This tax season, as in previous years, about 75% of individual taxpayers will receive a federal income-tax refund, with the average refund totaling around $3,000. From a purely economic standpoint, this makes no sense! If we hate paying taxes, then why do we consistently overpay them, collectively lending Uncle Sam some $300 billion every year interest free? The rational thing to do is to pay just enough taxes throughout the year to avoid owing a penalty at tax time, and then pay any balance due when you file your return. That way, you get an interest-free loan from Uncle Sam instead of Uncle Sam getting an interest-free loan from you.
But that is not what most of us do. Why not? One possibility is that we are actually acting rationally because, with interest rates so low, there's not much pain or loss associated with loaning some money to the government for a while; it wouldn't have earned much interest anyway. But this probably isn't it, since history shows that we tend to overpay our taxes in both high interest rate environments and low ones. Another theory is that we find it too confusing or difficult to 'zero out' our tax bills. Regardless of the many easy-to-use online paycheck calculators, like the ones at PaycheckCity, it seems that taxpayers hesitate to investigate different W-4 scenarios in order to find that balance, even when they believe they could adjust their withholding relatively easily.
So why do we actually prefer getting tax refunds? Because they pay emotional dividends. For one thing, it seems to free us from worry and uncertainty. It's just uncomfortable to have to write a check at tax time, and even more so if we don't have the cash to pay it. So, to avoid any unpleasant surprises, we err on the side of caution and overpay throughout the year, engaging in a form of forced savings. Apparently, we also don't trust ourselves to set aside money in advance to pay our taxes with good reason. In a survey for Capital One Financial, only one-quarter of respondents who owe taxes this year had set aside cash specifically to cover the cost. Then there is the rush we feel from getting a refund, an experience akin to putting on your spring jacket for the first time in a year and finding a $20 bill in the pocket. We see it as income. Taxpayers seem addicted to this adrenaline rush. No matter what their size, refunds clearly give taxpayers a huge dividend by providing a bit of spending enjoyment. It seems we view money differently if it comes in a big chunk like a tax refund than if it is dribbled out in smaller amounts, as is the case when you decrease your withholding to give yourself more take-home pay each week.
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