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Sales Tax Holiday—Great Politics, Poor Policy

November 02, 2017

First Take is a regular opinion column by D.C. Policy Center Senior Fellow David Brunori.

Sales tax holidays are good politics. A legislator from Maryland once told me that they were the easiest things to vote for. And politically useful arguments are plenty: Hard working families get to buy tax free right before school starts. People on a budget will save money. Shoppers will flock to the stores. That is good for the economy.

In 2017, 16 states will hold sales tax holidays that mostly cover clothing and school supplies, but could also include other things. States have expanded the holidays to hurricane preparedness equipment (Alabama, Florida, Louisiana, Texas, and Virginia), energy saving appliances (Maryland and Virginia), and even guns and ammunition (Louisiana and Mississippi).

The D.C. Council is considering reinstating a sales tax holiday it had abandoned in 2010 (to close a budget gap in the aftermath of the Great Recession). Councilmembers should resist the temptation. Sales tax holidays are not what they appear to be. Yes, shoppers will save the 5.75 percent sales tax on selected purchases.  Fewer dollars will flow to the government coffers (somewhere around $1.5 to $2 million, if previous sales tax holidays in D.C. are a measure), but not all will be kept in shoppers’ pockets, who might have to pay higher prices. Total spending won’t increase, just the timing will shift. Shoppers will find that some things they want to buy are covered, but others are not, without rhyme or reason.

The tax might be zero, but prices go up

The sales tax holidays do not deliver the expected savings. Proponents of sales tax holidays argue that the tax holiday would support low and middle-income families by reducing out-of-pocket expenditures when families must incur these expenditures (such as before schools open). But basic economics will tell you that when everyone shops on the same weekend, prices will go up. It is a supply and demand thing. More people will be in the stores and prices will be higher than normal.

Research shows that the claims about savings during sales tax holidays are misleading. Retailers could capture much of the savings by increasing prices—not by a lot mind you, but enough to make the deals worse for consumers. If the stores know everyone is shopping on Saturday, there is not much incentive to lower prices on that day. One reporter in North Carolina noted in 2009 that retailers offered better deals before the sales tax holiday began, but increased prices during the sales tax holiday to capture much of the savings. Another study that examined the prices of 10 apparel items across 10 retailers in Pensacola found that retailers captured 20 percent of the tax savings by increasing prices during Florida’s sales tax holiday.

It is possible that while consumers in D.C. could save 5.75 percent on their purchases, they may see more than 5.75 percent increases in the cost of the underlying goods. And this means we should not expect that folks from Virginia and Maryland will come to D.C. to spend their dollars during the tax holiday. They will likely find better deals in their own neighborhoods.

Sales tax holidays do not increase overall spending

There is no real effect on the economy either. Supporters of tax holidays often claim that holidays will create a boom in the economy by increasing overall expenditures of both items covered in the sales tax and impulse purchases. They also hope that firms will hire more employees to manage growing demand.

Think about it. Sales tax holidays merely change the timing of purchases. Rather than shopping the third week of August, you will shop the weekend of the holiday. And, those hard working families are unlikely to spend appreciably more because of the holiday. If you budget $200 for back to school shopping, you are not going to spend $400 because you are saving 5 percent sales tax on some items. People don’t work that way.

Again, the research does not support the claim that sales tax holidays create economic growth. Researchers from the Federal Reserve, by examining daily transaction volume data, found that Massachusetts’ rather generous sales tax holiday is associated with significant shifts in the timing of purchases by consumers, but not necessarily a net increase in sales. Researchers at the New York Department of Taxation and Finance found evidence that while clothing sales increased during the week-long sales tax holiday, total clothing sales for the year remained the same compared to previous years. A study from the University of Michigan found that 30 to 90 percent of the increase in the volume of computer sales during Michigan’s sales tax holiday can be explained by shifting of the purchase time.

Sales tax holidays are arbitrary in what they exempt

In Missouri, one week out of the year, you could buy an Energy Star appliance with no tax. In Texas, you have three days to do the same, but you better need a clothes washer (exempt) and not a clothes dryer (not exempt).  In South Carolina, you have three days in early August to buy bath soap and bedding tax free. South Carolina’s sales tax holiday extends to daily planners if used by school children, but not if used by others. In Mississippi, you have two days to load up on shoes and clothes (belts with buckles are exempted, but not belt buckles), but three days to fill your gun cabinet with pistols, revolvers, rifles, and shotguns tax free. In New Mexico, one week out of the year, you can buy shoes tax free but not shoe inserts. You can get all kinds of clothing tax free, but not things that you use to make clothes such as yarn, fabric, zippers, and buttons. What is the rationale?

The answer is, there is none, at least from a consumer’s point of view.

The real winners tend to be the retailers. They know when the big crowds are coming to shop. They can set staffing, inventory, pricing well ahead of time to maximize returns. I do not blame them. I would do the same. But there is a reason why retailers lobby hard for holidays. They make more money when there are holidays than when there aren’t.

Still, the political optics are strong. And the cost of granting the holiday is usually not great. Political leaders win. The coffers lose a little money. Consumers more or less break even. And retailers get a small windfall. That is a recipe for political success.

But sales tax holidays are also bad tax policy. For hundreds of years, public finance experts have said that a sound fiscal system is built on a broad base, with low rates. You should not have carve outs for particular products. And you should minimize the use of the tax laws to influence market decisions. I have been writing about holidays since 1997 when New York first enacted one. I called them gimmicks then. They remain so today.

Both consumers and retailers would be far better off with an across-the-board, year-round reduction in the sales tax.  Lower taxes would mean more spending at the stores. And those hard-working families will not have to worry about whether to buy their pencils and erasers the second week of August or the third.

Feature photo by Mr. T in DC (Source).

David Brunori, who writes the regular column First Take, is a partner in the Washington office of Quarles & Brady LLP and a research professor of public policy at The George Washington University. He is a nationally known expert in state and local tax and public finance.