The Case Against Sales Tax Holidays

July 29, 2005

It is back to school time, which means among other things, it’s sales tax holiday season. From CNN money:

While many students shudder at the onset of the back-to-school season, parents have reason to smile, as it signals the start of the tax holidays.

In the coming weeks, 11 states and the District of Columbia will offer periods of sales tax exemptions. Those few days of tax freedom mean consumers can save a few bucks on everything from clothing and footwear to school supplies and computers.

The following states (and the District of Columbia) are granting sales tax holidays this year: Connecticut, Florida, Georgia, Iowa, Massachusetts, Missouri, New Mexico, New York, North Carolina, South Carolina and Texas. Other states plan to follow suit as well in coming years.

Is it possible that a gimmick which lowers taxes is actually poor tax policy? Economically speaking sales tax holidays are poor tax policy for two main reasons.

First, sales tax holidays are distortionary because they are non-neutral across products. This means that consumers have an incentive to buy products which fall under the sales tax holiday as opposed to goods that are not covered in the holiday.

Second, sales tax holidays are non-neutral over time, which means that they create incentives for consumers to purchase items during the sales tax holiday that they otherwise would have purchased at another time.

Additionally, sales tax holidays add to retailers’ compliance costs and make the tax code less stable. Although sales tax holidays are good for certain consumers of certain products, they are poor tax policy overall.


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