Sales Tax Breaks Erode State Revenues

As shoppers in 15 states rush to buy tax-free clothing and school supplies this August, some lawmakers are experiencing buyer’s remorse: Their “sales-tax holidays” are pinching revenues at a time when state coffers are hurting.

Nearly all of the states offering sales tax breaks this month estimated they could miss out on millions of dollars in income when they could least afford it in this recession-ravaged climate, according to data provided by state budget offices.

Fearing those losses, three states – Florida, Maryland and Massachusetts – recently canceled their much-anticipated tax-free weekends in August. The District of Columbia decided in July to suspend its first of two annual tax breaks.

Generally, tax holidays are mixed blessings for states, even when their budgets are intact. On one hand, the breaks – which last a day to a few months – are very popular. Parents appreciate the lower prices, stores value the uptick in business and lawmakers prize constituents’ support.

But tax-free holidays also deprive states of important revenue, often beyond the tax-free period, said Mark Robyn, a staff economist at the non-partisan Tax Foundation . The increase in sales on these days can trigger a decrease in sales later in the year, as consumers plan their shopping sprees around the tax calendar, he said.

“Anything that’s reducing states’ already depleted tax collections is not a good thing, especially a policy like this that has problems in good economic times,” explained Liz McNichol, a senior fellow at the Center on Budget and Policy Priorities . “Research says (tax holidays) really just move sales from one period to another, so it’s not creating new economic activity; it’s not stimulating business.”

Consequently, some states this year have re-evaluated how long – if at all – they offer temporary tax breaks. Massachusetts, for example, hiked its sales tax from 5 to 6.25 percent in June to address the $5.1 billion deficit troubling its 2010 budget. But if Beacon Hill had approved the sales-tax holiday lawmakers debated July 31 – what would have been the sixth tax holiday in six years – the state could have missed out on up to $15 million in revenue, state officials said.

Washington, D.C. lawmakers suspended the city’s back-to-school sales tax break 12 days before the holiday. For the first time since 2004, D.C. buyers lost nine days of tax-free shopping on clothing, shoes and school supplies costing less than $100 each. District officials estimated this move would bring in $640,000 to the budget at a time when the city is struggling to tame a $666 million deficit.

Other states, however, are planning to weather the predicted losses. In Vermont, where lawmakers struggled to overcome a $282 million deficit, the Department of Taxes fears its approaching tax-free day could deprive the state of about $2.2 million in revenue, said Susan Mesner, one of the department’s tax economists.

“It’s a political thing,” Mesner said, noting this year’s proposal faced considerable opposition in the legislature. “There’s a lot of research out there that shows (the holidays) aren’t an effective tool, and there’s concern in a number of corners about lost revenue. But they are heavily supported by businesses and retail associations.”

States can bear the brunt of the tax holidays in other ways as well. Oklahoma lawmakers, for example, built a holiday into their tax code in 2007 to compete with nearby Texas, which debuted its tax-free weekend in 1999. But in 2008, Oklahoma’s holiday deprived state coffers of about $6.6 million in sales tax revenue. And because cities and counties were obligated to participate in the tax holiday, lawmakers forked over an additional $3 million that year to the local governments, thanks to a provision that guaranteed the state would compensate local jurisdictions. Its third annual back-to-school holiday – an exemption on clothing items $100 and under – takes place this weekend (Aug. 7-9).

Yet, lawmakers insist these “losses” – which they call “consumer savings” – obscure the intent of a sales tax holiday: It allows struggling families to purchase school supplies and back-to-school clothes at cheaper prices. But tax analysts contend that brief changes to the tax laws – no matter how temporarily beneficial – do very little to help consumers’ finances in the long term.

“From a policy perspective, we would prefer all sales be treated the same,” Robyn of the Tax Foundation said. “If states want to provide real tax relief and provide a real benefit to the economy, they would lower the sales tax rate on all goods year-round by a comparable rate.”