Sales Tax Holidays Make for Terrible Tax Policy

This weekend Virginia and Maryland begin a sales tax holiday for the worthy-sounding goal of helping to reduce the cost for parents shopping for school clothes and supplies for their children. But a sales tax holiday makes for terrible tax policy.

The problem is that most of it is inevitably captured by the merchants, who anticipate increased demand for their goods during the holiday and respond by keeping prices higher than they otherwise would be. As a result it utterly fails to achieve its ostensible purpose. 

It’s easy to see that this is true if we considered doing the opposite and had a short term sales-tax spike. With a short-run sales tax spike people would do their best to evade the tax–either by delaying their shopping until the tax expired or shopping elsewhere. Stores would be forced to eat most of the tax if they wanted to keep their customers coming to the store during the spike. If the increase were permanent no such evasion would be possible and stores would fully pass the tax to the customer. In the long run such evasion would be difficult or impossible so prices would rise enough to pass the tax along to the customer.

A sales tax holiday, and the attendant publicity that comes with it, pushes shoppers to hit the stores during that period. Savvy store owners respond by holding more sales before and after the holiday, knowing that the holiday makes makes such sales unnecessary. Studies on tax holidays confirm this behavior. 

Sales tax holidays not only fail to save shoppers any money but they also allow politicians to pretend they are doing a tax favor for their constituents, and help convince a few voters that their state’s tax code isn’t all that bad after all. The reality is otherwise.