Friday, June 3, 2011

The Sales Tax Holiday: Economic Development Tool or Political Gimmick?

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The sales tax holiday is back in force in 2010, with 19 states announcing tax breaks on selected items—but how effective are such events really?

Ask the Illinois Retail Merchants Association, and they will say, “very.”

Illinois enacted its first sales tax holiday this year—suspending the 5 percent sales tax for 10 days on clothing and footwear priced under $100—and school supplies “used in the normal course of study”—and IRMA issued a gleeful press release congratulating the governor for his foresight.

“Both consumers and businesses have been crying out for relief during this difficult economic downturn. The road to recovery goes through retailing and consumers, and Illinois’ first-ever sales tax holiday will go a long way in aiding these efforts,” IRMA President & CEO David F. Vite said in the release.

According to IRMA, the typical sales tax holiday effectively creates Christmas in August, with a huge uptick in shopping during the month in which it is held.

But the Grinch of sales tax holidays—The Tax Foundation—was not far behind with its own release. A long-time critic of the practice, the Tax Foundation in July issued an updated version of its report, Sales Tax Holidays: Politically Expedient but Poor Tax Policy, in which it blasts the practice as a “political gimmick” that fails to provide genuine tax relief or even to generate any real growth in retail activity.

IRMA cites a study by the Washington Economics Group, of Coral Gables, Fla., showing that Florida’s tax holiday boosted the gross sales by 8 percent during the month in which it was held. According to the study, if Florida had held a tax holiday in 2009, it would have translated into roughly “a $1 billion increase in the states’s gross domestic product”—leading to “a net increase of $118 million in state and local taxes,” for the year, according to IRMA.

But Tax Foundation Staff Economist Mark Robyn is skeptical of such extrapolations. He told reporters Aug. 4 that such studies often fail to take into account the fact that any increase in sales during the holiday is offset by depressed activity before and after. While the tax holiday may bring out shoppers in droves, it is not a permanent increase in activity. Rather, what the holiday does very well, he said, is persuade consumers to either delay or accelerate purchases they were intending to make anyway.

"Call me cynical," Robyn said, "but I'd say it's a political calculation. Lawmakers want to be seen as tax cutters. But if you took the revenue loss from the sales tax holiday and spread it over the full year, it would be very small—maybe one-tenth of one percent."

Robyn is co-author, with Micah Cohen and Joseph Henchman, of the Tax Foundation report.

If tax relief is the intention, he said, it would be far more effective for lawmakers to broaden the sales tax base in their states and reduce the sales tax rate overall.
Studies conducted by the New York Department of Taxation and Finance and the University of Michigan, he said, have shown that tax holidays change the timing of retail sales, but have little impact on the aggregate level of sales.

New York discovered as much in 1997, when it found that retail clothing sales increased during its tax holiday, yet clothing sales for the year were "almost unchanged." The study led New York to drop the tax holiday and instead, enact a permanent exemption for clothing price under $100.

Among other objections raised in the Tax Foundation report:

• Sales tax holidays discriminate arbitrarily among products—reducing market efficiency by favoring some products over others.
• Sales tax holidays create "costly complexity and instability"—hidden costs of compliance, such as reprogramming store registers and computers for the holiday, or having to comply with special rules that apply only during the holiday.
• Sales tax holidays don't benefit customers as much as they benefit retailers. Because the state usually promotes the holiday, the retailers are receiving free marketing to advertise what is effectively a sale offering a 4 to 7 percent price reduction. There is some evidence, as well, that retailers respond to the increased demand during the holiday by raising their prices.

Despite the vehemence of its argument, the Tax Foundation will not likely win many converts very soon. Even though the mix of states changes each year, the general trend has been for more and more states to offer temporary breaks in the sales tax. What started in 1997 in New York expanded to seven states three years later, to a dozen states by 2005 and to 16 states, plus the District of Columbia, in 2008. This year, 19 states are offering tax holidays—not including the district, which dropped the practice in 2009 because of its budget concerns.

Florida and Massachusetts also dropped their tax holidays in 2008, but both states restored the holiday this year. Georgia dropped its tax holiday in 2010, and Maryland adopted its first tax holiday since 2006.

Clearly, elected officials see value in the tax holiday, but Robyn insists they delude themselves and taxpayers if they think the tax holiday is a boost to the state’s economy.
Regardless of the claims of retail groups, Robyn said, legislators who support a tax holiday are ensuring that their state will be forced to look for revenue raisers in some other part of the budget. Some other program will have to be cut, or some other tax or fee will have to be increased, to make up for the temporary sales tax break, he said.
"Programs need to be prioritized against spending," he said. "It is up to the legislators and the voters. They need to stop viewing these things like they're a free lunch."

By Dolores W. Gregory
 

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