October 14, 2008
New Jersey Republicans Propose Sales Tax Holiday
Last week, we traveled to Trenton to announce the release of our 2009 State Business Tax Climate Index, which found that New Jersey has the country's worst business tax climate. We spoke to an assembled group of legislators and staff, and laid out several near-term options for improving their state tax climate without taking a big bite out of government revenue:
- Conforming New Jersey's treatment of corporate net operating losses to federal policy.
- Allowing the corporate income tax rate to fall to 9% as scheduled in July 2009.
- Broadening New Jersey's very narrow sales tax base and offsetting that move with sales tax rate cuts.
- Reducing or repealing realty transfer taxes.
- Combining or reforming the state's separate estate and inheritance taxes.
Since then, Democrats and Republicans in the state legislature did move a bill out of committee which would make the corporate tax change in the first bullet above. Additionally, New Jersey Republicans have responded to their state's tax climate problem by proposing a sales tax holiday, which you'll note was not one of the suggestions on our list. The holiday would run throughout the holiday shopping season, from Thanksgiving to January 4. It would reduce sales taxes by half to 3.5% (or 1.75% in specially designated "urban enterprise zones" which ordinarily have a 3.5% sales tax rate) and would apply to all taxable goods and services.
As regular readers know, the Tax Foundation is disinclined toward sales tax holidays, because they violate at least four of our five principles of sound tax policy: neutrality, simplicity, stability, and growth promotion.
- Sales tax holidays are non-neutral across time (because they apply different tax rates to transactions on different days) and in many cases are non-neutral across activities (because many holidays apply only to select goods and services).
- They lack simplicity because they require consumers to determine what goods are subject to holidays at what times, and because they require retailers to repeatedly update their computer systems to reflect changing tax rules.
- They violate stability because they create uncertainty about future tax rates. If a legislature makes an irregular practice of enacting sales tax holidays—as is the case in many states that offer them only in flush economic years—consumers may wait to make large purchases on the belief that the legislature might enact another holiday. And like any temporary tax cut, sales tax holidays do not foster investment with the promise of lower tax rates in the future.
- Finally, sales tax holidays do not promote growth. A study by the New York State Department of Taxation and Finance, performed after that state's first sales tax holiday in 1997, found that the holiday did not increase retail sales of the subject goods (i.e., clothing). Rather, the study found that nearly all of the increased clothing sales activity during the holiday was offset by reduced activity before and after. For the quarter in which the holiday fell, clothing sales rose just 2.9% from a year earlier, which the Department attributed to normal economic growth. This fact makes Republicans' claim that the tax holiday would largely pay for itself through increased economic activity especially dubious.
Generally, we advise state lawmakers who are considering sales tax holidays to instead calculate the tax revenue that would be foregone in the holiday and use it to cut the sales tax rate all year. New Jersey Republicans estimate that their sales tax holiday would produce a static revenue loss of $500 million; alternatively, that money could be used to cut the sales tax rate from 7.0% to 6.6% (3.3% in enterprise zones) for the entire year. It's not sexy, but such a change would put the same money back in taxpayers' hands without the distortions and complications associated with a sales tax holiday.
There are three key ways in which the New Jersey Republicans' proposal is better than most sales tax holidays. (1) It applies to all goods and services, not just a select set, which improves the proposal from a simplicity and neutrality standpoint. (2) It does not reduce the rate all the way to zero, which is also advantageous from a neutrality standpoint. And (3) it applies for a relatively long time period, which decreases the lumpiness of the sales—a mad, two-day rush to sell tax free goods adds to retailer costs and is not pro-growth. In fact, if enacted, this proposal might be the least-bad sales tax holiday in the country.
However, the proposal still is not a good idea. Tax holidays narrow the sales tax base, add compliance costs, distort consumer choice, and don't appear to generate economic activity. Instead of gimmicks like sales tax holidays, New Jersey lawmakers should focus on real tax reforms that make the state a better place to do business.
