Sales tax holidays create complexities for tax code compliance, do not promote economic growth or increase consumer purchases, and distract policy makers from truly beneficial tax reforms.
School starts for most Iowa students on August 23rd, which means families have already received their back-to-school shopping lists. What better way to get ready for school than to shop during Iowa’s Sales Tax Holiday, Friday and Saturday, August 4 and 5? A tax holiday is a limited period of time during which certain items are free from state and local sales taxes, only clothing and footwear with a selling price less than $100 in Iowa. While this idea sounds like a good way to give families with school-aged children a tax break, it’s not the best policy for states crafting prudent budgeting and tax policy.
Iowa Background
Iowa implemented its sales tax holiday, held annually on the first Friday and Saturday of August, in 2000, and it has become popular particularly because of its alignment with back-to-school shopping. During the last few legislative sessions, some Iowa lawmakers have unsuccessfully proposed extending the holiday, while others have introduced legislation to expand it to include emergency preparedness supplies.
The Numbers
The Iowa Department of Revenue estimates the state missed out on $4.7 million in revenue during a recent sales tax holiday. Adding emergency preparedness to the list of tax-free items would reduce revenue to the General Fund, the Secure an Advanced Vision for Education (SAVE) Fund, and the local option sales tax (LOST) by an additional $3.6 million, for a total exemption of $8.3 million per year. This reduction of funds to Iowa schools and local governments generated by SAVE and LOST programs will affect local government decisions, perhaps pushing them to seek even more property tax revenue.
Other States
Nationwide, sales tax holidays were not very popular until 1997, when New York tried the policy as a solution to citizens’ practice of border shopping — traveling to nearby states to take advantage of lower sales tax rates. The idea caught on, and a wave of states adopted such opportunities, although New York has since abandoned its own. In 2023, 18 states offer sales tax holidays at some point during the year, up from 17 in 2022, but down from a peak of 19 states in 2010.
Policy Considerations
Proponents of sales tax holidays argue that they promote economic growth and provide tax relief. Experience and academic studies have proven sales tax holidays accomplish neither.
Research has shown that individuals do not increase their spending but instead shift the timing of purchases they already intended to make. For most who shop during sales tax holidays, the exemptions simply provide a modest and unexpected benefit for doing something they would have done anyway. And while sales taxes are somewhat regressive, this policy in no way provides meaningful relief to low-income individuals and provides a break to higher-income families, as well. Moreover, low-income families or childless couples who have no need for school clothes are just as deserving of tax relief as those who purchase exempt products.
Economists and public finance scholars commonly agree that a well-structured sales tax should extend to all final consumer purchases, whether goods or services, building up a solid sales tax base. Each exemption erodes that base, often delivering political benefits and little else. Exempting certain goods and services from taxation is a direct example of government “picking winners and losers.”
Although policymakers may intend to make the sales tax less burdensome for their constituents by supporting exemptions, narrowing the base for special sales tax holidays adds confusion for consumers and retailers alike. For example, Iowa exempts clothing and footwear, but this does not include any special clothing or footwear designed primarily for athletic activity. And what about clothing sets that include items not exempt, like hairbands or belts?
Additionally, large population centers just over the state line in the Quad Cities, Omaha/Council Bluffs, and Sioux City raise the question of how much of the tax break goes to those living in Illinois, Nebraska, and South Dakota. None of these bordering states offer a sales tax holiday.
Takeaway
When a state moves away from sound tax policy, even if it does so with the best of intentions, unintended consequences inevitably follow. Sales tax holidays create complexities for tax code compliance, do not promote economic growth or increase consumer purchases, and distract policy makers from truly beneficial tax reforms.
Tax reforms enacted over the last few years have put Iowa on a good path forward. The state should continue its momentum by removing underwhelming tax exemptions and continue to seek out more-beneficial changes to our tax code.
Print a PDF