Sales Tax Holidays: An Ineffective Alternative to Real Sales Tax Reform
briefAuthors
Sales taxes are an important revenue source, making up close to half of all state tax revenues.[1] But sales taxes also are inherently regressive because low-income families spend a greater share of their income on goods and services subject to the tax. Lawmakers in many states have enacted “sales tax holidays” (20 states will hold them in 2022) to temporarily suspend the tax on purchases of clothing, school supplies, and other items. These holidays may seem to lessen the regressive impacts of the sales tax, but their benefits are minimal while their downsides are significant—particularly as lawmakers have sought to apply the concept as a substitute for more meaningful, permanent reform or arbitrarily reward people with specific hobbies or in certain professions. This policy brief looks at sales tax holidays as a tax reduction device.
Lawmakers in 2022 increasingly turned to the tax holiday concept, particularly in states with better-than-expected revenues after the pandemic-induced downturn of 2020, in some cases proposing holidays with unheard-of scope and duration. Lawmakers in Florida, for example, greatly expanded the breadth of their sales tax holidays by adding five additional tax-free holidays that range in category—from tools for home improvement projects to diapers and books for children—that will cost the state over $1.2 billion (if you include the month-long gas tax holiday).[2]
How Sales Tax Holidays Work
Sales tax holidays are temporary sales tax exemptions, usually applying to a small number of taxable items for a very limited period. These holidays are typically timed to take place in August during the traditional “back to school” shopping season and offer breaks on school-related items such as clothing, school supplies, and computers. However, a few states exempt all taxable goods during the holiday. Most sales tax holidays last only two or three days, and almost all holidays apply only to items below some specified price (e.g. clothing items priced over $100 are generally not exempted).
In addition to traditional back-to-school weekend holidays, some states now hold longer, broader holidays, with varying themes. Holidays for energy-efficient appliances and storm preparation materials are becoming increasingly common, for example. In 2022, there are also holidays being held for hunting season in Mississippi, small businesses in New Mexico, and for National Guard members and their families in Nevada.
History of Sales Tax Holidays
The notion of such a holiday was first introduced in 1980 when Ohio and Michigan opted to not tax the sale of automobiles for a period of time.[3] New York experimented with the current concept of sales tax holidays in 1996 but has since abandoned the policy. More than 20 states have enacted legislation at some point to temporarily suspend sales taxes, and proposals to extend the concept to more states and more types of purchases appear every year.
Many states either repealed or temporarily ended sales tax holidays when facing significant revenue gaps. For example, lawmakers in Florida, Georgia, Maryland, Massachusetts, and the District of Columbia all canceled holidays during the height of the Great Recession; and although most of these reinstituted them afterward, Georgia and the District of Columbia’s holidays have not been revived. Louisiana, which once held three separate holidays for back-to-school shopping, hunting season, and hurricane preparedness, started paring them back due to revenue shortfalls in 2016 and has now cancelled all three.[4] Holidays in Illinois, New York, North Carolina, Vermont, and Wisconsin were also either short-lived or repealed, though Illinois’s returned this year.
Trending in 2022: State Gas Tax HolidaysAt the moment the United States, not unlike other advanced economies around the world, is confronting rising prices overall and high energy costs in particular—including increases in the price of gasoline.[5] While it is unlikely that the price increases will last long into the future, they have lasted long enough for lawmakers to feel pressure to act as drivers feel the squeeze at the pump. Naturally, some have chosen a familiar, politically expedient approach: gas tax holidays. Gas tax holidays have been passed in five states this year including Maryland, Connecticut, Georgia, New York, and Florida. Maryland was the first state to enact its month-long holiday back in March, but other states have opted for holidays that span the course of several months like New York’s, which is in effect from June to December. Combined, the five gas tax holidays will cost state and local governments around $1.5 billion in foregone revenue. These holidays suffer from some of the same shortcomings as sales tax holidays: most notably, a large share of the tax reduction will not reach the families facing the most difficult economic circumstances. An ITEP analysis of a proposed gas tax holiday in Virginia, for example, concluded that 30 percent of the cut would have flowed to the oil industry while another 24 percent would have gone to out-of-state residents. Moreover, gas and other fuel taxes help fund important state infrastructure projects and with rising prices that also means that the inputs for projects—like asphalt—will cost the state more.[6] Fortunately, state lawmakers on both sides of the aisle from Utah to Virginia have rejected these gas tax suspension proposals. |
Problems with Sales Tax Holidays
Policymakers tout sales tax holidays as a way for families to save money while shopping for “essential” goods. On the surface, this sounds good. However, a two- to three-day sales tax holiday shopping spree for selected items does nothing to reduce taxes for low- and moderate-income taxpayers during the other 362 days of the year. Sales taxes are inherently regressive. In the long run, sales tax holidays leave a regressive tax system unchanged, and the benefits of these holidays for working families are minimal. Sales tax holidays also fall short because they are poorly targeted, cost revenue, can easily be exploited, and create administrative difficulties.
Sales Tax Holidays Are Poorly Targeted
- Because wealthier taxpayers also benefit from sales tax holidays, they offer less “bang for the buck” from a fairness perspective than more targeted tax breaks such as low-income sales tax credits (described in ITEP Policy Brief, “Options for Progressive Sales Tax Relief”) or Earned Income Tax Credits (described in ITEP Policy Brief, “Rewarding Work Through Earned Income Tax Credits”).
