The Strange Spending Trends Around Sales Tax Holidays

The summer season is here, and while most of us tend to associate that with spending on sunblock, grilling meats and bathing suits, the reality, particularly for American parents, is that summer is also the time to start spending for the next school year. While by the end of July school is a distant memory for most children, by early August parents have not only been thinking (or daydreaming) about their beloved children returning to school, they’re almost halfway through their shopping for it.

According to the National Retail Federation, as of last year parents entered August with about 45 percent of their back-to-school shopping done.  And though that figure fluctuates a bit from year to year — to an all time high point in 2013 when 52 percent of back-to-school shopping was done by early August, from a low point in 2012 when the figure slipped down to 40 percent — it tends to stay snuggly in the middle range.

That spend is big spend. Retailers have reason to want to tap into it because back-to-school shopping is an incredibly valuable run of commerce activity.

In 2017, Americans spent $83.6 billion on back-to-school shopping, and while that number is expected to slide slightly in 2018 to $82.8 billion, it is still a more valuable run of commerce activity than Mother’s Day, Father’s Day, Easter and Valentine’s Day combined — which is why state tax holidays placed at the end of July and beginning of August have become so very popular over the last two decades. This year 17 states will have sales tax holidays of one form or another — up from 16 last year, but down from the national high of 20 states in 2010.

And while sales tax holidays are always politically popular, and favored by consumers, there remain two large question marks around their usefulness, as showcased in two Federal Reserve studies: whether they actually encourage new spending, and whether they encourage spending among the right consumers.

How Tax Holidays Work

The first income tax holiday experiment was done in New York State in the summer of 1997, and the perception that the high-tax state had managed to achieve a signifiant revenue boost via a weekend-long tax holiday kicked off the trend in the U.S.

However, every tax holiday is a bit different, and what state a consumer resides in determines how much of a break they are getting from sales tax. Some states, like Louisiana, cut the overall sales tax rate — from 5 percent to 3 percent in Louisiana’s case. Most states offer a tax holiday on items specific to back-to-school shopping — clothing, footwear, supplies and backpacks make almost every list — while some states also allow for tax-free sales of computers or other peripheral electronics.

Massachusetts’ legislature has not yet fully approved its pending 2018 tax holiday, but if passed by the state Senate it would be the nation’s most permissive, fully suspending all state sales tax across purchases under $2,000 for the entire weekend of August 11 and 12. Governor Charlie Baker has also recently signed legislation that would make the retail sales tax holiday an annual event enshrined in law as of 2019.

The basic operating theory under these holidays is driving consumers — who can be counted on to do back-to-school shopping no matter what if they have children — into stores and spending, while at the same time hooking consumers who may not be parents but would like to get a good deal on a pair of sneakers or a new computer. And once they are already in stores, consumers are generally more likely to bulk up their baskets with various impulse buys that may be only tangentially connected to their back-to-school shopping mission.

“At first glance, sales tax holidays seem like great policy. They enjoy broad political support, with backers arguing that holidays are a highly visible form of tax cuts and provide benefits to low-income consumers. Politicians and other supporters routinely claim that sales tax holidays improve sales for retailers, create jobs, and promote economic growth,” wrote the Tax Foundation in a recent report on tax holidays.

The problem, they argue, is that they don’t quite deliver as much as they promote — and can be a costly path to merely modest retail gains.

That conclusion has some backing in two reports by the Federal Reserve.

Do Tax Holidays Work?

That question, as it turns out, is somewhat complicated.  The Tax Foundation is one of many groups have argued that while popular, tax holiday programs are actually bad policy that tend to be more costly to states and municipalities in revenue than they helpful are helpful to either merchants or consumers.

That position, in light of data, however, is perhaps a bit strongly worded. Tax holidays can be helpful, and generate revenue in some conditions — it just depends on how they are done and where they are focused. A study by the Fed found, for example, that where tax holidays are broadly focused, with a general suspension of sales tax (as opposed to taxes on specific goods), they tend to perform better.

“Evidence from a natural experiment in Massachusetts suggest the sales-tax holiday provided a net boost to retail spending over the month as a whole, as opposed to only a re-timing of spending within the month,” the Fed wrote in its report.

But more goods-focused holidays — the type that are far more common among states holding tax holidays — tend to be less effective for generating spend.

Most of the time, the Fed notes, such holidays just moved the spend, with consumers holding out until the holiday to make their purchases. States see a big swell in commerce on those sales tax-free weekends, according to the Fed, but they are more likely to be leveled out when it comes to judging monthly performance.

Moreover, a study from the Federal Reserve Bank of Chicago found tax holidays often aren’t terribly helpful to the working-class consumers they are aimed at helping.

“The dates for STHs are often chosen to coincide with periods of high seasonal demand, such as back-to-school shopping periods, with the intention of providing relief to lower-income, liquidity-constrained households or those otherwise deemed worthy of tax relief by policymakers,” the report noted. In justifying Illinois’s 2010 holiday, the lead sponsor said, “[w]orking families with kids going back to school, we want to give them a break.”

The problem is, by the numbers, the programs are actually much more likely to give affluent parents that break than working-class parents.  According to the Chicago’s Fed’s study, sales tax holidays led to “no statistically significant change in consumption” during sales tax holidays for households earning less than $30,000 a year. Households earning more than $70,000 per year, on the other hand, increased the amount of clothing they purchased during sales tax breaks by 48 percent.

“Wealthier taxpayers are often best positioned to benefit from the holidays since they have more flexibility to shift the timing of their purchases to take advantage of the tax break,” the report said, noting working-class customers have less flexibility to shift their spend, because they are more likely to be living from paycheck to paycheck.

Affluent consumers driving more spend is the norm almost by definition, of course — and it is good news for retailers if tax holidays are inclining households with near or above six-figure incomes to spend more on clothing.

Is it enough of a difference to make up for the estimated $300 million states lose out on in revenue to provide the tax holidays to start with?

The data, at best, remains mixed.