Lower Tax Refunds, Not Bad News

Despite what CBS and others tell us, the report from the IRS that “tax refunds are about $170 lower than last year” is not bad news. The fact that “the average refund so far this year is $1,865, down from $2,035 in 2018” is only a timing issue. People who think otherwise are forgetting how income taxes work.

Employers are required to withhold taxes from each paycheck. These are sent to the federal and state governments. It is better to have them withhold a little more to avoid being hit with penalties and interest for not paying enough up front. But traditionally, taxpayers have jacked up their withholding on each paycheck to ensure a large refund. It makes up for lacking the discipline to voluntarily put aside a little each pay period. 

At the beginning of each year they experience what seems to be a windfall. But it’s not some gift from Uncle Sam; it’s really just a matter of getting their own money back after it has been withheld from them throughout the year. Withholding and the refund are not separate, unrelated pieces. They are each part of the whole. Changes in one lead to changes in the other, but the total paid in taxes is exactly the same whether you get it today or next March.

Getting a smaller refund leads some to believe that the tax cut was not real. (See the CBS piece for examples.) But they have only themselves to blame. “According to payroll processing firm ADP, only a small fraction of workers bothered to change their withholding” as the IRS urged them to do after their employers adjusted their withholding. They were happy to get more in their paychecks, but want to complain later about a smaller refund.

If they looked at total taxes paid, it would be obvious. When someone else files the tax forms and people only sign at the bottom, it’s so easy to ignore the total tax and only care about the size of the refund check. 

Then the news media stir things up by airing the complaints and making a big deal of it while only explaining the details in the last part of the report (if at all). And Bloomberg predicts that Democrats will intentionally promote this misunderstanding to their political advantage. 

As one expert told CBS, "I think taxpayers generally will try to avoid thinking about taxes, even after a major overhaul." The story is the same with taxes, tax refunds and other related issues, such as Social Security and Medicare. Many Americans don’t want to take the time to understand the details. They just want to complain. The frightening part about democracy is that someone who doesn't pay attention has the same number of votes as someone who does.

Figures Don't Lie, but...

Last time I was enthusiastic about a sign of better discipline among Americans, that 84% of those receiving income tax refunds planned to use them to pay down debt according to a Bankrate article.  Although I hate to put a damper on such good news, I may have to rethink my position and should surely have been a little more careful.

Since this is the week of the tax deadline, other articles and statistics also appeared along the same lines.  From the USA Today/Gannett on Friday (April 11), the chart shown here tells a different story.  About 58% intend to pay down debt or save the refund.  This is more than half, but quite a bit less than the 84% from Bankrate.  This information looks reliable with references listed as: Internal Revenue Service; H&R Block; Tax Foundation; Tax Policy Center; Bankrate.com; Giving USA; Center on Budget and Policy Priorities; Pew Charitable Trusts.

A few days later on April 15, another small box ran in the USA Today with this information based on a Capital One Bank survey of over 1000 people.  Now only 40% intend to save a majority of it and 42% show up as spenders.  What’s up with all these discrepancies?

The lesson for me and for all of us is one I covered way back in October 2011.  Surveys and polls cannot be totally trusted.  Even if they have an adequate sample size and the professional pollsters have gone to great lengths to ensure a representative sample, other problems may still arise.  When self-reporting, people are not always honest.  Sometimes they want to impress the questioners, as it could be in this case, or even shock them, as may be the case with drug polls of teenagers.  Even when they are trying to make every effort to be honest, the wording of the polling question can influence people – choice of words or introductory phrases can imply the intention of the question.  The order in which the survey presents the questions can develop a mood or a pattern.  Outside events or experiences also can influence the mood or opinion of the survey subjects, for example, opposition to gun ownership peaks shortly after a highly publicized shooting incident.

I’m glad many people are making responsible decisions about the use of their tax refunds, but in retrospect, I’m really not sure if it’s a majority or not.

Good Tax Refund Advice

During tax return season we are bombarded with ads about good ideas for spending our tax refunds.  We are encouraged to spend on cars, vacations, appliances and furniture.  Because many of the companies that sponsor these ads run them on network television, it’s a little surprising to find wise, helpful advice on the CBS website.

Here they list seven smart ways to use the refund:  Pay down credit card debt (or college loans); Start an emergency fund (target: 6 months of income); Increase 401(k) donation; Pay down the principle on a mortgage; Deposit it in a Health Savings Account (HSA); Start a college savings plan for children; or make a home improvement that pays for itself. (Note:  Very few home improvements actually do).  Only the last one represents spending and that is spending with an expected payback.  The rest are ways to put yourself in better financial shape and surprisingly “84 percent of Americans receiving refunds intend to pay down debt,” as this Bankrate article indicates.

A minor problem with the Bankrate report is that they refer to the refund as a “windfall,” which it really is not.  It is your money, over-paid to the government and held by them at zero interest.  People would have been better off using it to make a larger credit card payment in the first place.  According to the figures given they could have saved nearly $500 (based on 17% of the $3,034 average refund).  Nevertheless, it’s not too late to save that money this year by using the refund and possibly adjusting the W-4 to free up money today to continue to pay down the debt instead of letting the government hold it for a year.

With so many temptations to spend the “windfall” this tendency by a large majority of those receiving refunds to do the right thing rather than the easy or pleasurable thing represents a strong showing in the discipline dimension.

More Americans Saving Tax Refunds

Here is some good news for the future of our society.  Yahoo! Finance reports that more Americans are planning to save at least part of their tax refunds than did so in the past nine years.  Others plan to use their refund to pay down debt.  Less than one-quarter expects to use it on splurge spending or a vacation.  Another survey mentioned in the article found similar results.

People have been known to give one answer to a survey and act differently (see blog from October 7, 2011), but if this one turns out to be true, perhaps fewer people would be living on the edge, paycheck to paycheck, in danger of default.  It’s good news not only for them, but for everyone.

Economic understanding about the flow of money tells us that when people are unable (or unwilling) to pay their legitimate debts - credit cards, auto loans, mortgages, or whatever - the rest of us must take up the slack.  Banks adjust interest rates, penalties, fees and their willingness to approve loans to make up for the added risk posed by these deadbeats.  The same reasoning applies to tax evaders who settle for “pennies on the dollar” or, for that matter, to shoplifters.  Those losses don’t go away or come out of some mysterious pot of money or some magic insurance policy with no premiums.  They are made up for out of your pocket and mine in the form of higher prices, premiums, taxes and fees.

So this expected increase in responsible behavior from some is good news for all.  (This example shows how more positive behavior by individuals in any of the five key dimensions moves America as a whole in the right direction.)