What Were You Thinking?

The psychology behind taxes

Marketplace Staff Apr 9, 2010
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What Were You Thinking?

The psychology behind taxes

Marketplace Staff Apr 9, 2010
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TEXT OF INTERVIEW

Tess Vigeland: Every year, they appear like weeds in a spring garden. The line of cars at the post office on April 15. These are the stubborn folks who wait until the last minute to mail their taxes. But not everyone waits. If you’re gettin’ a refund, you filed a loooong time ago to get your grubby little hands on that check from Uncle Sam. But that means that last year you gave him an interest-free loan. Which prompts us to ask…

Comedian: Let me start with question number one: What were you thinking?

What the hell were you thinking, our ongoing look at why we do what we do with our money.

Well, refund fans have something going on in their brains that folks like Bill Congdon like to study. He’s with the Brookings Institution and wrote recently about incorporating behavioral finance into tax policy. Thanks for joining us.

Bill Congdon: Hi, and thanks for having me.

Vigeland: Finish your taxes yet?

Congdon: I have not, actually no.

Vigeland: You have not. Well, are you expecting to owe or get a refund?

Congdon: I will likely owe.

Vigeland: What was your thinking behind that math?

Congdon: Having been trained in economics, my thinking comes from the standards, sort of the way economists think about tax refunds, which is that they are a kind of mistake. That when you receive a tax refund, that’s money you could’ve been getting in your paycheck all throughout the previous year.

Vigeland: Right. And you’ve described this as a great example of irrational economic behavior, of people basically giving the government an interest-free loan. Yet, so many of us, myself included, love getting a refund. What are we thinking?

Congdon: There’s evidence that what we’re thinking is that this is a way that we can save some money that we might otherwise not have the self control or the will power to save. That if we were getting that money in our paychecks every week, we would spend it on things we wouldn’t notice — extra cups of coffee, that sort of thing. But if we let that extra money slide off to Uncle Sam and we sort of out of sight, out of mind, and those temptation problems won’t arise, because we won’t have the money. And then when we get the refund, we have this amount saved up, that then we can use to do things that maybe we wouldn’t have been able to do on our own.

Vigeland: And it’s no small amount of money either.

Congdon: No, the average refund among returns that got a refund in recent years has been north of $2,000.

Vigeland: $2,000!

Congdon: Yes.

Vigeland: Do you have any notion of what most people use it for?

Congdon: Yes, and that’s part of the reason why we think what people are doing is sort of saving with their refund. There is evidence that people take that money and they will save it, they will use it to pay down debt or they will use it to buy durable consumer goods, like a new appliance, or use it as a down payment on a car.

Vigeland: And isn’t there just something as basic as pain and pleasure going on here? I mean, who wouldn’t rather get a paycheck deposited into their checking account, rather than writing a check to Uncle Sam for some amount that you owe — even if it’s not a lot and you’ve actually done the math well, so that you’re kind of where you’re supposed to be? You just don’t want to give ’em more of your money, right?

Congdon: Absolutely. And there are a number of behavioral tendencies that point people in that direction. The first is just that you might not notice the amount of money that’s being withheld out of your paycheck every month. So there’s literally no pain to you for the gain of getting the refund later. The other behavioral aspect of that is exactly what you said, people really, really hate having to pay money. They feel the pain of having to pay $100 greater than the pleasure of getting an extra $100.

Vigeland: So what do you tell yourself when you’re writing that check?

Congdon: What I have told myself in the past, before I started studying behavioral economics and how it applied to taxes more, was that I was acting as a rational economic agent. It is an annual point of contention in my household, however, because I married a refund person.

Vigeland: Uh oh.

Congdon: It’s not that big a point of contention, but the interesting thing about it is is that I’m starting to think my wife might be right.

Vigeland: She’s going to want to be sure to listen.

Congdon: And yes, and it shouldn’t surprise me at all. But looking at and thinking about it from a behavioral perspective, maybe that would force me to save extra money, and maybe I would be able to use that refund and put it towards savings or something else that I wouldn’t otherwise have saved up to do.

Vigeland: So your W-4 is going to be all different this year.

Congdon: It might.

Vigeland: Bill Congdon is a research director in economics at the Brookings Institution. Thanks for dissecting our brains when it comes to refunds.

Congdon: Thank you.

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