Economic Perspective: Why Are Tax Refunds Smaller?

MARY WALDEN:

“Today’s program asks, ‘Why tax refunds are smaller?’ Mike, we’re in tax filing season when many people anticipate getting money back from the federal government, but I hear many refunds are smaller than people expected, especially after the large tax cut enacted in late 2017. What’s the explanation?”

MIKE WALDEN:

“And this is important because a lot of people rely and plan on those. In fact, I saw one statistic that for the majority of households in the country their tax refund is bigger than their monthly paycheck. And I should caution that the complaints we’re hearing about the refunds being smaller, this is based on refunds to date. We’re not done with obviously the refund season.”

“But all of that said, there are two big explanations for why refunds may be smaller for some people. Number one, we did have that big tax cut at the end of 2017 which took effect for the tax year of 2018, and the IRS instructed employers to therefore withhold less money from workers’ paychecks. That’s where the refunds come about when you have money withheld from your paycheck. If you have too much withheld then you obviously get a refund, and the point is that those refunds schedules were adjusted to account for the fact that many people are going to be paying less taxes.”

“So that’s one reason, and number two: some people may actually be seeing their tax bill higher in 2018 because of the changes in deductions, exemptions and standard deductions et cetera. Now I want to go back and talk about those refunds however. You shouldn’t necessarily hope for a big refund because that means you have overpaid to the federal government, and essentially you’ve given the federal government an interest free loan. That is to say if they, for example, collected $1,000 more from your paycheck for your taxes, and they refund that $1,000 they don’t refund that with interest.”

“So you should actually plan for zero refunds if you can get it in terms of adjusting your withholdings.”

Mike Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.