Ask The Experts: Are Sales Tax Holidays A Good Idea?

A number of states declare sales tax holidays from time to time. For example, during the back-to-school shopping season in early August, 17 of the 45 states that ordinarily charge a sales tax will declare that purchases of school supplies and apparel are exempt from this tariff on a particular weekend.

For consumers, who spend more than $600 on back-to-school items each year, according to data from the National Retail Federation,  the ability to save as much as 7.25% certainly sounds appealing. It’s a good reason to shop on that weekend.

For businesses, it means more traffic in their stores. And since consumers aren’t paying sales tax, they are a bit less sensitive to prices. In other words,  no need to slash prices on a sales tax holiday weekend.

Prevalent, but at what cost?

In all, 18 states have declared sales tax holidays of one form or another for 2013. Normally they are for two or three day periods, though Connecticut has a seven-day sales tax holiday in August for clothing and footwear. Some states have more than one tax holiday period, declared for different purposes.

But what does it mean for the economy? Is the consumer better off? What about the businesses? Paying less is always a good thing and it’s hard to see how the business can lose on this kind of deal. But what about the taxpayer?

William Fox, Director, Center for Business & Economic Research in the College of Business Administration at the University of Tennessee, thinks these sales tax holidays have very little impact on the economies of the states that declare them. He also sees little benefit to the consumer.

“The evidence on that suggests the benefit is most for businesses,” Fox said. “The work that I have seen suggests businesses are less likely to have sales during a tax holiday, and maybe even increase their price a little bit. So the consumer isn’t seeing much of a lower price.”

Equally skeptical

Others are equally skeptical. Mildred Robinson, professor of law at the University of Virginia, concedes some benefit to the consumer but is unsure to what extent it is a factor.

“Whether these are consumers who would be unable otherwise to afford that cost is unknowable,” she said. “If taxpayer relief is the objective, even with purchase limits in place the relief may be broader than is needed.”

Charles L. Ballard, professor of economics at Michigan State University, argues that sales tax holidays are plenty valuable, but more so as political capital than any sort of economic aid.

“In my opinion, these sales-tax holidays may make good politics,” he said.  “Legislators who push for these things will reward themselves with glowing press releases, and anyone voting against will be portrayed as a Scrooge.”

In short, there are a number of competing interests and issues to consider in regards to sales tax holidays, but it appears they aren’t as great of a bargain as one would initially assume. At least that’s the opinion of most of the experts that we queried.

Our Experts:

  • Charles L. Ballard – Professor of Economics Michigan State University
  • Calvin Blackwell – Associate Professor Department of Economics & Finance College of Charleston
  • William Fox – Chancellor’s Professor William B. Stokely Distinguished Professor of Business The University of Tennessee
  • John E. Anderson – Baird Family Professor of Economics University of Nebraska-Lincoln
  • TR White III – Professor of Law, University of Virginia
  • Mildred Robinson – Professor of Law, University of Virginia

Charles L. Ballard - Department of Economics, Michigan State University

Charles L. BallardIs there a significant economic benefit when states observe sales tax holidays?

In my opinion, these sales-tax holidays may make good politics—legislators who push for these things will reward themselves with glowing press releases, and anyone voting against will be portrayed as a Scrooge.

However, the economic effects are likely to be small. It is sometimes claimed that the holiday will stimulate additional economic activity, but these tax holidays only tend to occur for a relatively short period of time, and they only apply to the things that are taxed by the sales tax. In most states, the sales tax does not apply to most services, and so these untaxed items will be unaffected by the tax holiday. In addition, lots of consumers are relatively unresponsive to these things. In economists’ jargon, the responses are likely to be inelastic in many cases. My son has graduated from college, but back in the days when I was doing back-to-school shopping, I made a list of things that needed to be bought. I would not change my purchases much (if at all) as a result of the sales tax. If my son needs two three-ring binders, I’m not going to respond to a sales-tax holiday by buying an extra binder.

Who benefits more, consumers or businesses?

I believe that in most cases, the consumer will reap most of the benefit of a sales-tax holiday. However, the exact division of the gains between the buyers and sellers will depend on the particulars of each individual market.

Aren’t governments creating future problems for themselves when they declare tax holidays? Don’t they have to make up the revenue at some point?

Your last question raises a very important point. Politically, it is easy to cut taxes, but every tax cut means we have to raise taxes somewhere else, which is difficult politically, or we have to endure further cuts in spending on public services. Here in Michigan, we have had lots of tax cuts in the last 20 years, and I’m not thrilled with the results. With dwindling revenues, the legislature has slashed higher-education funding, which means that the universities have had to raise tuition repeatedly, which means that our young people are having more and more difficulty in financing a college education. Another fallout of the revenue reductions is that many of our roads are in terrible shape. To his credit, Governor Snyder has tried to convince the legislature to adopt a package of revenue-raising measures to fix the roads, but so far he has not been successful in getting the legislature to act.


Calvin Blackwell - Associate Professor, Department of Economics & Finance, College of Charleston

Calvin BlackwellIs there a significant economic benefit when states observe sales tax holidays?

If by economic benefit, you mean increased spending, then yes, sales tax holidays appear to increase economic activity. Removing the tax reduces the cost to consumers, which they obviously like. Removing the tax also benefits sellers, because they get a higher price (although the consumer’s price falls, the seller’s net-of-tax price actually rises when the tax is removed) and they are able to sell more units.