- Wealthier taxpayers are often best positioned to benefit from the holidays since they have more flexibility to shift the timing of their purchases to take advantage of the tax break—an option that isn’t available to families living paycheck to paycheck. Many low-income taxpayers spend most or all of their income just getting by, which means that they also have less disposable income than wealthier taxpayers to spend when the holiday arrives. One study found households that earn more than $30,000 were likely to shift the timing of their clothing purchases to coincide with a sales tax suspension, but households earning less than $30,000 were not.[7]
- Sales tax holidays are not limited to state residents but instead extend to anybody who happens to be within the state’s borders at the time of the tax suspension, including tourists and individuals who live close to the border.
- Though the holidays are often marketed as boons to local businesses, nearly all these holidays (New Mexico’s “Small Business Saturday” is an exception) apply to online purchases, even those shipped from other states, giving no advantage to locally owned businesses.
Sales Tax Holidays Reduce State and Local Revenue
In 2022, these holidays will cost states and local governments more than $1 billion in lost revenue, up from an estimated $550 million just a year ago.[8] Revenue lost through sales tax holidays will ultimately have to be made up elsewhere, either through painful spending cuts or increasing other taxes. And local jurisdictions like cities and counties—which often have few revenue options and have to rely on sales taxes to fund important priorities like roads, parks and police and fire protection—rarely have a choice in the matter of sales tax holidays. Only Alabama, Mississippi, and Missouri allow localities to opt out of the holidays.
Moreover, now that most online sales are subject to state and local sales taxes, the cost of holding these holidays has quickly grown. Online purchases, which are tax-free under all but one of these holidays, are a large and growing share of retail sales, and it is also relatively easy for shoppers to time their online purchases to coincide with a tax holiday.
Lawmakers’ recent experiments with longer and broader tax suspensions add to this growing price tag as well, heightening the need for a better understanding of why sales tax holidays are ineffective and how states can do more with less through more targeted policies.
Some Retailers Exploit Sales Tax Holidays
Retailers can also take advantage of the shift in the timing of consumer purchases by increasing their prices or watering down their sales promotions during the tax holiday. The influx of shoppers gives them economic incentive to do so, and the evidence suggests that they often do.[9] One study of retailers’ behavior during a sales tax holiday in Florida, for example, found that up to 20 percent of the price cut consumers thought they were receiving from the state’s sales tax holiday was actually reclaimed by retailers.[10]
Sales Tax Holidays Create Administrative Difficulties
Sales tax exemptions create administrative difficulties for state and local governments and for retailers who must collect the tax. For example, exempting groceries requires a sheaf of government regulations to police the border between non-taxable groceries and taxable snack food. A temporary exemption for clothing (or for any other back-to-school item) requires retailers and tax administrators to wade through a similar quantity of red tape for an exemption that lasts only a few days. Further complexity can arise in states with local sales taxes when some localities opt not to participate in the holiday and consumers unexpectedly end up paying local sales taxes on their purchases.
Conclusion
Sales tax holidays are poorly targeted and too temporary to meaningfully change the regressive nature of a state’s tax system. Lawmakers must understand that they cannot resolve the unfairness of sales taxes simply by offering a short break from paying these taxes. If the long-term consequence of sales tax holidays is a higher sales tax rate, low-income taxpayers may ultimately be worse off as a result of these policies. Policymakers seeking to achieve greater tax fairness would do better to provide a permanent refundable low-income sales tax credit or prioritize state-level Child Tax Credits (CTC) or Earned Income Tax Credits (EITC) which would do more to help families make ends meet and to offset the impact of the sales tax on low- and moderate-income taxpayers.
Appendix
[1] U.S. Census Bureau, U.S. Census Bureau, 2021 Annual Survey of State Government Tax Collections.
[2] Dr.flgov.com (2022) Governor Ron DeSantis Signs Largest Tax Relief Package in Florida’s History. [online] Available at: https://www.flgov.com/2022/05/06/governor-ron-desantis-signs-largest-tax-relief-package-in-floridas-history/
[3] Janssen, C. B. (2012), (Un) Happy Holidays: The True Meaning of Sales Tax “Holiday” Policy, Loyola Consumer Law Review. 24: 411–440.
[4] Some local jurisdictions in Louisiana still have hunting season exemptions from local sales taxes in place because the repeal of state-level holidays in 2018 did not extend to localities. Louisiana Department of Revenue, Revenue Information Bulletin No. 18-020.
[5] Romei, V., & Smith, A. (2022). Global inflation tracker: See how your country compares on rising prices. Financial Times. Available at: https://www.ft.com/content/088d3368-bb8b-4ff3-9df7-a7680d4d81b2
[6] Davis, C. (2022). Rising prices: Another reason to be wary of tax cutting right now. ITEP. Available at: https://itep.org/rising-prices-another-reason-to-be-wary-of-tax-cutting-right-now/
[7] Marwell, Nathan and Leslie McGranahan (2010), The Effect of Sales Tax Holidays on Household Consumption Patterns. Federal Reserve Bank of Chicago.
[8] ITEP survey of cost estimates from state tax expenditure reports, fiscal notes, revenue departments, and academic studies.
[9] Brunori, David (2017), Sales Tax Holiday: Great Politics, Poor Policy. D.C. Policy Center, https://www.dcpolicycenter.org/publications/sales-tax-holidays-great-politics-poor-policy .
[10] Harper, R. K., Hawkins, R. R., Martin, G. S. and Sjolander, R. (2003), Price Effects around a Sales Tax Holiday: An Exploratory Study. Public Budgeting & Finance, 23: 108–113.