What’s So Bad About Tax Holidays?

Dave and I have debated tax holidays before, but even he thinks the gas tax holiday is a bad idea (and so does Judy Blume, apparently). Now Cato has just published an article about the gas tax holiday. The authors, Peter Van Doren and Thomas A. Firey, show that the savings from the holiday could go to consumers rather than producers if certain conditions are met. They argue that to determine whether a gas tax holiday would be appropriate, one should simply weigh the benefit to consumers against the loss of tax revenue.

The article does a good job of showing how the burden of the tax could fall on consumers, but evaluating a gas tax holiday proposal is more complicated than they make it out to be. Basically, Van Doren and Firey analyze the holiday as if it were a permanent repeal of the tax. In fact, the holiday would offer a reprieve for only a few months. And when you get rid of a tax for a short amount of time, you have to consider the economic distortion that would result — not just the lost tax revenue. When people change their behavior in response to the arbitrary dates of the tax holiday — for example, by going on a car trip in July instead of in May — they make worse choices than they would have without the holiday. That causes economic waste. In order for the economy is function optimally, consumers must be responding to real price changes that reflect supply and demand, not government fiat.

Now, any tax changes price levels and results in some distortion. We accept this because the government needs to collect revenue. But legislators should avoid unneccesarily magnifying that distortion, which means resisting the temptation to create lots of holidays.