This is Dominic Pino filling in for Jim Geraghty.
On the menu today: Sales-tax holidays. They sound nice and are popular, but they’re bad tax policy.
What Are Sales-Tax Holidays?
It’s back-to-school-shopping season, which means it’s also sales-tax-holiday season in many states.
A sales-tax holiday is a set period of time when sales tax does not apply to a certain category of purchases. States will announce these holidays ahead of time. The idea is to encourage the purchase of certain goods or ease the financial burden on the purchase of necessities.
Now is the time of year when many states have sales-tax holidays for school supplies. Alabama, Arkansas, Florida, Mississippi, Missouri, New Mexico, South Carolina, Tennessee, Texas, Virginia, and West Virginia all have sales-tax holidays for school supplies in July or August of this year, according to the Tax Foundation.
States also use sales-tax holidays for other goods. Clothing is another common category. Some states have holidays for energy-efficient appliances. Some have them for generators and other preparedness goods before hurricane season. Louisiana has one for firearms and ammunition before hunting season begins.
The basic logic of sales-tax holidays is sound. If you want people to buy more of something, taxing it less is one way to do that. Reducing the tax burden is, in general, a good idea. But digging a little deeper into the logic demonstrates that holidays don’t achieve their intended goals and can even create new problems.
Why Are They Bad Policy?
The most fundamental issue with sales-tax holidays is that they don’t actually give people more money to spend. If more money was being spent, it would help to boost economic activity. But what a sales-tax holiday does instead is shift the same total amount of spending so that it occurs in different windows of time.
Families already know they are going to need to buy school supplies for the new school year. If the state doesn’t have a sales-tax holiday, they will buy the supplies whenever is convenient for them. If the state does have a holiday, they will probably buy the supplies during it instead.
They haven’t spent any more money than they otherwise would, so no business is making more income than it otherwise would, and investment and worker pay — the stuff we want to see improve for economic growth — will be the same. Really the only change is that the state government will lose out on revenue for school-supplies purchases for a few days or weeks, depending on how long the sales-tax holiday was.
Not only that, but sales-tax holidays can result in slightly higher prices. If a business knows there will be lots of purchases in a category of goods in a short amount of time, one way to prevent shortages is to raise prices in that category. If prices are even slightly higher, that could wipe out any benefit to consumers from the sales-tax holiday, since sales taxes are generally only around 5 percent to begin with.
All taxes are bad, but some are worse than others. A sales tax is a type of consumption tax, and consumption taxes are better than income taxes. One of the advantages of a well-designed sales tax is that it has a broad base, i.e., it includes nearly all purchases made in the jurisdiction in which it applies. The broad base allows for a low tax rate to still raise a lot of revenue without being too economically distortive.
Sales taxes are also better than income taxes because they are transparent. Every receipt you get includes the sales-tax calculation on it. You have a much higher chance of knowing what your state’s sales-tax rate is than knowing what its income-tax brackets are.
Sales taxes are also easier to comply with than income taxes. From the individual’s point of view, you don’t have to fill out a tax return, disclose any personal information, or do any calculations to successfully comply with a sales tax. The tax is collected from businesses, who also don’t have to disclose the personal information of their customers when they send the money to the government.
Sales-tax holidays undermine these advantages of sales taxes. They introduce unnecessary complexity into the tax code, favor some purchases over others, and do so on a temporary basis that doesn’t help the economy.
What counts as school supplies? Sales-tax holidays put government in the position of having to decide whether, for example, tissues count as school supplies. Many students are asked to bring tissue boxes for their classrooms to use, but tissues are not school supplies in the same way pencils or markers are. People might be under the impression that a purchase they are making is included in the sales-tax holiday when it is in fact not.
States also have a broader problem: Over the past few decades, their sales-tax bases have been shrinking. That’s because most sales taxes were originally designed to apply mostly to purchases of goods, and over the past several decades, services have gradually become a greater proportion of consumer spending.
Professor John Mikesell of Indiana University was one of the top scholars to raise the issue of sales-tax-base erosion due to consumer spending shifting from goods to services. He calculated sales-tax breadth as the percentage of a state’s personal income that is included in the sales-tax base. Jared Walczak of the Tax Foundation has continued those calculations using Mikesell’s methodology.
Walczak found that the average state sales-tax breadth is only 35 percent, meaning that most consumer spending in most states is not subject to sales tax. It was 50 percent in 2000. The mean sales-tax rate increased from 5.16 percent in 2000 to 6.01 percent today to compensate for the shrinking base.
That’s the opposite of good tax policy. States should broaden the sales-tax base, so as not to discriminate between consumers’ choices, which will then allow them to reduce the rate to be less harmful. That means not excluding huge categories of purchases, as many states do for services right now, and not changing the tax code on a temporary basis through sales-tax holidays.
ADDENDUM: For a more comprehensive look at why sales-tax holidays are bad policy, including why they were a bad response to inflation in 2022, check out this Tax Foundation report from Janelle Fritts.