Are Instant Tax Refunds Rational?
Thursday, February 21st, 2008 By Marc KilmerBuckeye Institute Guest Scholar James Stotter offered these
comments on another set of financial products coming under fire
from self-appointed consumer advocates: Refund Anticipation Loans (RALs), Instant Refund Anticipation Loans (RALs), and Refund Anticipation Checks (RACs).
“I really like the big refund. It’s the one time of year I feel like I have a lot of money.” So replied one woman to a tax preparer’s question about why she claimed zero deductions on her W-4 when she was entitled to four.
These comments shed light on the assumption by economists that people are “rational and calculating.” Lower middle and middle income Americans are quite rational and calculating. They just don’t rationalize and calculate the way economists assume. These Americans also don’t calculate the way consumer advocates think best. Thus, these advocates pressure legislatures to force those Americans into financial behavior that is presumably “better for them.”
Many of the same people and groups that are fighting payday loans are also railing against IRALs and their siblings, RALs and RACs, which are offered by many tax preparation services. IRALs are Instant Refund Anticipation Loans. RALs are IRALs where it takes taxpayers 24-48 hours to get their refund loan instead of the “instant” 3 minutes. Refund Anticipation Checks (RACs) are not loans and it takes up to 15 days to get the refunds. Per Economics 101, those financial products that carry the most risk to the lender and are in most demand —- that is, are most valued by the consumers — carry the highest APR.
IRALs, RALs, RACs and their much maligned cousins the payday loans are simply high tech versions of their three-ball predecessors — pawn shops. Pawn shops have been around since ancient times. Why? Because almost since the invention of money some people have been short of cash and willing to sell their assets at deep discounts or go into debt to solve pressing liquidity problems. If people weren’t optimist about their futures, their behavior would be different.
Cash problems for individual and business will probably exist for as long as people use money. Therefore, “bridge” loans in one form another will be, too. And economic trends will continue to run in cycles. Thus, the blossoming of today’s “instant money” bridge loans probably will run its course. However, that blossoming is much more a reflection of the market meeting people’s needs during these current difficult economic times than of a scheme to sucker people. If the latter were the case, then many perpetrators would pop up and most would fail in short order. Since that hasn’t happened, one concludes it is the current economic backdrop that provides the incentive for such services.
The tax preparer mentioned earlier heard many clients express shock at the very high Annual Percentage Rate of IRALs then turn around and request one. “It’s only thirty dollars more” (compared to a RAL, which in turn might be $20 dollars more than a RAC) and “What’s $30 out of three thousand?” (the size of that taxpayer’s refund) are commonly heard statements. The people asking for IRALs are as desperate for liquidity as any cash-strapped business or wealthier person being hounded by collectors. They make their choices based not on ignorance but on value to them. And, as the above quotes demonstrate, they do think at the margin. They are trying to survive and are familiar enough with the choices to make up their minds in about 30 seconds. The market perceives these needs and tries to satisfy them.
Stotter is the manager of a tax preparation service’s branch office.
Tags: Regulation
