A tax holiday is a temporary reduction or elimination of a given tax. Usually it is enacted in order to achieve a short-term benefit. The American Jobs Act proposed by President Obama could be considered a tax holiday because it eliminates certain taxes (payroll taxes) for a limited amount of time in the hopes that it will spur employers to hire more workers. The benefits of that type of tax holiday are dubious.
Another common type of tax holiday is a sales tax holiday. These tax holidays eliminate sales taxes on purchases that take place during certain time or for certain types of products or even in certain geographic areas.
Sales taxes are usually administered at the state level. For these governments, issuing a tax holiday is a tradeoff. They will lose the revenues that would have been generated from sales that take place during the holiday. In theory, this cost is more than offset by the benefits of consumers spending more than they otherwise would have spent. Part of these additional sales consists of accelerated purchases, meaning that consumers would have spent the money anyway, just later. The other part consists of new purchases that would not have been made had it not been for the tax holiday. Impulse buys make up a large component of these new purchases.
Sixteen states planned tax holidays in 2011. There is growing interest from other state legislators to consider holding sales tax holidays as a way to stimulate the economy.
Will holding a sales tax holiday benefit your business in the long run?
The evidence is doubtful. The New York Department of Taxation and Finance conducted a study of the state’s sales tax holiday on clothing. The results showed a spike in sales during the holiday but this was preceded by greater than expected reductions in sales before the holiday. In effect the holiday simply shifted sales that would have happened before or after the holiday to the holiday dates. Other studies by the University of Michigan and the University of Maryland show similar results.
Businesses owners and consumers start gaming sales tax holidays
In states where tax holidays have existed for years, consumers and businesses are becoming savvier about manipulating them. Consumers wait until tax holidays to buy. Retail business owners in many cases raise prices during tax holidays as a way to capture additional revenues. Consumers in effect are paying the same prices they would have paid without the holiday. Business owners pocket the difference. This negates the entire purpose of the holiday. Consumers don’t save money and businesses make a little extra on the margins, but this is offset by lower sales pre- and post-holiday—and the state government doesn’t see a boost to its revenues.
Before jumping onto the tax holiday bandwagon it’s important to consider the empirical evidence to determine whether or not it’s worth the effort involved. So far the evidence is doubtful. But given the “feel good nature” of a sales tax holiday we will most likely see their expansion in the coming years.