Personal Finance

Tax holidays may not be the bargain you think they are

Key Points
  • Saving some cash always feels good, but sales-tax holidays come with a price tag that consumers don’t always see.
  • "The holidays appear to be a gesture that helps these struggling families and relates to education,” says Dylan Grundman of the Institute on Taxation and Economic Policy.
BSIP | Universal Images Group | Getty Images

Everyone loves a bargain.

Except when the bargain doesn't really save you money.

It may feel great not to pay tax for back-to-school clothes and backpacks, but the Institute on Taxation and Economic Policy says sales-tax holidays do little to help students, teachers and public schools.

The lift on taxes can last an entire week in some places but for the most part takes place over a weekend around the time people are shopping for back-to-school supplies. Shoppers get a break on sales tax for items such as backpacks and clothing, up to a set dollar amount.

The tax-free periods are popular because they tell a feel-good story that seems to address real issues.

"The holidays appear to be a gesture that helps these struggling families and relates to education," said Dylan Grundman, senior policy analyst at the Institute on Taxation and Economic Policy.

In fact, very little of that benefit gets to families, Grundman says.

"Lower- and middle-income families are less able to time their shopping to make sure they get those deals," Grundman said. People with higher incomes, on the other hand, have more time and the resources — whether child care, free time or access to a car — to shop around and make sure they are saving.

A win for retailers

Stores know these events bring more shoppers in to look for bargains. "It's free advertising," Grundman said. "There is evidence that to some extent stores will raise prices and delay sales." In other words, some of the benefit is being soaked up by retailers.

Sales-tax holidays are a partnership, according to Verenda Smith, deputy director of the Federation of Tax Administrators, but it's a partnership that creates winners and losers.

Among the winners are retailers, which may make out better than the states. Retailers do the heavy lifting to advertise, but they gain in sales and foot traffic.

States, on the other hand, lose revenue, Smith says. The holidays are passed by the legislature and treated like any other expense. In order to balance the budget, states may have to spend less or drop funding on another program.

Tax agencies dislike tax holidays, Smith says. "It's a fair bit of work, and it invites noncompliance," she said.

The state makes a decision to pay for a sale on behalf of a certain segment of retailers. "This generally runs counter to the basis of good taxation," Smith said. Ideally, that is a broad base with a low rate of taxation, and the playing field should be relatively even.

People will not cross the street to save 5 percent on jeans, but they'll take a day off from work to go to a sales-tax holiday.
Verenda Smith
deputy director, Federation of Tax Administrators

Consumers may be winners, but that's debatable.

Some consumers may actually bank the money saved, but Smith says this is not always the case. "People will not cross the street to save 5 percent on jeans, but they'll take a day off from work to go to a sales tax holiday," she said. "Then, the money they save they'll spend on an extra dessert at lunch or a nicer lunch."

The reason is that it feels free, though it is not free. "Taxpayers are supporting this in real dollars and that is why you are seeing more public debate against them," Smith said. And, she added, depending on state budgets, they certainly come and go.

Who's in, who's out

This year, 17 states are holding tax holidays, up from last year's 16. The peak year was 2010, when 19 states participated, according to the Tax Foundation

Most of the sales-tax holidays have passed, but four states will hold an event later in August.

This year, Wisconsin held its first sales-tax holiday. Louisiana suspended its program in July, after 10 years, for financial reasons.

"They had a major budget crisis to deal with after their temporary tax breaks expired," Smith said.

New York state permanently ended sales tax on clothing up to $110 last August.

In fact, people who like to sew or knit or crochet get a break on state taxes on some supplies. So-called yard goods and notions — which includes yarn, fabric, thread and related items — are not taxed because they could be used to make clothes.

The bottom line, says Grundman at the Institute on Taxation and Economic Policy, is that the policies distract from the real issues that families and states are going through. "That money could be put to policies that deliver more bang for the buck," he said. More carefully crafted tax credits "can really target the families and the teachers you are trying to reach."

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