Although the summer equinox started a little over a month ago, the summer break is already winding down. Students are gearing up for the academic year. Part of that gearing up is having the parents buy school supplies and backpacks. In an attempt to boost consumer spending, state governments have implemented what are referred to as sales tax holidays (see below). We already see such states as Florida and Tennessee are implementing sales tax holidays this summer for school supplies.
A sales tax holiday is a "limited-time period where a state allows sales tax to be waived or reduced on categories of items." State tax holidays typically last a few days, but can last longer. These temporary sales tax exemptions are not limited to school supplies. States have enacted sales tax holidays for such goods as computers, clothing, groceries, and sporting goods. This year, more states are looking to expand these tax-free periods due to inflation and large state budget surpluses. While sales tax holidays are a great political gimmick, they do not make for great tax policy.
Much of what makes a sales tax holiday ineffective is the temporary nature of the exemption. The assumption made by proponents is that the tax holiday boosts additional sales. As a report from the Federal Reserve Bank suggests, what happens is that the sales tax holiday only shifts the timing of the purchases instead of increasing overall purchases (Aladangady et al., 2017). Since sales tax holidays primarily shift purchases, as opposed to increasing them, they do very little to increase economic growth. This makes sense since sales tax holidays are usually offered when demand is at its highest and most inelastic, thereby doing little to shift overall demand curves.
The temporary nature also means time-based discrimination. Why should a purchase during one small window of time be time-exempt while the same product during the rest of the year is taxable? Also, what is a consumer to do if they cannot purchase that weekend? Some are working or on vacation. Others could be in between paychecks during the sales tax holiday, especially if the holiday is only a few days. A study from the Federal Reserve Bank of Chicago shows that those who benefitted the most were those with incomes over $70,000 because they had the financial stability and resources to time their purchases (McGranahan and Marwell, 2010).
Time is not the only form of discrimination. Sales tax holidays are generally arbitrary on the items that they produce. Aside from creating economic distortion and reducing market efficiency, these holidays also complicate inventory management and taxation. For the exemption to be successful, retailers need to comply with the tax code to if they are to be at all successful. The tax code should be as simple as possible. However, it takes a lot of paperwork and man-hours to wade through red tape for an exemption that typically lasts for a few days.
This red tape and complication in the tax code creates more opportunity for tax evasion. Mentioning tax evasion is notable because one of the advantages of using a consumption tax is that a sales tax is easy to track, measure, and tax (Fritts, 2020). It ends up being complicated to make so many adjustments for such a short period that many businesses (small businesses in particular) do not want to deal with the compliance or adjusting cash registers.
Finally, some retailers might exploit the tax holiday by increasing their prices. This would reduce the benefit of the sales tax holiday to the consumers (e.g., Hawkins et al., 2003), which is one of the main reasons for such a tax holiday.
Sales tax holidays do not increase purchases, promote economic growth, or provide relief to consumers, especially those from low-income households. The fact that you need a tax holiday in the first place implies that the current sales tax structure is too burdensome. Sales tax holidays are first and foremost a distraction from the fact that sales tax holidays do nothing to provide long-term relief. It must be bad when tax policy think-tanks both on the Left and the Right cannot stand sales tax holidays. If politicians want to make a true difference, they should work on making a more competitive tax system that works for consumers and producers alike.
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