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The True Cost of State Sales Tax Holidays

By Sheryl Nance-Nash, DailyFinance

NEW YORK (DailyFinance) -- 'Tis the sales-tax-holiday season, when states give the gift of tax-free shopping for clothing, computers and other back-to-school supplies.

It seems like a good thing: Take a little pressure off the pockets of cash-strapped parents, make retailers smile and make politicians look good for supporting tax relief.

But as states grapple with huge budget deficits, the debate is on over whether states should be more like Scrooge than like Santa.

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Last year, Illinois passed legislation creating a sales tax holiday. Now the state is sitting on the sidelines because it "just cannot afford it this year," according to State Sen. Toi Hutchinson (D-Chicago), who was the chief sponsor of the state's holiday last year.

What It Costs

It's expensive to be generous. When states give up their portion of the sales tax, they give up much-needed revenue for a weekend or, in some cases, for up to a week. Massachusetts will see a revenue reduction of $20 million to $25 million, projects Sujit CanagaRetna, senior fiscal analyst with the Council of State Governments. That's not far-fetched considering that last year's loss was about $20 million, according to Tom Astore, tax director at Rodman & Rodman.

Another example is North Carolina. According to press reports, the state department of revenue last year estimated that it gave up $14.5 million during its back-to-school tax holiday and $1.7 million during its November tax holiday for Energy Star appliances.

"Our sales-tax holiday results in the loss of $12 million each year, money that could support early childhood education or improve the educational attainment level of the state's young work force -- both of which were cut this year because of the failure to take a balanced approach to closing the budget shortfall," wrote Alexandra Forter Sirota, director of the North Carolina Budget and Tax Center, a public-interest organization, in The News & Observer. "The sales-tax holiday simply further undermines the adequacy of the revenue system to support shared investments."

Administering the sales-tax exemptions also creates significant red tape. Retailers and revenue departments, as well as local governments, must monitor and document the distinction of eligible and ineligible products, for example. In her opinion piece, Sirota calls for better, long-term solutions that will lead to real improvements in the state's revenue system.

Some States End the Holidays

In 2011, 17 states will conduct sales tax holidays, down from a peak of 18 states in 2010, according to Mark Robyn, staff economist and co-author of the Tax Foundation's Sales Tax Holidays: Politically Expedient but Poor Tax Policy.

The dip is not surprising. "Any effect on revenue must be a consideration for lawmakers, especially in light of the flailing economy," says Carol Kokinis-Graves, a state tax analyst for CCH.

Several states considered canceling their sales-tax holidays for that reason. "Texas broached the topic, but as far as I know, Illinois was the only state that cancelled it," CanagaRetna says. Aside from school supplies, some states also include Energy Star appliances, hurricane-preparedness products, firearms and hunting supplies in their sales-tax holidays.

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