.

They have heavy administrative and compliance costs. Sales tax holidays are also non-neutral across time, since the tax treatment of many things will differ depending on when it is purchased. Anecdotal evidence suggests that purchases are merely shifted in time to the holiday, requiring retailers to have more inventory on hand but without increasing overall sales. Tracking which purchases are exempt and which aren't can be a headache for business owners. Tax holidays create unstable tax codes that force businesses to develop new administrative and compliance strategies every time a tax holiday is enacted.

They divert attention from longer-term tax reforms. It would be better tax policy (less distorting, more neutral) to drop the three-day tax holiday altogether and instead reduce the overall sales tax rate by 3/365ths (or more) all year long. Consumers would get the same benefit without all the headache and administrative mess of picking a date that everyone can agree on. But holidays allow politicians to take credit for cutting taxes when they really haven't.

They mislead consumers. State-funded advertising campaigns usually leave the fact that only some goods are exempt for the fine print. For the most part, consumers just buy what they were already planning on buying. According to the New York State Department of Taxation and Finance, while the Empire State's first sales tax holiday increased sales during the period of the holiday, sales for the year were virtually unchanged. In other words, shoppers didn't buy more; they just shifted the timing of their purchases. Other studies have indicated that retailers may raise their pre-tax prices during the tax holiday, leaving consumers out of the full tax savings. So consumers may not even save anything.

Politicians love enacting these holidays as a gimmicky way to appear to cut taxes without really cutting taxes. There are certainly easier ways to help poorer students get supplies and clothes for schools other than giving everyone in the state a weekend-long exemption. If taxes are too high, the best solution would be to lower the tax rate year-round, not just for one weekend.

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