Taking a Holiday from Common Sense: Proposed National Sales Tax Holiday Offers Questionable Benefits to Consumers

December 24, 2008 12:17 PM | | Bookmark and Share

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In a December 23 letter to President-elect Barack Obama, the National Retail Federation (NRF) suggested that Obama’s pending stimulus plan should include a provision for a series of nationwide “sales tax holidays” during which consumers would pay no state sales taxes on their purchases. The NRF proposal would suspend all state sales taxes for three ten-day periods during 2009. But the actual benefits to consumers from a tax holiday would be more uncertain—and less immediate—than the stimulative impact of direct federal spending.

How Would a National Sales Tax Holiday Be Implemented?

The NRF’s letter to Obama suggests three temporary “holiday” periods of ten days each, in March, July and October of 2009, during which state governments would not collect sales tax on transactions that would normally be taxable under state tax laws (with the exception of tobacco and alcohol). This means that every item sold, from a hamburger to a new car, would be exempt if purchased during any part of this thirty-day period in 2009. (During the other eleven months of the year, of course, these items would all be taxable.)

The NRF suggests that state governments would voluntarily not collect sales tax revenue during these three ten-day periods, and would be entirely reimbursed for their revenue loss by the federal government. The five states that do not levy state sales taxes would each receive grants approximating the amounts given to a sales-tax state with similar populations.

Who Benefits from Sales Tax Holidays? Lessons from the States

The idea of a temporary sales tax holiday is not a new one: more than fifteen states have enacted a temporary holiday from their state sales tax in recent years. These holidays average 2 or 3 days in length, and usually apply to specific items such as back-to-school supplies. These holidays are consistently popular among elected officials because they are among the most visible tax cuts available (what other tax cut gets free advertising from retailers? ) and because they cost less than permanent tax cuts.

It’s no mystery why lawmakers like sales tax holidays—but it’s far less clear whether these holidays end up primarily benefitting consumers or retailers. On its face, a “holiday” from a 5 percent sales tax should reduce consumer prices by 5 percent. But retailers can take advantage of a tax holiday by increasing their prices (or failing to reduce them by the full 5 percent) during the tax holiday. And there is some evidence that Florida retailers did exactly that during a sales tax holiday there: one study found that up to 20 percent of the potential benefits from that state’s sales tax holiday were reclaimed by retailers in the form of higher prices.

There are also questions about how families at different income levels would be affected by a tax holiday. Sales taxes hit low-income families hardest, so a permanentsales tax cut will offer the biggest benefit to less well-off families. But temporary tax cuts offer the biggest benefit to those consumers who can afford to delay their purchases to coincide with the tax holiday. Since low-income taxpayers frequently spend most of their income just getting by, these families don’t have the luxury of shifting the timing of their spending in this way. By contrast, wealthier taxpayers are more likely to be able to delay their purchases.

Of course, to the extent that a tax holiday simply shifts the timing of consumption rather than increasing it, the stimulative impact of such a plan would be sharply reduced. Given the choice between paying sales tax on a new car in January and buying the car tax-free in March, many sensible consumers will wait until March. But it’s hard to see how encouraging consumers to delay their purchases two months can be seen as an economic stimulus.

If consumers delay their purchases, that will also increase the likelihood that the sales tax holiday turns out to be a net revenue loss for the states, since federal reimbursements to the states would have to be based on sales tax forecasts rather than actual retail sales. “Dozens of states already face huge budget shortfalls this year,” noted CTJ State Tax Policy Director Matt Gardner. “State lawmakers’ first goal right now is likely to avoid painful spending cuts, not to blow a new hole in their sales tax base.”

There are also questions of timeliness. Everyone agrees that any stimulus legislation should be enacted quickly. But it would be difficult to promptly implement the tax holiday, as it would require not only Congressional approval but also immediate legislative action in each of the 45 states that levy state sales taxes.

Lastly, the NRF proposal presents troublesome design questions:

  • Should stimulus dollars be sent to the very richest Americans? A sales tax holiday would make no distinction between low-income families in danger of losing their homes and well-off families whose consumption has been unaffected by the economic downturn.
  • Why should the federal government pay for a holiday for state sales taxes, but not for local taxes? Doing so gives a much bigger break to a wealthy state like Connecticut, with a 6 percent state tax and no local tax, and penalizes poorer states like Louisiana, which has a state tax of 4 percent and local taxes averaging more than 4.7 percent.
  • Who would pay for the worker training and computer programming costs that retailers would incur in preparation for the tax holiday?
  • Does it make sense to give the biggest tax breaks to consumers living in the states that have the highest state tax rates and the broadest tax bases? Consumers living in states that have made their sales taxes less unfair by exempting groceries and utilities will get less under the NRF plan.

Achieving Federal Stimulus: Better Alternatives

The NRF’s rationale for its tax holiday idea is a good one: they hope that it will “help stimulate consumer spending.” But a better way to achieve this goal is short-term government action that will immediately boost spending. Increasing food stamps or extending unemployment insurance benefits are targeted forms of financial assistance that will likely have this effect.

As many economists have suggested, tax cuts are simply a less direct stimulative tool than direct spending. “Federal aid to state governments can be stimulative if it goes towards ‘shovel ready’ projects or allows the states to avoid cutting essential services,” noted Gardner. “But a federally-funded state sales tax holiday would be an administrative nightmare for Congress and the states, and offers benefits to consumers that are neither immediate nor clear.”

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Auto Industry Bill Would Have Expanded the Infamous “Wells Fargo Ruling” and Provided a Bailout for Illegal Tax Schemes

December 12, 2008 02:17 PM | | Bookmark and Share

If Congress decides to again consider legislation to save the automobile industry from collapse, it should exclude (or dramatically revise) two tax provisions included in the bill approved by the House of Representatives and rejected by the Senate this week.

The first provision would waive a section of the tax code (for the auto industry only) that prevents the use of mergers as abusive tax shelters. The second provision would essentially provide a bailout for public transit agencies suffering from the consequences of participating in an illegal tax scheme.

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Principles for Progressive Taxation During a Recession

December 4, 2008 02:00 PM | | Bookmark and Share

The recession faced by the United States has changed the nature of the debate over taxes. Questions of who should pay how much to fund public services have been replaced with questions about how quickly we can boost the economy with tax cuts or government spending that is not paid for. Some of the points raised in this debate have been quite valid, while others have been more problematic. While raising taxes to balance the federal budget is not a high priority during an economic downturn, this should not be used as a justification for enacting unlimited tax cuts without replacing the lost revenue in the future. The following principles can guide the search for a rational and fair tax policy that will mitigate the recession without causing long-term fiscal damage.

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Latest State-by-State Data Show Why Obama Should Scale Back His Proposal to Cut the Estate Tax

December 3, 2008 01:59 PM | | Bookmark and Share

New estate tax statistics from the IRS show that the percentage of deaths resulting in federal estate tax liability is below one percent nationally and in most states and continues to fall. Under the tax cut enacted by President Bush in 2001, the federal estate tax is being reduced gradually over the decade (meaning the exemption for estates is gradually increasing while the tax rate is gradually decreasing) until it disappears entirely in 2010. Like almost all of the Bush tax cuts, the gradual changes in the estate tax expire at the end of 2010. If Congress simply does nothing, the federal estate tax will be repealed for 2010 but then return in 2011 in a form much closer to what existed at the end of the Clinton years.

President-elect Barack Obama has proposed a change that would prevent the estate tax from disappearing in 2010, but which would also unnecessarily cut the estate tax below the level it would reach in years after 2010 if Congress simply does nothing.

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