What Is a Tax Holiday? How They Work, Examples, and Effectiveness

What Is a Tax Holiday?

A tax holiday is a temporary tax break. In the United States, tax holidays often suspend state and local sales taxes paid by consumers.

Governments also use tax holidays as investment incentives that may exempt a new plant from property taxes for a number of years, for example.

Key Takeaways

  • A tax holiday is a governmental incentive that temporarily reduces or eliminates taxes for consumers or businesses.
  • The objective of a tax holiday is to encourage economic activity and foster growth.
  • Tax holidays may also be offered to businesses as an investment incentive.
  • There is ongoing debate about whether the benefits of tax holidays justify their costs.
  • Some states that have offered sales tax holidays in the recent past have canceled them amid political opposition.

How a Tax Holiday Works

When a government wants to encourage consumer spending or business investment it may offer a tax holiday—a temporary period during which certain taxes are reduced or lifted altogether.

Tax holidays may also seek to offset the effect of market-based increases in prices. This was the case with gas tax holidays instituted by some states and advocated by President Joseph Biden in 2022 in response to sharply higher prices at the pump.

Sales Tax Holidays

Some tax holidays have become an annual tradition. For example, some state and local governments in the U.S. offer a sales tax holiday the weekend before school resumes in the fall to reduce parents' outlays for school supplies.

The goal is to increase store traffic, which can boost overall spending. States declaring a tax holiday may also hope to draw consumers from other nearby states.

Business Investment Tax Holidays

National or local governments may also offer a tax holiday for businesses to foster growth. Developing countries sometimes use tax holidays to attract foreign investment.

Tax holidays focused on business investment may be defined based on the location of the investment, as with the Opportunity Zones created by the Tax Cuts and Jobs Act of 2017. These defer capital gains taxes on funds reinvested in qualifying projects within designated low-income areas.

Alternatively, business investment tax holidays may target particular companies or industries. For example, the state of Wisconsin initially offered $2.85 billion in tax credits to Taiwan electronics manufacturer Foxconn. However, it scaled that back to $80 million when Foxconn failed to follow through on plans to invest $10 billion in a new plant in the state.

Some researchers found that sales tax holidays led households to increase purchases of clothing by more than 49% and shoes by more than 45%. Others have concluded that the regressive nature of sales taxes on lower-income families throughout the year overrides the benefits they may obtain from a few annual holidays.

Are Tax Holidays Effective?

The net benefit of tax holidays is still up for debate. On the one hand, even though the government loses out on tax revenues that would have been generated from sales during the tax holiday, such tax breaks may increase revenue over the long term because they stimulate spending and investment.

In addition, the lost tax 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 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.

One study found that a weekend-long broad sales tax holiday in Massachusetts increased spending in the state over the entire month and relative to that in neighboring states.

Some retailers may take advantage of tax holidays by raising their prices, effectively pocketing some of the subsidy intended for consumers.

Perhaps not coincidentally, retailer groups have been among the strongest advocates of sales tax holidays, while lawmakers in several of the states that have offered them in the recent past have grown more skeptical of the concept.

How Much Can You Save During a Tax Holiday?

That 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. Others including California and Rhode Island charge 7% or more. When local sales taxes are added, 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), or 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 policy can certainly affect consumption and investment. The notion that a sales tax break on some or all consumer goods for a few days in a year could permanently increase sales and prosperity has been a harder sell, despite its obvious attractions for retailers, shoppers, and politicians.

Business investment tax breaks invite neighboring jurisdictions to offer incentives of their own in a beggar-thy-neighbor race to the bottom, while risking sweetheart deals for favored businesses from friendly politicians.

A tax holiday may provide a temporary economic boost but it is not the proverbial free lunch.

Article Sources
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  1. The White House. "Fact Sheet: President Biden Calls for a Three-Month Federal Gas Tax Holiday."

  2. Tax Foundation. "Does Your State Have a Sales Tax Holiday?"

  3. IRS. "Opportunity Zones."

  4. Reuters. "Foxconn Mostly Abandons $10 Billion Wisconsin Project Touted by Trump."

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

  6. Institute on Taxation and Economic Policy. "Sales Tax Holidays: An Ineffective Alternative to Real Sales Tax Reform."

  7. Federal Reserve System. "The Effect of Sales-Tax Holidays on Consumer Spending."

  8. Stateline. "In Some States, Sales Tax Holidays Lose Luster."

  9. Tax Foundation. "State and Local Sales Tax Rates, Midyear 2023."

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

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