Saturday, April 14, 2012

Loaning Money to the Government

There are tens of millions of Americans who loan money to the government every year.  I'm not talking about people buying government bonds.  I'm talking about people who have extra income taxes withheld throughout the year and then receive a big refund after filing their taxes.  With the main part of tax filing season coming to an end, now is a good time to discuss the topic.

Believe it or not, I actually have mixed opinions on this.  I understand the point made by those who say that you shouldn't loan the government any money at zero percent interest, but I think there are also arguments to be made the other way.

First, if you live in a state with a state income tax, I would be very careful not to overpay too much on your taxes throughout the year.  This is especially true for states that have major fiscal problems, which is many. There have been states, California being one example, in the last few years, that have delayed refunds to taxpayers because of the budget crunches created by politicians spending recklessly.  If I lived in a state like that, I would be sure to not overpay on state taxes.

As for federal taxes, I don't think there is much of a threat of having your refund delayed.  It may take over a month if you file now during the busy time.  But the federal government does not face the same constraints as the state governments (unfortunately).  The government in DC can issue more debt and can get the Fed to buy that debt if needed.  The federal government is not going to delay tax refunds for several months because then people will lower their withholding and it will just cause more of a temporary shortage of money for the government.

I can understand why many Americans overpay on their taxes during the year.  Some reasons are good and others are not as good.  If you don't have a salaried job and your income is not steady, I can see why you might overpay.  The same goes for people who have substantial taxable investments.  They may not know how much they are going to end up making.  People in this situation may want to be conservative and overpay on their taxes, just to make sure that they don't end up owing a large sum when they file their taxes.

The majority of Americans who overpay on their taxes do so because they don't want to have to write a check when filing.  From this point of view, it is actually a good reason.  It is tough to budget and you want to make sure that you don't have an extra unexpected (or even expected) bill.

But many Americans overpay by thousands of dollars and receive huge refunds after filing.  They do this just so that they can have a big windfall, even though it is just money coming back to them that they already paid.  They are basically using the tax system as a forced savings plan.

While I would prefer that Americans simply have the discipline to save their own money, I am not sure that giving an interest free loan to the government matters all that much right now.  If you save your money in your checking, or even savings, account, then it is there, tempting you to spend it.  Meanwhile, even if you have it in a savings account, a couple of thousand dollars won't earn enough interest for you to buy lunch.

If we lived in the 1970's where we had double digit interest rates, I would have a stronger opinion that people should not be significantly overpaying on their taxes.

Of course, there are many Americans who will not pay any federal income tax (but please don't say they don't pay taxes, because they pay many of the other taxes out there).  Some people may even get refundable tax credits where they not only don't pay any income taxes, but they actually receive a check after having not paid anything.  These people don't have to worry about giving a loan to the government because they are getting money that is being redistributed anyway.  They are not getting back money that they already paid in, at least from that pool of taxes collected.

In conclusion, I don't think it is that big of a deal if you give the government an interest free loan, unless you live in a state that is having financial difficulties.  You should teach yourself to save on your own though.  If we hit a situation where we have double digit price inflation and double digit interest rates, then I will have a stronger opinion about not handing over a free loan to the government.

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