The biggest tax code overhaul in decades has made sport of tracking this year’s average tax refund size. (Currently this year’s refund is $22 higher versus last year.)
The scrutiny is also reviving any even older and highly emotional debate over the financial soundness of getting a refund at all.
While financial experts say it’s smarter to receive bigger paychecks during the year rather than a refund, that’s not what most Americans do. About seven in 10 typically get a refund, which may help sustain the financially flawed practice.
“The ubiquity of it disqualifies the logical reason to not do it,” says Kit Yarrow, a consumer psychologist and professor emerita at Golden Gate University. “It doesn’t feel like a mistake if everyone is doing it.”
(Photo: GETTY IMAGES)
But there are other deep-seated – and not necessarily irrational – reasons why people choose refunds over larger paychecks. There’s also just as much passion from the minority of taxpayers who prefer to zero out their taxes.
Here are their takes.
The new “Christmas Club”
Donna Batton, a retired grandmother and widow, uses her tax refund to replenish the money she took out of her savings to pay for Christmas gifts. Her strategy echoes a long-ago service banks offered called Christmas clubs, says Hal Arkes, an emeritus professor of psychology at Ohio State University.
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Banks would sequester a small sum each month from a customer’s account into a non-interest bearing one that couldn’t be tapped until November. “Without this, they would spend money throughout the year,” says Arkes. “Because they didn’t have the self-control.”
Batton – who remembers Christmas clubs – relates to this. She realizes she could get larger pension and Social Security checks and squirrel that money away each month for the holidays.
“I just like knowing I have that refund to put back into my savings.”
Donna Batton, a retired taxpayer
“But I never seem to be able to do that,” says the 76-year-old, who habitually gets refunds. “I live paycheck to paycheck. At the end of the month it gets hard and things come up that you’re not prepared for.”
She’s also not missing out on much, she reasons. Her tax refund this year was $683. If she had deposited $57 a month last year into a savings account – and received 2 percent in a high-yielding online account – she would have made $8 in interest over the year.
That’s not worth the peace of mind knowing the money will be there after spending on Christmas.
“I just like knowing I have that refund to put back into my savings,” she says.
An emotional high
Tax refunds can also feel like a windfall or lottery winnings that can be put towards a big purchase, vacation or other small luxury. “There is a level of excitement that people feel around their tax refund,” Yarrow says. “That’s intoxicating.”
Matt Riley of Forsyth, Illinois, has earmarked this year’s refund for a bathroom remodel in his new home. Other times the cash went toward a trip. “It’s a little fun fund,” says the 24-year-old bank trust officer.
While he doesn’t like the idea of paying the government too much each month, he prefers the smaller paychecks because they force him to live on less each month.
“Then that refund is a nice treat,” Riley says. “From a financial standpoint it doesn’t make too much sense. But from a behavioral perspective, March is a happy month when I get that money.”
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The biggest gripe that money-savvy folks have against refunds is that they are interest-free loans to the federal government. They aren’t wrong. Over the year, you pay too much in tax from your paycheck to Uncle Sam, who then refunds that extra amount after you file your taxes – with no interest.
At the very least, any extra in each paycheck could go into a savings account and earn interest, these financial gurus say. A better strategy would be to use those extra dollars to pay off high-interest credit card debt, even if you had planned to put the refund toward that same balance.
“That won’t be as good because you could have whittled the balance down throughout the year,” Arkes says.
“It’s the economic concept of opportunity cost, if there is a better use for that money.”
Hal Arkes, emeritus professor of psychology at Ohio State University.
Once people understand there’s a better use for that money – called opportunity cost in economics – they’ll less likely to want a refund, Arkes says.
Take Joe Berry, a math and social studies teacher outside Evansville, Indiana. He and his wife used to get the biggest refund possible, he says. But three years ago, after talking with friends who are financial planners, he now tries to zero out his taxes.
The extra money goes to his Roth IRA or his son’s 529 college savings plan.
“While I could fund [these] with a large refund at the end of the year, I’d be missing out on compounding interest,” he says.
Asked if he was familiar with “opportunity cost,” Berry said: “I teach that to my fifth graders.”
Tax filing season is here, and the overhaul of tax laws means some potentially big changes for your budget. Did you get refund, or do you owe the IRS? Josmar Taveras, USA TODAY