Sales Tax Holidays: Politically Expedient but Poor Tax Policy

August 4, 2006

As we head into this first weekend of August, it is becoming increasingly popular for the back-to-school shopping season to be accompanied by sales tax holidays, where state sales taxes on certain items are temporarily suspended for a weekend or even longer. Today, we have released a new report entitled “Sales Tax Holidays: Politically Expedient but Poor Tax Policy”, which details why these sales tax holidays are simply bad economics. Here is the conclusion:

The purpose of sound tax policy is to raise necessary revenue for programs while minimizing distortions in the economy, and interfering as little as possible with the choices of free individuals in the marketplace. Unfortunately, sales tax holidays fail this test of sound policy.

Not all forms of tax relief are created equal. Lawmakers have the ability to choose among many alternative forms of tax relief, and sales tax holidays are among the least desirable options. If lawmakers wish to reduce the burden of taxes on consumers, they should enact permanent, broad-based tax relief that avoids the costly economic distortions caused by tax holidays.

Essentially, in order for one to believe that sales tax holidays are optimal tax policy, he/she must assume that government is in a better position to allocate resources across time and across sectors than is the private sector. In other words, one must believe that in this situation, central planning is superior to the private marketplace. We have no reason to believe that this is the case with respect to back-to-school shopping.

Even if sales tax holidays are an improvement in economic efficiency relative to the status quo as some believe because it is still technically a “tax cut”, they are still not optimal in terms of being the best alternative. In other words, as this report demonstrates, it would still be better in terms of economic efficiency to lower sales tax rates across-the-board equal to the same revenue amount that the sales tax holiday would cost.

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