New York State enacted the first sales-tax holiday in 1997. Florida and Texas quickly followed suit, and by the 2000 legislative session, 21 states had considered the concept. The appeal is understandable: These targeted tax breaks take tangible advantage of state surpluses, help taxpayers save money and promote commerce with administrative ease and minimal political exposure. The seven states (including Connecticut, Iowa, Pennsylvania and South Carolina) that have held sales-tax holidays so far declare them "wildly successful." Maryland's is slated to begin in 2001.
But if this all sounds like a "win-win" situation, then you're probably not a local official. In the midst of their growing popularity with state legislators, consumers and merchants, the implications of such tax breaks on municipal governments--which assess sales tax in 29 states--have largely been overlooked. In fact, the whole issue of sales-tax holidays can create some intergovernmental strife--by pitting states against states, localities against localities, and localities against their own states.
Proponents of sales-tax holidays often frame the political debate in terms of helping out the little guy. "I think it's a real good tax cut for working families who really need the help," says Danny Hilliard, an Oklahoma state representative who sponsored a sales-tax-reprieve bill this year that failed to make it into law. "Most of the time, these families have to buy clothing. It's not a luxury--it's a necessity." But the real impetus for such legislation clearly comes from the retail community, which has the most to gain financially.
Generally speaking, sales-tax holidays take place in August to coincide with the back-to-school buying binge and last between two and seven days. During that time, qualified items that cost up to about $100 are exempt from state--and often local--sales tax. Exactly what merchandise is included varies from state to state, but it's usually limited to specific articles of clothing and footwear. Although backpacks, pencil cases and notebooks are at the top of most families' shopping lists, South Carolina and Florida are the only states to include accessories. In Pennsylvania, which already has exemptions on clothing, this year's weeklong holiday applied solely to the purchase of personal computers for home use.
Even though the holidays tend to be of relatively short duration, the revenue loss--or consumer savings, depending on one's perspective-- amounts to millions of dollars for states alone. For 1999, Texas calculated a $25.6 million tax-revenue loss for its three-day holiday; Florida sacrificed $34.7 million over nine days and New York forfeited $56 million over 15 days.
Retailers are quick to point out that states' losses may be partially offset by a rise in income-tax receipts related to the need to hire additional employees--just as occurs during the Christmas shopping season--and more revenue from corporate-income taxes due to a higher level of sales. There is also something called the "price effect": The more money that shoppers feel they are saving, the more they will spend. And not all of that spending is tax-exempt. A family out on a spree will most likely also spend money on taxable accessories, sports equipment and meals.
When Iowa held its first sales-tax holiday this summer, on August 4th and 5th, it was reminiscent of the day after Thanksgiving. "There were long lines at cash registers and the malls were packed," reports Jim Henter, president of the Iowa Retail Federation. That was good news for a state that had seen shoppers regularly flocking across its northern border to the Mall of America or other stores in Minnesota to take advantage of that state's long-standing sales-tax exemption on clothing.
The so-called "border effect" has been a particular thorn in the side of some state officials who have watched potential tax revenues drain from their coffers into those of neighboring states. That's what got the ball rolling several years ago in New York, which had been losing shoppers to other Northeastern states. Connecticut, Massachusetts, New Jersey, Pennsylvania and Vermont all have full or limited tax exemptions on clothing. An Arthur Andersen study, done before the Empire State implemented its holiday, found that for every 1 percent difference in sales tax between New York and its neighbors, per-capita sales were decreasing by 5 percent.
Southern Oklahomans, likewise, have been taking advantage of Texas' sales-tax holiday for their back-to-school shopping. While in Texas, they also buy "dinner, gas, Cokes, ice, a movie and maybe two or three nights in a hotel," says Joel Scott Mitchell, executive vice president of the Oklahoma Retail Merchants Association. So Hilliard, whose district borders on Texas, sponsored a tax-holiday bill that passed the House and Senate, but it languished in committee during appropriations battles. By letting the bill die, Mitchell laments, the state "lost an opportunity to suck money from Arkansas, Kansas, Missouri, New Mexico and Colorado."
Considering that there are four states without any sales tax on clothing, six with a limited sales tax and now eight with sales-tax holidays, there's clearly mounting pressure on the remaining states to either get on the bandwagon or be left behind. Hilliard vows to reintroduce his bill in the next session, and in the coming months, Nebraska and Georgia retailers are planning to push for tax holidays to counter programs in Iowa, Florida and South Carolina.
What's more, border battles occur not only between states but within them as well. Of the eight states with holidays, New York and Texas give localities the option not to participate. While this affords municipalities some financial security, they risk losing shoppers to neighboring jurisdictions. Local tensions have been magnified in New York since March when clothing purchases of--up to $110 per item-- became permanently exempt from the state's 4 percent sales tax. Localities are still permitted to opt out and keep their share of sales-tax revenue, which can be as much as 4.5 percent. Before the holiday became a fixture, "most counties supported it," says Ken Crannell, director of intergovernmental services for the New York State Association of Counties. "It was very targeted, with a limited impact on sales-tax revenue." Faced with giving up needed tax revenue for good, however, only 14 counties and five cities chose to go along with the state--leaving 48 counties and 25 cities with a sales tax.
Broome County is one of the largest counties along the state's borders that decided to suspend its sales taxes to keep New York shoppers in state. "We're getting even for all those years when people went to Pennsylvania to shop," says Broome County Executive Jeffrey Kahan. But he is just as interested in attracting shoppers from surrounding counties that continue to tax. To that end, the county has budgeted for a marketing campaign--likely to include billboards and radio spots--that will publicize Broome County as "A Sales-Tax-Free Zone" for clothing. So far this year, Kahan says, Broome County has made up any losses in sales-tax revenue from the sale of ancillary items. In fact, he claims that sales-tax revenues are up 5 percent over last year.
Assuming that at least a portion of those sales are due to out-of- county shoppers, some of Broome County's gains come at the expense of upstate counties that kept their tax. Looking at a potential loss of $8 million annually, Onondaga County felt it had to retain the levy. "Utilities are up this year, Medicaid costs are up. We just needed it to balance the budget," says county financial analyst Joan Ferrara.
Although the fiscal impact on localities in other states is less acute, primarily because their tax holidays last only for a couple of days, there is an underlying current of concern about what might happen in the future. In Texas, the three-day sales-tax holiday that began in 1999 initially caused little alarm. "The economy was doing so well," says Frank Sturzl, executive director of the Texas Municipal League, "that whatever ill effects there might be would have been masked." Recently, however, Lone Star lawmakers have been talking about expanding the holiday over two weeks (and three weekends) in August. Sturzl says his organization would actively oppose such a move. "The loss of sales-tax revenue would become obvious," he explains, and "that will hurt."
Three of the eight states with sales-tax holidays must revisit and renew them each year. Such an approach at least provides governments with a regular means of evaluating whether they can afford their program. It seems likely that as long as the economy keeps on humming, states (and some localities) will continue to jockey for advantage. And it's interesting to ponder whether the popularity of sales-tax holidays might eventually negate their effectiveness.
