A Sales Tax Holiday – Will It Stimulate the Economy?

By Joseph Diedrich
Special Guest Perspective for the MacIver Institute

Last week, two bills that would create “sales tax holidays” were concurrently introduced in the Wisconsin Assembly and Senate.

The bills – Assembly Bill 108 and Senate Bill 89 – would create two, two-day sales tax holidays every year during which specified consumer goods would be exempt from state and local sales taxes. The first would occur in August and include clothing, computers, and school materials. The second would take place in November and eliminate sales tax on certain EnergyStar appliances.

The bills’ sponsors are both Republicans–Senator Rick Gudex (Fond du Lac) and Representative Chad Weininger (Green Bay). According to Rep. Weininger, “regular folks just need a break.” Thus, the ostensible goal of the holidays is to provide economic relief for Wisconsin families.

The Wisconsin Department of Revenue has estimated that the sales tax holidays would cost the state nearly $15 million in tax revenues, just a small portion of the annual $4.3 billion in collections. Sen. Gudex, however, suspects that an increase in revenue could actually result due to a potential boost in consumer spending on non-exempt items.

Sixteen other states have sales tax holidays planned for 2013, including Virginia, which has set aside fourteen days for the purpose.

At first glance, the idea of a sales tax holiday appears to be a favorable one. When considered carefully, however, the proposal may prove to have the potential to cause more harm than good.

First, tax breaks – like any sale or discount – inevitably cause consumers to alter their behavior; the degree to which they do so depends on how they value both the discounted goods and the alternatives to those discounted goods. Under the proposed bills, the application of the “discount” would be determined by politicians via legislation; certain industries (and implicitly, companies) would benefit, while others would not. In this way, the proposed sales tax holidays would create an artificial distortion in consumer preference while allowing the government to pick “winners” and “losers.”

Second, the claim that sales tax holidays stimulate the economy is dubious at best. A 2001/2011 study by the Tax Foundation concludes that, “Rather than stimulating new sales, sales tax holidays simply shift the timing of sales.” This conclusion is supported by evidence from a New York Department of Taxation and Finance report on the Empire State’s own tax holiday, which states, “[A] significant amount of the clothing sales reported by vendors during the exemption week were simply sales that were diverted from other weeks in the sales tax quarter. Based on this analysis, it appears that much of the $174 million in ‘additional’ clothing sales during the exemption week were not new sales generated by the exemption but were sales that would normally have occurred during prior or later weeks in the sales tax quarter.” Sales in the weeks preceding a sales tax holiday slow as consumers adjust their spending plans; likewise, sales in the weeks following a holiday also tend to be low as the market adjusts itself.

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Finally, sales tax holidays such as the one proposed may inadvertently hurt businesses. To accommodate for the abnormal, artificial fluctuations in sales and accompanying inventory deviations, businesses may end up incurring more expenditures than they otherwise would. Further costs would surely also come along with the red tape associated with an additional layer of tax code. The aforementioned Tax Foundation study goes on to say, “Because of their impacts on labor alloca┬Čtion and inventory management, sales tax holidays add complexity to sales taxes and are accompanied by administrative costs which can place a large burden on businesses. This extra burden represents a real cost to businesses, particularly small businesses, as valuable resources are diverted to pay for compliance with and implementation of sales tax holidays.”

It is findings such as those presented above which led the Chicago Federal Reserve to conclude in 2010: “As a policy that aims to accomplish multiple goals for disparate parties, the STH [sales tax holiday] falls short of satisfying all of the policymakers’ stated intentions…[T]he STH is too blunt a policy tool for addressing the many problems it seeks to resolve…Policymakers should be aware that the STH is not a panacea.”

In short, a sales tax holiday will not give “regular folks” a break, stimulate the economy, or help businesses. Nevertheless, the idea of tax reduction is one that should be considered. To accomplish worthwhile goals and produce lasting effects, however, any tax reduction must be nondiscriminatory and permanent.