When a state starts to move away from sound tax policy, even if it does so with the best of intentions, unintended consequences can abound. Exempting certain goods and services from taxation is a literal example of government “picking winners and losers.”
A sales tax holiday is a limited time period during which a state frees purchases of specific items from state and local sales tax. At first glance this seems like a good policy for consumers, especially since it means getting a break when people are already being pinched by high inflation as they are right now. The bottom-line reality, though, is different.
Even as sales tax holidays appear to represent a form of tax relief, research has found that retailers increase their prices to capture much of the savings, resulting in less of the relief that politicians intend for consumers. On the other side of the ledger, the 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 out even more property tax revenue.
During recent legislative sessions, including the present one, some Iowa lawmakers have proposed expanding the current sales tax holiday to include emergency preparedness supplies. Instead of adding more carve-outs, Iowa should, instead, repeal the policy that’s already in place.
A common agreement among economists and public finance scholars is 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 that gets introduced begins to erode that base. Often exemptions will only end up delivering political benefits and little else.
When a state starts to move away from sound tax policy, even if it does so with the best of intentions, unintended consequences can abound. Unfortunately, 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.
Exempting certain goods and services from taxation is a literal example of government “picking winners and losers.” Though 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. Both groups are left wondering what will qualify for the exemption and what will still be subject to the tax?
Though it is a counterintuitive idea, the fairest sales tax for taxpayers and tax-collecting businesses is one that only exempts business inputs and includes all final consumer goods and services. This policy enables the lowest possible tax rate to be collected on goods and services and has the simplest rules for compliance.
Tax reforms enacted over the last few years have put Iowa on a good path forward. The state should continue its momentum by focusing on a tax code with more beneficial reforms: a broader base with fewer exemptions, more certainty and less complexity, and of course, across-the-board tax rate reductions.
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