Are sales tax holidays good for anyone?
All evidence points to no, say economists.
As American families prepare to hit the stores to buy back-to-school supplies and clothing in the coming weeks, 17 states will offer them a tax-free weekend to help spur economic activity and reduce costs for lower-income families.
At least that’s the intention. Ideally, a tax-free weekend, which amounts to giving consumers a 4 to 7 percent discount on select items such as notebooks, pencils and computers, drives more traffic to local businesses. In theory, it could also generate some tax revenue for states hoping that hordes of shoppers will also buy items that are not tax-exempt.
But after 20 years of observing the effects of sales tax holidays, both conservative and progressive economists widely agree that they don’t work as intended.
“Experience shows that the claims of economic stimulus, increased revenue, and consumer savings are greatly exaggerated,” write Scott Drenkard and Joseph Henchman in a 2015 report for Tax Foundation, a Washington-based tax policy think tank. “States see little net economic activity as a result of sales tax holidays; the holidays instead represent a costly-to-administer revenue loss for the government.”
Sales tax holidays became popular in the late 1990s after New York popularized the practice as a way to discourage its residents from crossing into New Jersey to avoid New York’s clothing tax. Since then, other states – including Massachusetts, Alabama and Florida – have instituted (and sometimes canceled) similar programs. Their popularity is puzzling, since many studies have reported a variety of drawbacks of these sale weekends. For one, there is evidence that they don’t benefit consumers that much, especially low income ones. A 2001 University of West Florida study found that some retailers raise prices on tax-free items leading into a holiday, siphoning off some of the potential savings from consumers.
“When lawmakers create sales tax holidays, the assumption is that the benefit will be passed on to consumers in the form of lower prices,” write Tax Foundation’s Drenkard and Henchman. “In reality, retailers often absorb those benefits for themselves.”
Other studies have found that tax-free weekends benefit wealthy families more than lower-income ones. A 2010 study by the Federal Reserve Bank of Chicago found that a tax-free weekend did not drive low-income families, those earning less than $30,000 per year, to buy more than usual, likely because they are less flexible when it comes to timing their shopping with holidays. But families earning more than $70,000 per year bought 136 percent more children’s clothing during a tax holiday than they would have otherwise, the report found.
“The major theme our analysis reveals is that the STH [sales tax holiday] is too blunt a policy tool for addressing the many problems it seeks to resolve,” study authors write. “As a method for stimulating economic activity for a limited number of goods, the STH is shown to be quite effective. As tool for providing economic relief to certain households, STH has fared quite poorly.”
It also appears unlikely that tax-free weekends benefit the local economy overall, say economists. A 1997 study by the New York Department of Taxation and Finance showed that instead of generating new sales, tax-free holidays simply shift the timing of purchases, with little impact, and probably a negative one, on economic activity for the year.
“Politicians love sales tax holidays as good campaign fodder. Retailers celebrate them with gaudy signs announcing tax-free shopping, and consumers line up to take advantage of the deals,” writes Richard C. Auxier, a research associate at the Tax Policy Center, another Washington-based think tank. “But economists and policy analysts across the ideological spectrum condemn them as poorly targeted tax policy that produces little economic benefit.”
Despite warnings from economists, 17 states will offer the traditional weekend of tax relief to their residents in the coming month. This is two fewer than a peak of 19 states that offered the deal in 2010.
But as the Washington-based research organization Institute on Taxation and Economic Policy (ITEP) points out, no new states introduced tax holidays this year. In fact several states have reduced or canceled theirs recently.
Massachusetts has canceled its tax holiday this summer as the state can’t afford to add $25 million of lost tax revenue to its $750 million budget gap. Kansas, Maine, Nebraska, Rhode Island, and Wisconsin recently have rejected new tax holidays targeting back-to-school shoppers, and North Carolina decided not to reinstate its tax-free weekend. Florida lawmakers scaled back their state’s back-to-school holiday and rejected proposals to create new holidays for hunting and fishing gear, as the ITEP reports.
Despite their bad reputation, Tax Policy Center's Mr. Auxier admits that in at least a couple of cases, short-term sales tax exemptions could work. He writes that a sales tax break might be "the least-bad" among tax-cutting options, given that its easily reversible, as opposed to a cut to income or corporate taxes. Another good application for tax-free weekends is in helping encourage residents to buy emergency supplies before hurricane season, for instance.
"In some situations, sales tax holidays can make sense," writes Auxier. "But generally, they’re bad tax policy unless the alternative is large tax cuts with dubious growth assumptions, and not just for a weekend but for the whole year."