IRS Enlists Tax Day to Push Consumers to Save

For many Americans, Tax Day—April 17, this year—means writing a check. For most it means a refund. Last year, the Internal Revenue Service refunded $300 billion, or 25 cents for every $1 it collected. More than 80% of the 143 million returns filed resulted in a refund.

Paying more in taxes during the year than one actually owes amounts to an interest-free loan to the government. Economists used to consider it irrational: The smart thing to do is reduce withholding to come close to matching one's tax obligation.

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But new evidence—and insights from behavioral economists—challenge that view and suggest that many people, particularly lower-income Americans, use the tax system to force themselves to save. Now, the government is looking for ways to take advantage of what Mark Iwry, the Treasury point man on saving and retirement issues, calls "savable moments."

"People want to have a ready way to save," says Michael Barr, a University of Michigan law professor and a former Obama and Clinton Treasury official. "For some families, tax time is a good time to do so."

In the mid-2000s, Mr. Barr and colleagues surveyed about 650 low- and moderate-income families in the Detroit area who had filed tax returns in 2003 or 2004. About 82% received refunds—either because they had overpaid or because they qualified for the federal Earned Income Credit, a federal cash bonus to low-wage workers that is paid through the IRS. The average refund exceeded $2,000, a significant sum for people who say they have trouble making ends meet.
Retailers often target refund recipients, and half the Detroiters said they spent all the refund, most often to pay bills or debts or to buy appliances or cars.

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Half the recipients saved at least some of the refund. "There is a desire to save," Mr. Barr says. "The saving is not for retirement. It's for short-term goals, for financial stability, so if tough times hit, they don't have to go see the payday lender or go to family and friends or stop eating."
In fact, Mr. Barr and co-author Jane Dokko of the Federal Reserve Board, found these folks don't want smaller tax refunds. In the survey, researchers offered them choices: Withhold $100 a month more and get a bigger refund (an option favored by 35%), withhold the same amount and get the same refund (46%) or withhold less and get a smaller refund (only 19%). This and other survey findings appear in a coming Brookings Institution book, "No Slack: The Financial Lives of Low-Income Americans."

Behavioral economists have found that people respond better to a nudge than a simple up-or-down choice, an observation that has led many employers to automatically enroll workers in retirement-savings plan (and allow them to opt out) instead of asking if they want to enroll or not. A 2005 academic experiment in which some H & R Block customers were offered a 20% or 50% match when they learned the size of their refund if they put money into an Individual Retirement Account proved more successful than the little-understood Saver's Credit in the tax code that offers much the same incentive.