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Sales Tax Carveouts: They’re All About That Base


Scrolling through Instagram as a parent of teenagers does from time to time, I tapped on a high school girl’s story that happily marked the end of Michigan’s “tampon tax.” I’m always thrilled when tax policy makes it into Gen Z’s social media consciousness, but I was frustrated, too.

Exempting feminine hygiene products from sales tax is trendy. Twenty-four states have done it in recent years, and bills are pending in two more—Nebraska and Colorado. But lawmakers also are busy carving out exemptions for a host of other products—from goods bought from “local” stores in Washington State to “Made in America” products in Iowa.

These bills may be good political messaging, but they reflect misguided tax policy that can be arbitrary, complex, and unenforceable. And they needlessly reduce a state’s tax sales base, a special problem since many states are debating increases in sales tax rates to fund income tax cuts.

Forty-five states and the District of Columbia have a general sales tax on goods and services. Those taxes generated $334 billion in 2019 to pay for public services like schools, roads, and police and fire departments. 

Sales tax exemptions present opportunities to score relatively inexpensive “wins” with favored constituents. In the case of the exemption on feminine hygiene products, it is women voters. 

It might feel like the exemption promotes equity between men and women. But it costs money—about $7 million annually in Michigan and around $9 million in Colorado. And what if states applied the same equity standard to other physiologically necessary items? Lawmakers would decide what those are and what criteria would be used, but would consumers agree? Would it be easier to have no sales tax at all? Or to tax everything?

A sales tax holiday to “buy local”

Sales tax holidays have been around a long time, exempting many products for a limited period. In some situations, they can make sense, like encouraging (or at least reminding) people in Southeastern states to buy hurricane supplies before hurricane season. 

But a Washington State lawmaker proposed a “three-day shop local and save” sales tax holiday for the upcoming Labor Day weekend. Clothing, computers, Energy Star appliances, health care equipment, over-the-counter drugs, and school supplies that cost $1,000 or less would be exempt from Washington’s 6.5 percent sales tax. It would reduce revenues by $119.3 million

The bill’s sponsor says: “neighborhood shoe shops, bookstores, and hardware stores are the backbone of the American economy, and yet they’re left in the lurch when large corporations can easily pivot in emergencies and out-compete them. It’s more important than ever to shop local and support our neighbors.”

Funny thing about this bill’s language: It does not require a consumer to purchase eligible items in person or in local stores. Not all states can differentiate between the two types of purchases—can Washington? As written, any eligible item would be exempt from sales tax. So, my friends who live in Seattle can buy their kids’ school supplies on Amazon that weekend and still pay no sales tax. 

Amazon is based in Seattle, so I guess the bill would work as intended?

A carveout to make you want to “buy American”

An Iowa lawmaker wants to cut his state’s 6 percent sales tax in half on goods primarily made in the United States. According to the very short bill, manufacturers would need to certify their products are eligible. The bill leaves it up to the revenue department to figure out how to administer the partial exemption. Lucky them. 

The bill’s sponsor, Rep. Dean Fisher, told Tax Notes, “By encouraging domestic manufacturing, I expect that the impact on revenue would be very positive because the revenue from the sales tax would be far less than the revenue generated by the jobs created.” Not only that, it would “bring further awareness to the idea of seeking out and buying USA-made products.”

But how much sales tax savings would it take to prompt manufacturers to hire Iowans to make their products instead of importing them? 

More important: The Supreme Court has twice blocked states from using tax policy to favor certain products based on their source. It rejected a Hawaii law that would have exempted locally produced liquor and wine. And the High Court held that Iowa could not allow a business to deduct dividends received from domestic but not foreign subsidiaries. Only Congress has the power to regulate business among states and with foreign countries.

But no matter. Introducing these bills can’t hurt elected officials claiming to promote job growth and American-made products, even if the bills won’t work.

You can’t blame a state for trying.

Carveouts like these sound great politically, and right now, states are flush with cash. Sales tax revenues were especially strong during the pandemic because so many of us were buying usually taxable goods instead of largely untaxed services.  

But as my TPC colleague Lucy Dadayan notes, circumstances are changing: “Consumption will shift back to services, and sales tax revenues will return to their pre-pandemic trend.” 

The last thing a state should be doing is reducing its tax base by exempting more products. Yet for many politicians, the temptation to serve their political base could be too hard to resist. 

That’s understandable, though they might want to be careful. Enacting sales tax exemptions is a lot like scrolling through social media. Once in a while is okay, but don’t overdo it.

 

The Tax Hound, published once a month, helps make sense of tax policy for those outside the tax world by connecting tax issues to everyday concerns. Have a question or an idea? Send Renu an email.



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