August 04, 2006

Sales Tax Holidays: Political Smoke and Mirrors

Fourteen states and the District of Columbia now hold sales tax holidays, eleven of which start this weekend. These weekend holidays allow shoppers to save money by ignoring the sales tax on selected items, usually school supplies, food, and clothing. Many lawmakers proudly promote the holidays as a way to help the poorest residents pay for necessary items. However, voters shouldn't be fooled into thinking that the holiday amounts to substantial tax reform.

Sales taxes are among the most regressive taxes levied by state governments, impacting the poor, who spend most of their income, much more heavily than the rich. The wealthy are able to save their money and spend a much smaller percent of their earnings. Any sales tax cut, then, will benefit low-income families the most. However, there is reason to believe sales tax holidays aren't effective. Many lower-income families live paycheck-to-paycheck, and may not be able to put off purchases to take advantage of the tax break. More wealthy individuals can more easily schedule their spending in order to benefit from the tax break. Additionally, we don't know whether or not stores will offer the same sale prices they would normally offer. Why would stores offer a ten percent discount if customers are coming in to save five to eight percent?

This weekend's tax holidays offers only the most fleeting relief. When the weekend is over, sales taxes will continue to push low-income families further into poverty. If policymakers want to aid low-income families, they would do better to scale back sales taxes permanently. These holidays is little more than political smoke and mirrors. For more on this topic, check out this policy brief. Not everyone is fooled by the sales tax holiday gimmick. Check out this article from USA Today.


At 12:36 PM, Anonymous Anonymous said...

I am inclined to think that sales tax holidays represent a transfer from governments (in the form of lost sales tax revenue) to retailers (increased sales at higher prices). There may be some "leak in the bucket," meaning that consumers might save a little, but I'm guessing that most of the benefit goes to retailers (and all of the loss comes from reduced gov't revenues).

The question of the economics of this (do retailers limit their discounts because the government is giving consumers a 5 to 8 percent tax break) is an empirical question.

Certainly there is research that provides an answer, no?

Steve Hill

At 9:57 PM, Blogger Matt G said...

There's a bit of research out there on this question. There's a guy named Richard Hawkins at (I think) the University of West Florida who's done research on what happens in Florida when they do their holidays. I'm oversimplifying a bit, but I think what he's found is that prices don't go down by as much as the value of the tax holiday, so that at least some of the holiday's value is (as you suggest) getting eaten up by retailers rather than consumers.

This turns out to be a pretty hard thing to measure, I think. Even when tax holidays cover only a single good (like gasoline), what states have found is that it's not that easy to demonstrate that retailers are price-gouging.

But you don't need an economist to tell you that this outcome is likely. Any clever retailer worth his salt will do whatever's possible to increase his profit.


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