Tag Archives: sales tax

Tax Holidays in the Dog Days of August

In what has become a common practice in about a dozen and a half states, August is the month for the sales tax holiday. Whether the goal is to encourage consumer spending or ostensibly offer tax relief to families, the three-day holiday waives sales tax on certain purchases – typically school supplies and clothing. Here’s a chart listing the states and the once-a-year exemptions they offer.

What exactly do sales tax holidays accomplish? Some claims:

  • They save consumers money.
  • They increase consumer spending on both tax-free and taxed items. On net, the result is more revenue in what the National Retail Federation calls a “win/win/win” for consumers, retailers and governments.
  • A weekend tax break keeps spending in the local economy. According to Bloomberg BNA Ohio and Michigan first experimented with a tax holiday on cars in 1980. New York picked up the weekend tax holiday in 1997 to entice borough residents to keep their clothes shopping dollars in NYC rather than cross the border to New Jersey’s malls.
  • It is a way for politicians to make good on tax relief without making permanent changes to the code.
The Tax Foundation claims that tax holidays only shift consumer spending and any savings in tax may be offset by higher retail prices. In addition, the “gimmick-y” exemption leads to arbitrary decisions (e.g. backpacks are exempt but briefcases are not – see Virginia). Basically, the one-time break is a way for politicians to crow about tax relief while avoiding more substantive reforms to the code such as broadening the base and lowering the rate of tax.
A 2009 econometric study, The Fiscal Impact of Sales Tax Holidays, by Adam Cole of the University of Michigan finds that sales tax holidays induce “timing behavior” in consumers. There is a reduction in sales and use tax collections by 4.18 percent in the month of the tax holiday. Half of this reduction is attributed to consumers timing their purchases to coincide with the tax-free weekend. Though there is no evidence that this leads to a large substitution of purchases during the rest of the calendar year.
Cole raises two interesting issues for researchers to consider. Do tax holidays produce cross-jurisidictional shopping effects? Secondly, because of their short duration, do tax holidays allow retailers to evade taxes by attributing earlier sales to the holiday weekend?

Marwell and McGranahan (2010) provide another set of questions to consider for those who over-sell the benefits of back-to-school bargains for family budgets. In their working paper, “The Effect of Sales Tax Holidays on Household Consumption Patterns“, the authors ask: Who’s shopping and what are they buying? Their preliminary findings suggest it is primarily upper income households and they are mainly purchasing clothes.

On a purely anecdotal note, I calculate that if our family went shopping during Virginia’s August 3-5 tax holiday we would have saved about $9.00 on backpacks and school shoes. To avoid the back-t0-school crowds we purchased those items at Tysons Corner the weekend before. If that’s the premium for efficient mall shopping, we paid it gladly.

 

Budgeting Tactics for States

Tax Foundation state projects director Joe Henchman writes in today’s Daily Caller about five ideas to help states facing budget shortfalls (that is to say, virtually every state) get back in black:

  • Prioritize appropriations. When the majority-Democratic Arkansas Legislature votes to appropriate money, the money isn’t immediately spent. Instead, each appropriation goes to a legislative committee that ranks them in order of priority. Items are funded only to the extent money is available, forcing debate about how best to allocate limited resources while permitting a wish list if revenue exceeds expectations.
  • Review tax incentive programs. Although many states recognize they have burdensome tax systems, they use targeted incentives for particular industries rather than reducing burdens for everyone. Besides dumping a higher tax burden on everyone else, the jobs created are dependent on the handouts and often vanish when the incentives end. Tax incentive programs also often escape oversight and cost-benefit analysis. Iowa recently recommended elimination of several ineffective tax incentives after a review. Other states should do the same.
  • Broaden sales taxes and use the revenue to lower tax rates. A good sales tax applies to all final goods once and only once. Exempting clothing and groceries may seem like a good idea, but doing so causes year-to-year revenue instability and drives up the rate on everything else. Gross receipts taxes and taxes on business inputs cause distortions that harm economic growth. Adopting a sales tax base of all final products and services would enable both lower rates and more predictable revenue.
  • Reduce reliance on taxes on high-income earners and corporate profits. When deciding in which state to live or locate their business, one of the factors that top earners must weigh is the marginal tax rate they will face in each state. While high statutory tax rates on high incomes may bring a revenue increase in the short term, they can harm long-term economic growth as providers of jobs and capital choose to locate in lower-tax states. With these volatile revenue sources at a minimum, it may be perfect timing to minimize them.
  • Establish rainy day funds and spending restraints. To ride out recessions, states need to build a rainy day fund of 12 to 18 percent of their annual spending. Setting aside 2 to 3 percent of each year’s budget in good times can accomplish that, but those structures need to be in place now or else states will be in this mess again.

Joe discussed state tax policies on C-SPAN earlier this month.