Who benefits more, consumers or businesses?

This question is trickier to answer. Theoretically, either side of the market may benefit more than the other, which means who benefits in general depends upon the specifics of the situation (which state, what products, etc.) If you put a gun to my head and made me answer, I suspect that for sales tax holidays for back to school shopping season, consumers are bigger winners than businesses.

Aren’t governments creating future problems for themselves when they declare tax holidays? Don’t they have to make up the revenue at some point?

Taxes are a necessary evil which allow us to generate the revenue governments need to provide the goods and services the public expects and wants. Not all taxes have the same impact upon society and the economy, and so tax policy is often a matter of choosing the right type of tax to minimize the problems you are concerned about. Obviously, revenue generation is generally a top priority for a tax, and declaring a tax holiday means no revenue. One concern with tax holidays is that consumers will spend less prior to the holiday and then more during the holiday, depriving the state of more than proportionate revenue. There is some evidence that consumers don’t employ this strategy. Governments do have to generate revenue somehow, and a sales tax holiday may require the government to generate more revenue from other types of taxes (like income or property) and this substitute tax may or may not be a good thing. Finally, the government could simply cut spending to match the lost revenue from the tax holiday – depending on how you feel about where that money was going to be spent, this cut may be a bad or good option.


William Fox - Director, Center for Business & Economic Research, College of Business Administration, University of Tennessee

William FoxIs there a significant economic benefit when states observe sales tax holidays?

No, I don’t think there is. I think it has very little impact on the economy of the state. What it mostly does is shift the timing of when people shop, rather than increase the amount of shopping. It’s not increasing sales or consumption, just changing when it takes place.

Who benefits more, consumers or businesses?

The evidence on that suggests the benefit is most for businesses. The work that I have seen suggests businesses are less likely to have sales during a tax holiday, and maybe even increase their price a little bit. So the consumer isn’t seeing much of a lower price.

Aren’t governments creating future problems for themselves when they declare tax holidays? Don’t they have to make up the revenue at some point?

Yes. They will clearly collect less in sales tax than if they had not declared the tax holiday. My belief has always been that the best taxes are low taxes that apply evenly to all things.


John E. Anderson - Baird Family Professor of Economics, University of Nebraska

John E. AndersonIs there a significant economic benefit when states observe sales tax holidays?

No, because a substantial portion of the increased sales during a tax holiday comes from temporal shifting of purchases within the month when the holiday occurs.  Sales that would have taken place anyway, albeit on different days, are shifted into the holiday. There is some overall increase in sales, but it is not substantial enough to have a significant impact on the state’s economy.

Who benefits more, consumers or businesses?

Both consumers and producers benefit to some extent. There is some evidence in the literature that sales of children’s clothing and shoes, in particular, during sales tax holidays are highly responsive to the price reduction. For a given percentage reduction in price due to the tax holiday, sales would then rise more than proportionately for those goods, raising revenue (and presumably profit) for retailers.

Aren’t governments creating future problems for themselves when they declare tax holidays? Don’t they have to make up the revenue at some point?

Yes, sales tax holidays are bad tax policy. A sales tax holiday is a form of narrowing the tax base, which then requires a higher overall tax rate as a result. It would be better to eliminate tax holidays for specific goods and lower the overall tax rate for all goods permanently. In addition, sales tax holidays provide an opportunity of tax evasion on the part of retailers who may choose to fraudulently over-report sales in the month with the holiday (and thereby reduce their payments to the state Revenue Department). There are also state border effects to consider with tax holidays. If the tax holiday encourages out-of-state consumers to purchase products, then there are revenue impacts for border states as well.  The goods purchased out-of-state may substitute for taxable sales in the consumers’ home state. All states with sales taxes also apply use taxes to out-of-state purchases brought into the state by its residents, but those use taxes are ineffectively collected in most states.


T.R. White III - Professor of Law, University of Virginia

T.R. White IIIWho benefits more for a sales tax holiday, consumers or businesses?

I’ve thought right along that they are intended to benefit business not consumers.  Evidence seems to bear that out.  And the revenue loss does not seem to be really important enough to create a problem.

 

 

 


Mildred Robinson - Professor of Law, University of Virginia

Mildred RobinsonIs there a significant economic benefit when states observe sales tax holidays?

There is a benefit to consumers who will be able to purchase items without the additional cost of retail sales taxes. Whether these are consumers who would be unable otherwise to afford that cost is unknowable. If taxpayer relief is the objective, even with purchase limits/retailer in place the relief may be broader than is needed.

Who benefits more, consumers or businesses?

Businesses may benefit from an increased influx of customers but the trade-off may be a subsequent decline in business. The bottom line remains about the same; the difference is in the timing of transactions.

Aren’t governments creating future problems for themselves when they declare tax holidays? Don’t they have to make up the revenue at some point?

Yes, the revenue foregone will have to be made up at some point.

 

Previous Ask The Experts: Evaluating the Financial Literacy Act for Students   The Occupy Prepaid Card Review Next
POST YOUR COMMENT

Our content is intended for general educational purposes and should not be relied upon as the sole basis for managing your finances. Furthermore, the materials on this website do not constitute legal advice and should not be relied upon as such. If you have any legal questions, please consult an attorney. Please let us know if you have any questions or suggestions.