People, if you want to know whether the Tax Cuts and Jobs Act (TCJA) was good for you or not, stop obsessing about the size of your refund and pay attention to your total income tax bill.
On Friday, the IRS released its report on Week One of the 2019 filing season. It showed that both the number and size of tax refunds were down compared to the same period last year. Twitter went nuts. Major newspapers ran front-page stories. And progressives found conspiracies in it all.
Can we all take a deep breath?
First, the data from the initial week of a filing season that will run for three months means almost nothing. And this year, because that first week was marred by the partial government shutdown that slowed both tax filing and processing, it means less than ever. The IRS received 2 million fewer returns than over the same time last year and processed 4.5 million fewer.
Picking the World Series winner
This is a bit like forecasting your favorite baseball team’s chances of winning the World Series based on the results of its rain-shortened opening day game.
Not only are the data incomplete and the Twitter anecdotes meaningless, but this obsession with refunds is wrong-headed. What should matter is not how big a refund check filers get this year but how much total tax they paid for 2018.
When the TCJA passed in December, 2017, the Tax Policy Center projected that filers would get an average tax cut of about $1,600 in 2018. TPC estimated that about two–thirds would get a tax cut in 2018, while about 6 percent would pay more.
Nearly everyone needed to review their tax withholding last year to reflect the TCJA’s many revisions in the individual income tax. But the IRS struggled to revise the Form W-4 we use to figure our withholding and it was slow getting an online calculator up-and-running.
Refunds matter for some
But most Americans just didn’t want to fiddle with tax withholding. And since most of us never look at our online paystubs, we really had no idea whether we had too much income tax taken out of our paychecks last year or too little.
That’s what our refunds will reconcile over the next couple of months.
For some of us, especially low- and moderate-income taxpayers who rely on predictable income from the Earned Income Tax Credit or the Child Tax Credit, the refunds matter a lot. They may use them to make a big purchase like a refrigerator, pay rent, or even buy food. One survey found that the largest share of respondents, 27 percent, said they’d use their refund to pay down debt.
For others, extra withholding has become a kind of forced savings—a way to put money aside throughout the year. There must be a better way to encourage people to save.
But for many Americans, refunds are a point of pride– a weird way to show how we’ve cleverly manipulated the IRS into giving us money. This, of course, makes no sense. But it feels good.
Think of it like this: Imagine a middle-income couple that owes $8,500 in federal income tax for 2018. If past years are any guide, they may have had about $10,500 withheld during the year. While they may be focused on that $2,000 refund, their net income tax liability still is $8,500—the same as if they received no refund at all.
Why do tax refunds make people feel so good? It is hard to know for sure, but salience may play some role: Your preparer probably makes a big deal out of the size of your refund, but you may never notice a small change in your take-home pay.
Then there is what behavioral psychologists call recency bias: The human brain is better at remembering the end of an experience. The path-breaking psychologist Daniel Kahneman and colleagues did a famous experiment in 1993. They called their paper: “When More Pain Is Preferred to Less: Adding a Better End”
In one trial, a subject held his hand in painfully cold water for 60 seconds. In the second trial, the subject held his hand in the same cold water for 60 seconds and then in slightly less cold water for an additional 30 seconds. Asked which experience they’d repeat, most chose the second, even though it meant holding their hand in painfully cold water for longer. Why? Kahneman concluded it was because they focused on the final experience of the slightly warmer water.
Is it the same with refunds? Do we dislike paying taxes less when our last tax experience of the year is getting a fraction of our payment back? Probably. But when it comes to real economic impact, that refund matters much less than our net tax bill.