Rex Nutting: The outrage over plunging tax refunds is premature — let’s wait for the facts

The story that income tax refunds are plunging 8.4% this year because the Trump administration messed up the withholding tables is speculative at best, and at worst spectacularly wrong.

It’s far too early to conclude,as many have, that millions of American taxpayers are going to have a shockingly large tax bill come April 15 instead of the tax-refund check they have always counted on.

“The government’s been goosing their paychecks with tax trickery, and now they’re getting hit with a big tax bill.”

—Sen. Ron Wyden

“We would not read too much into headlines like this just yet — it overstates the case,” says Neil Dutta, head of economics for Renaissance Macroeconomics.

“Nobody — not us, not other economists, not the U.S. government knows whether refunds will be larger or smaller than in past years,” said Robert Martin, an economist for UBS.

I agree with Dutta and Martin, even though I take a back seat to no one in my criticism of the Tax Cut and Jobs Act.

At this point, we don’t really know any more about the size and scope of tax refunds than we knew eight months ago. We have lots of anecdotes about taxpayers shocked by their tax bill, but we also know that no one complains on Twitter when they are surprised by how big their refund is.

The data that’s being reported so breathlessly is based on just one week’s worth of tax returns, and those numbers could change dramatically as April 15 approaches. The first week of processing was plagued by delays stemming from the government shutdown. The volume of tax returns that were processed fell by 26%. So the fact that average refund amounts fell 8.4% is just statistical noise.

The Tax Cut and Jobs Act passed in December 2017 made a lot of changes to tax rates, exemptions, deductions, tax credits, pass-through income, the alternative minimum tax and more. And while experts in and out of the government made good-faith estimates of the impact of the tax bill would have on various groups of taxpayers, no one will really know until taxpayers file their returns.

It all depends on each taxpayer’s specific situation. Refunds will probably soar for those who qualify for the refundable child tax credit and for those who will get relief from the alternative minimum tax. On the other hand, taxpayers who have itemized deductions in the past — especially those in states with high state and local taxes that won’t be fully deductible anymore — could find themselves with an unexpectedly large tax bill when they file.

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It’s quite possible that both of these things will be true: Fewer taxpayers will get a refund than usual this year and refunds in the aggregate will increase modestly, say, by $15 billion to $30 billion.

Politically, what will matter is the distribution — how many will get refunds or owe money unexpectedly — rather than the total amount refunded. In terms of economic impact, however, the total matters more.

Most independent economists are expecting the total level of refunds to increase compared with last year, calculated from estimates of how much tax would be owed and the hard data on how much was pre-paid by withholding throughout the year. They expect a modest boost to disposable income and consumer spending in the first half of the year due to the refunds.

Economists’ estimates of the increase in refunds range from about $15 billion (Goldman Sachs) to $30 billion (Merrill Lynch). UBS and Oxford Economics expect $20 billion. Capital Economics is a contrarian, expecting refunds to fall by about $30 billion.

Everybody likes a refund

Both the Treasury and taxpayers like big refunds. The Treasury likes refunds because tax compliance is higher if too much is withheld. Issuing a refund check is a lot easier than going after someone who underpaid.

And taxpayers like refunds, too, even though it means they lent the government their money at zero percent interest. The reason why isn’t too surprising: Taxpayers are risk-averse and don’t want to pay a penalty or to have to suddenly come up with thousands of dollars to pay the taxman. Getting a big check makes them happy.

Many households use overwithholding of taxes as a way to force themselves to save money. They usually have big plans for their tax-refund windfall, including major purchases of durable goods, paying down debts and even elective surgery.

For a political party that just passed a big tax cut, the incentives are different. The Trump administration wanted voters feel grateful and to reward the Republican Party in the November midterm elections, which meant that the bulk of the savings from the tax cut would have to be visible as additional take-home pay in 2018, not as a big refund after the election was over.

But that strategy ran into a problem: Polls indicated that most taxpayers didn’t notice any savings in their take-home pay. For most of them, the amounts were small when spread over 24 or 26 pay periods.

But they do notice when their refund goes down. Most people have no idea how much they paid in taxes last year, but many can remember how much their refund was. It was likely their largest financial transaction of the year. About 100 million taxpayers got a refund last year, averaging nearly $2,800.

Did politics play a role?

“It sure looks like the Trump administration decided to put politics first, lowball the estimates of how much tax should be withheld from everybody’s paychecks, and lure people into the false sense of security that they’d gotten a big tax cut, courtesy of Donald Trump,” charged Sen. Ron Wyden, the top Democrat on the Senate Finance Committee, in a speech on the floor of the Senate.

“The government’s been goosing their paychecks with tax trickery, and now they’re getting hit with a big tax bill,” the Oregon Democrat said.

So far, there’s little direct evidence that the Trump administration tinkered with the withholding tables for political gain. Both the IRS and the Treasury Department said they used the same formula to set withholding rates that they had before, and designed the plan to minimize both underpayments and overpayments.

They also urged taxpayers to seek expert advice, and encouraged them to use an online withholding calculator that would be more individualized than the W-4 tables, but few actually completed the calculator.

Still, consistent with the accusation that the IRS did try to goose take-home pay last year, the Treasury and the IRS estimated that the number of taxpayers who would get a refund this year might decline by about 4 million, and they would end up owing something (how much, we don’t know) to Uncle Sam, according to a report by the General Accounting Office released last July.

Based on these estimates, it’s quite possible that the administration will be hearing from a few more angry taxpayers by the time filing season is over. That would certainly be a fitting chapter in the story of the most incompetent tax cut in history.

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