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Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds

Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds Abstract Over three-quarters of US taxpayers receive income tax refunds, which are effectively zero-interest loans to the government. Previous explanations include precautionary and/or forced savings motives. I present evidence on a third explanation: inertia. I find that following a change in tax liability, prepayments are only adjusted by 29 percent of the tax change after one year and 61 percent after three years. Adjustment increases with income and experience, and for EITC recipients, I rule out adjustment greater than 2 percent. Thus, policies affecting default-withholding rules are no longer neutral decisions, but rather, may affect consumption smoothing, particularly for low-income taxpayers. (JEL D14 , H24 , K34 ) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Economic Policy American Economic Association

Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds

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Publisher
American Economic Association
Copyright
Copyright © 2012 by the American Economic Association
Subject
Articles
ISSN
1945-7731
eISSN
1945-774x
DOI
10.1257/pol.4.1.158
Publisher site
See Article on Publisher Site

Abstract

Abstract Over three-quarters of US taxpayers receive income tax refunds, which are effectively zero-interest loans to the government. Previous explanations include precautionary and/or forced savings motives. I present evidence on a third explanation: inertia. I find that following a change in tax liability, prepayments are only adjusted by 29 percent of the tax change after one year and 61 percent after three years. Adjustment increases with income and experience, and for EITC recipients, I rule out adjustment greater than 2 percent. Thus, policies affecting default-withholding rules are no longer neutral decisions, but rather, may affect consumption smoothing, particularly for low-income taxpayers. (JEL D14 , H24 , K34 )

Journal

American Economic Journal: Economic PolicyAmerican Economic Association

Published: Feb 1, 2012

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