Happy Day Before Tax Day

I don’t think that Haley Sweetland Edwards, writing at Time, really understands how the tax system works. She concentrates too much on the backend spending component:

Tax Day has a reputation for doom and gloom, but for most of us, there’s a silver lining: the promise of a little extra scratch.

Almost 77 percent of Americans will receive a tax refund this year, averaging about $2,798 per person, according to the most recent IRS statistics. Between April 2015 and April 2016, the IRS divvied out a grand total of $228.78 billion in money back.

So what’s that large cash infusion do for the overall economy? So far, the answer is unclear.

“I don’t think we really know,” said Roberton Williams, a tax expert at the Urban-Brookings Tax Policy Center at the Urban Institute. “When you have people waiting to make this big purchase and then saying, ‘Now that I have this money I’m going to go out and buy that big TV set or that washing machine,’ that’s certainly a direct stimulus.” Consumer spending represents about 70 percent of the U.S. GDP.

But when people save that money or pour it into repaying their debts? “That’s a much less direct stimulus on the economy,” he said.

The reason that this answer is inadequate is that the money was withdrawn from the private economy via the mechanism of automatic payroll deductions (or estimated tax installment payments) to begin with. Those taxes reduce economic activity before they encourage it. The question that she’s actually addressing appears to be whether higher taxes would be good or bad for the private economy. The issue that is, unfortunately, so rarely addressed is that of deadweight loss and when you take that into account the answer is much clearer.

But even once you’ve identified the question she’s actually addressing the issue is more complicated even than she’s suggesting. There is evidence that too large a debt overhang inhibits economic growth, too. So paying off that credit card balance or paying off more of the principle on that mortgage may or may not be a bad thing. There’s no way to tell a priori.

Just to recap my views on taxes, budgets, and economic growth, I think that

  1. The federal government’s spending more than it takes in is probably benign as long as the growth in aggregate product is greater than the deficit.
  2. With the deficit running at more than 3% of the economy while the growth rate lags at below 2%, that’s not the case.
  3. If you’re going to run a deficit, use it to make investments.
  4. Consumption is not the same as investment.
  5. Borrowing to pay operating expenses is a bad idea even if you’re the federal government. It’s even worse when you’re Chicago.

We can probably keep getting away with our profligate ways as long as the dollar is the world’s reserve currency. We can’t rely on that forever so it might be a good idea to start making better habits.

Even with all of that said, you can’t ignore deadweight loss. It wasn’t stupidity or a universal longing for freedom that killed the Soviet Union or that’s causing China trouble now. It was deadweight loss. Which is just another way of saying that bad decisions made over a long enough period of time have a way of coming back to bite you in the butt.

5 comments… add one
  • PD Shaw

    Very weird article you found. The journalist appears to be a specialist in middle east issues. Most personal finance writers abhor over-withholding.

    But taken as finding a sliver-lining, my main reaction on the day before tax day is that the interest rates are too low, and for most Americans the amount of interest earned during the year is far too low to be taxed. This is nuisance reporting. The first $10 in interest income in a federally-insured account(s) should not be taxed.

    And part of the underlying problem the article points to is the inability of most Americans to save beyond their paycheck. Low interest rates are part of this. Is an arbitrary forced-savings provisions a solution? Doubtful, most people who need such gimmicks to accumulate found money are not going to use it to “buy a car” or “go to college.”

    What is the average income of someone receiving this $2,800 in over-withholding? Do they make enough money to pay their regular expenses? Have they saved at least three months expenses? What did they do wrong that government policy is used to trick them into creating customers for Wal*Mart and Amazon?

  • PD Shaw

    I’m clearly more focused on the withholding aspect, than the gray area of aggregate demand prodding:

    The purpose of withholding is to make sure people pay their taxes, and reduce collection costs for the IRS.

    In theory, the government could withhold all of the money and never have collection concerns, but the only metric that makes sense to me is that optimal policy is to withhold as close to the amount that will be owed as possible.

    26% of people use their IRS reimbursement to pay for food and utilities. 30% of people will use it to pay down their debt, i.e., they have spent more than they make. This withholding is immoral. It takes money from those that need it for basic necessities for the convenience of the government. It does not become more moral because this harm might help merchants or the general economy (though it might not).

  • Andy

    I did our taxes with TurboTax online in February and discovered we owed money this year. So naturally, we didn’t complete the return and pay until this past Friday. The fact that we owed money didn’t stop an endless stream of emails from intuit urging me to complete my return so I could get my refund faster. It was annoying, but I guess in this case it’s probably a good thing the right hand didn’t know what was in the left.

  • steve

    It isn’t that difficult to adjust your withholding. I think many don’t bother so they have an enforced savings plan of sorts.

    Steve

  • Guarneri

    “A” is probably true, but proper credit mgmt would argue for “the deal has to get better over time” before something happens………like “b.”

    That’s a credit death spiral. It is also where we are currently headed. Next stop – debauched currency.

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