Why People Are Outraged at Lower Tax Refunds (but Probably Shouldn’t Be)

Which would you rather have: an extra $50 in each biweekly paycheck, or a $1,300 refund payment in a single lump sum in April of the following year? The simple idea of the time value of money — that a dollar today is more valuable than a dollar tomorrow — suggests you should want the higher weekly paycheck.

When you withhold more in taxes than you ultimately owe, you are giving the United States government an interest-free loan. You’re better off calibrating your withholding so that you have no refund, or owe a little when you complete your tax form (although you want to keep that obligation low enough to avoid I.R.S. penalties).

But as the discontent over smaller refunds shows, actual humans — as opposed to the rational automatons of economics textbooks — don’t view it that way.

“The question that befuddles traditional economists is why people want these refunds,” said Richard Thaler, a Nobel-winning economist at the University of Chicago’s Booth School of Business. “Why do they want to make interest-free loans to the government? If they just went out and met a noneconomist, they would find that people like” refunds.

Essentially, the Trump administration chose to set withholding tables that created a short-term political talking point (your paycheck went up!) but that are likely to make people less happy over the medium term (your refund shrank!).

The term “behavioral economics,” for the study of psychological dimensions of how people make economic decisions, had not yet come into use when the United States introduced tax withholding during World War II. But the creators of that system showed keen intuition about behavioral economics lessons that would become more formalized decades later.

At the time, the government needed to raise a lot of money fast for the war effort. If it had simply increased tax rates and expected everyone to write the government a large check at the start of the ensuing year, there would have been popular outrage.

Article source: https://www.nytimes.com/2019/02/27/upshot/lower-tax-refunds.html?partner=rss&emc=rss