Tax Holiday

What Is a Tax Holiday?

A tax holiday is a government incentive program that offers a tax reduction or elimination to consumers or businesses for a temporary period. In the United States, tax holidays often involve state and local sales taxes paid by consumers, but governments also use them in developing countries to help stimulate foreign investment and business growth.

Key Takeaways

  • A tax holiday is a governmental incentive that temporarily reduces or eliminates taxes for consumers or businesses.
  • A tax holiday can encourage economic activity and foster growth.
  • Tax holidays are instituted by local governments as well as by national governments in developing countries to help stimulate foreign investment.
  • Some economists believe that tax holidays can increase long-term tax revenue, more than making up for the short-term loss in revenue.

How a Tax Holiday Works

When a government wants to encourage the purchase of certain items or bolster participation in certain activities, it may declare a tax holiday—a temporary period during which the tax rate it applies to particular products or services is reduced or removed.

Tax holidays can also ease the burden on consumers when important products experience a price hike due to market forces. In early 2022, for example, some officials were calling for the temporary elimination of both state and federal gasoline taxes in response to near-record-high prices at the pump.

Some tax holidays have become an annual tradition. For example, some state and local governments in the United States will have a sales tax holiday the weekend before school resumes in the fall to reduce the prices parents have to pay for their children's school supplies or clothing. By doing so, they also increase store traffic, which can mean more sales of other kinds of items. States can also declare a tax holiday to draw consumers from other, nearby states.

Researchers found that, on sales tax holidays, households increase the quantities of clothing and shoes they buy by over 49% and 45%, respectively, compared with what they would normally buy during that time frame.

Countries may also implement a tax holiday for businesses to encourage economic activity and foster growth. Developing countries sometimes use tax holidays to attract foreign investment or encourage foreign companies to establish a base there.

These tax holidays often target particular industries. In some cases, new businesses will be offered tax holidays to help reduce their costs of operation so they can focus on raising revenue and growing. This fiscal policy measure may also serve as an incentive for more people to start businesses.

Are tax holidays effective?

The overall benefit of tax holidays is still a matter of debate. On the one hand, even though the government loses out on tax revenues that would have been generated from sales during the temporary period, tax holidays may increase revenue over the long term because they help businesses stay in business and grow. In addition, the lost revenue may be offset by consumers' increased purchases of items in product categories that are not affected by the tax holiday.

On the other hand, increased sales during a tax holiday may be preceded by reduced sales before the holiday because consumers know they'll save money by waiting. Thus, the tax holiday simply shifts sales that would have happened before or after the holiday to the holiday dates.

Also, some retailers may take advantage of tax holidays by raising their prices, so that consumers who aren't paying close attention don't save as much as they think they're saving.

How Much Can You Save During a Tax Holiday?

How much money you can save during a tax holiday depends largely on the customary sales taxes in the state or locality where you're shopping. A few states, such as Delaware and Oregon, have no state sales tax at all. Other states, such as California and Rhode Island, charge 7% or more. When local sales taxes are figured in, total sales taxes in some areas can top 9%.

What Kinds of Products Can You Save on During a Tax Holiday?

The most common items subject to tax holidays in the U.S. include clothing, footwear, school supplies, and computers. Some states single out other products such as firearms and ammunition (Mississippi), generators and air conditioners (Texas), and sports equipment (West Virginia).

How Long Do Tax Holidays Last?

State tax holidays generally last from two to seven days, according to a list compiled by the Federation of Tax Administrators.

The Bottom Line

Tax holidays are a way that local or national governments can encourage consumer spending and business growth by cutting or eliminating sales and other taxes for a period of time. Though the government receives less tax revenue in the short term, it hopes that it will recoup that money, and more, over the long term.

Article Sources

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  1. The Hill. "Democrats Divided Over Proposal to Suspend Federal Gas Tax."

  2. The Hill. "States Consider Gas Tax Pauses as Prices Spike."

  3. Social Science Research Network. "The Effect of Sales Tax Holidays on Household Consumption Patterns."

  4. Board of Governors of the Federal Reserve System. "The Effect of Sales-Tax Holidays on Consumer Spending."

  5. Tax Foundation. "State and Local Sales Tax Rates, 2022."

  6. Federation of Tax Administrators. "2022 Sales Tax Holidays."

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