Revenue-rich states offer targeted sales tax breaks as inflation skyrockets

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As a new school year looms for students, Texas is once again giving parents and guardians a break by suspending sales taxes on apparel and school supplies particularly at a time inflation is hammering household budgets and its coffers are overflowing with cash.

The three-day tax holiday — an annual event in the Lone Star state since 1999 — starts on Friday and is expected to save back-to-school shoppers, and cost Texas and its local governments, an estimated $112 million.

Texas is among 19 states holding a total of 34 sales tax holidays in 2022, according to the Federation of Tax Administrators (FTA). That’s up from 23 holidays in 16 states in pre-COVID pandemic 2019 and 27 in 17 states in 2021.

Several states are giving shoppers temporary breaks from sales taxes on school supplies and other items this year amid strong revenue collections, even as critics say they will do little to ease the impact of high inflation.

Bloomberg News

The Institute on Taxation and Economic Policy said this year’s sales tax breaks will cost states and local governments more than $1 billion, up from an estimated $550 million last year.

“Local jurisdictions like cities and counties — which often have few revenue options and have to rely on sales taxes to fund important priorities like roads, parks and police and fire protection — rarely have a choice in the matter of sales tax holidays,” the institute said in a July report, noting that only Alabama, Mississippi, and Missouri allow localities to opt out of the holidays.

It added, the temporary breaks do nothing to change the “inherently regressive” nature of sales taxes.

“In the long run, sales tax holidays leave a regressive tax system unchanged, and the benefits of these holidays for working families are minimal,” the report said. “Sales tax holidays also fall short because they are poorly targeted, cost revenue, can easily be exploited and create administrative difficulties.”

The temporary tax breaks reached a peak of 19 states in 2010, according to Janelle Fritts, a policy analyst at the Tax Foundation, which is not counting two states on the FTA’s 2022 list — Illinois, with a reduced sales tax rate for its back-to-school holiday this month, and Nevada, which is holding a tax holiday in October only for National Guard members.

She said the holidays are viewed by the foundation as “a short-term gimmick” that distracts from real tax relief and their existence is “an implicit recognition that there is something wrong with the sales tax.”

“Some of this motivation is coming from the fact that states are really flush with cash right now and they are also looking for ways to reduce the burden on people who are already struggling to afford things with inflation,” Fritts said. “But a sales tax holiday is not the way to do it.”

Lucy Dadayan, senior research associate at the Urban Institute, said state sales tax growth was strong in fiscal 2022 due to pent-up demand, “revenge” spending, and rising prices. Collections for all states that impose a sales tax, except Nevada and New Mexico for which data was not available, totaled $360 billion from July 2021 through May 2022, up 15.7% over the same period in 2020-21.

“However, growth in sales tax revenues has substantially weakened or even declined in some states in the months of April and May,” Dadayan said. “That’s likely attributable to consumers starting to tighten their wallets due to elevated inflation and as the pandemic savings are being drained.”

Inflation continued its spike in June, with the Consumer Price Index climbing 9.1% on an annualized basis, the largest 12-month increase in 40 years, according to the U.S. Bureau of Labor Statistics. The rise in prices, particularly for consumer goods, has boosted sales tax collections.

“The overarching theme is really ‘sure (sales tax holidays) provide some relief on the individual level,’ but when you’re dealing with inflation at a 40-year high, it’s hard to really counteract that with some of this relatively small relief,” said Shannon Seery, a Wells Fargo economist.

In a statement last week, Texas Comptroller Glenn Hegar said, “with inflation driving prices higher on just about everything, this sales tax holiday provides Texas families some small relief managing the costs associated with kids heading back to the classroom.”

The school-related tax suspension will result in an estimated $112 million in lost state and local revenue. Texas collects a 6.25% tax while its local governments can impose a tax of up to 2% for a maximum combined rate of 8.25%.

The hit to the state’s budget is minimal. With a month to go before fiscal 2022 ends on Aug. 31, Texas has collected $35.43 billion in sales taxes, just 1.7% shy of fiscal 2021’s record $36 billion.

Last month, Hegar released a revised revenue estimate that more than doubled the projected budget balance at the end of fiscal 2023 to nearly $27 billion from $12 billion. Sales taxes, the state’s top revenue source, has been generating average monthly collections of $3.5 billion with inflation being a significant factor, he said.

The abundance of cash also allowed the state to skip a tax and revenue anticipation note sale this summer for a second year in a row.

Florida added new holidays, bringing its total to nine this year, with the loss of sales tax revenue in fiscal 2023 estimated at $599.4 million, according to the state’s revenue department. Tax breaks for diapers, baby and toddler clothing, and energy star products span a year, while another for hurricane protection products lasts two years.

“Florida has been fiscally responsible, so we are in a good position to provide meaningful relief for families right now,” Gov. Ron DeSantis said in a May 6 statement.

The state reported that fiscal year 2022 sales tax revenue of $31 billion as of the end of May exceeded estimates and was 26% over collections during the same period in fiscal 2021.

Back-to-school holidays are the most popular, occurring in 18 states this year, according to the FTA. Alabama, Florida, Texas, and Virginia offer tax breaks for disaster supplies, while Mississippi and Tennessee have gun-related holidays.

Sales taxes on groceries, which are collected by 13 states, were suspended in Illinois and Tennessee, eliminated in Virginia, and will be phased out in Kansas, according to the National Conference of State Legislatures.

“Food purchases are a significant component of sales tax bases in states that tax them, and most of these reductions were estimated to reduce revenues by hundreds of millions of dollars,” a July NCSL fiscal brief said.

Tom Kozlik, head of municipal research and analytics at HilltopSecurities, said given the strong fiscal situation of states and local governments, the holidays won’t impact their credit or ability to deliver necessary services.  

“Tax holidays do not usually increase the overall amount of economic activity, they usually just refocus a portion of it to occur during the specified holiday period,” he said.

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