A tax refund is
A no interest loan to Feds.
Free money? Think twice.

A previous Fiku discussed what interest income is: compensation to a lender for the risk he/she/it takes in lending a borrower money.

If they didn’t manifest in such ugly ways, Americans’ feelings about the government would be hilariously self-contradictory. For example: Americans generally want Social Security to endure and expand, better and more affordable healthcare, better education, broad social services, and lower taxes.

Uh… what?

When comparing American attitudes about taxes with other developed economies in the world, economies that are outpacing the United States in many key metrics of prosperity and happiness, tax rates stand out as an interesting differentiator.

This is a complex topic to research, so I turned to our future robot overlords (ChatGPT) for some help. Here was my question:

“Compare individual tax rates in America to other developed countries in the world. Are taxes in the United States higher or lower than those countries on a per capita basis?”

And here was the response:

“On a per capita basis, taxes in the United States are generally lower than many other developed countries. According to data from the Organisation for Economic Co-operation and Development (OECD), the United States ranks 31st out of 36 OECD member countries in terms of the tax burden as a percentage of GDP. In 2019, the tax-to-GDP ratio in the United States was 24.5%, which was below the OECD average of 33.8%.”

Of course, this should all be taken with a grain of salt (or perhaps silicon), given the fallibility of our nascent AI technology and the way data can be twisted this way and that to produce suspiciously convenient conclusions.

However, in this case, ChatGPT appears to be spot on. The Urban Institute and Brookings Institution Tax Policy Center provides a helpful chart that demonstrates just how low our taxes are compared to our European counterparts and diplomatic allies.

What the data fails to capture is the historical relationship America has with taxes. An anti-tax posture is part of the DNA of our nation. Remember the Revolutionary War? (#neverforget) What fueled the desire for American independence? “No taxation without representation.”

As early as Washington’s Presidency, Americans were willing to sacrifice their lives (and, arguably, their morals) to fight tax increases. The Whiskey Tax Rebellion of 1794 pitted the public against the Federal Government. While exact figures are hard to come by, potentially as many as a few dozen people died as a result of skirmishes between the anti-tax alcoholics farmers and distillers and a Federal force of 12,000 militiamen sent by George Washington to quell the drunken rebellion.

Plenty of other examples exist. Historically, to be American is to resist taxation.

And yet…

Many Americans hope every year for a tax refund. This stands in direct conflict with the general American attitude towards taxes and government. Why?

A tax refund represents an overpayment of taxes to the government. A feature of our tax system is that estimated taxes must be paid in advance, quarterly, every year. When taxes are withheld from a paycheck, for example, those are estimated tax payments.

The minimum amount of your estimated payments – called the “Safe Harbor” amount – has three underlying rules:

You won’t get an underpayment penalty if you pay no estimated tax and expect to owe less than $1,000 after subtracting your withholding.
You won’t get an underpayment penalty if you pay 100% of your tax liability for the previous year via estimated quarterly tax payments. If your adjusted gross income for the year is over $150,000 then the amount is 110%.
You won’t get an underpayment penalty if you pay at least 90% of your actual liability for the current year.

Fail to comply with these rules, and you’ll get a letter from the IRS notifying you that owe an underpayment penalty. Any delay in paying the penalty may accrue interest.

By overpaying your estimated taxes, you’ll avoid any underpayment penalty. Getting a small refund in this case is great. You avoid penalties and you get some money back.

But a big refund, which can feel great when you get it, includes no interest payment to you, the taxpayer.

If you underpay your taxes, you may owe penalties and interest to the government. If you overpay, you get your money back without interest or any other form of compensation for your unintentional largesse.

On a certain level this makes sense. If interest is compensation for a lender’s risk, it is far riskier for the government to “lend” an individual money through underpayment of taxes than it is for a taxpayer to lend the mightiest government on earth money through overpayment of taxes.

But would most Americans agree that the government is a trustworthy entity, and that any money spent in overpayment of estimated taxes will come back to them without fail?

To the extent such a question can be answered, the answer appears to be a resounding “No.” The Pew Research Center’s metrics on this topic indicate that only around 20% of the American public trusts the government.

To recap:

Americans don’t trust the government. Americans don’t want to pay taxes. Most Americans hope that they get a big tax refund each year. Tax refunds represent an interest-free loan to the government paid via an overpayment of taxes.

Cognitive dissonance abounds.

A person can “win” the tax game over time with careful attention paid to estimated tax payments. One of the most practical ways to do this is to be mindful about your tax withholding on income (especially retirement plan distributions).

The tax code is hard to understand for nearly everyone. If you need help making sure you aren’t paying more tax than you have to, or if you want to make sure your financial choices are aligning with your personal values, we’d love to have a conversation with you.

We’re here to help you unravel the parts of the tax code most relevant to you and connect you with resources and strategies designed to help your money go to work the way you want it to.

Click here to schedule a complimentary consultation.