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Reflecting on tax refunds

A couple of weeks ago, I posted about income-tax refunds, noting the average refund this year was close to $3,000, similar to last year (see the latest filing-season stats from the IRS in the table below).

Tax columnist Laura Saunders at the Wall Street Journal reports that the size of the average refund has nearly doubled since 1999.

Why? Likely answers: changes in the tax code, low interest rates, and a different mindset among younger taxpayers.

The past decade also brought new or short-lived tax benefits for which taxpayers may not have adjusted their withholding.... Examples include the American Opportunity education credit; two of the three home-buyer credits; and the expanded child credit.

But nontax factors likely came into play as well. The conventional wisdom used to frown on large tax refunds, because they amounted to an interest-free loan to the government and reduced investment capital by the same amount. Better, it was thought, to have the money upfront and invest it, or else let it earn interest.

Yet over the past decade the opportunity cost of big tax refunds fell sharply. Interest rates plunged to multidecade lows, while the stock market stagnated....

Meanwhile, with incomes for many people growing only modestly, the notion of a big lump-sum payment grew more appealing. It was like a bonus, in a smoke-and-mirrors kind of way....

[And there appears to be a generational shift,] with younger taxpayers who welcome large refunds, and older taxpayers who don't.

"We try to be withheld to within $100 of our actual tax," says Wes Schultz, 70 years old, a retired financial executive from the Milwaukee area. But he has younger family members who overwithhold on purpose. "One of them earmarks his refund to pay next year's property taxes and replenish his emergency cash supply," he says....

[Dara Rosenberg, a 24-year-old actress in New York,] tries to overwithhold all year long in order to ensure a larger refund; this year, it will be $1,600. Ms. Rosenberg reserves part to pay veterinarian bills for her bulldog, Truman. "I count on that every year," she says.

What about you? Do you go for a large refund? Or try to keep it as small as possible?

(By the way, if you want an "itemized receipt" for your income tax, Social Security, and Medicare payments for 2010, visit the White House's new Federal Taxpayer Receipt page.)

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