Tax Refunds

One thing Hofstadter discusses is reasons to be irrational. I was recently thinking about this in the context of tax refunds. In the U.S., if you underpay your taxes during the year by less than $1000 or so, you can just pay the difference on April 15 and all is well. (The total amount you may underpay and avoid a penalty depends on how much tax you paid last year. The rules are a bit complicated and I don’t remember them. Don’t take tax advice from some random blog.) So if you are fully rational about money, and you have a steady salary, you should calculate the witholding amount at the beginning of the year to ensure that you owe a small amount of money at the end of the year. If you don’t underpay–if you, in fact, overpay–then you are effectively giving the government an interest free loan of the amount of your overpayment. There is no reason to do that–if you want to give the government some money, just do it, don’t do it by giving them an interest free loan which they have to repay.

Nevertheless, most people do in fact overpay, and receive a refund when they file their tax return. Not only that, most people are happy when they get their refund. That seems crazy at first glance. Can it ever be rational?

The answer is yes, and it is clear once you realize that people are not unitary beings. We contain multitudes, and those component parts are not all aligned with each other. (Peter David’s version of Jamie Madrox, the Multiple Man, in X-Force comic books is an amusing example of this. Madrox can split himself into many different duplicates of himself, but those duplicates don’t necessarily agree on what to do.)

Rationality is a complex thing. Some people have a tendency to spend the money they have when they have it. If they buy something they don’t need, that will prevent them from saving to buy something expensive that they do need. People who know that they have this tendency can decide to force themselves to save by putting the money out of reach through various mechanisms, one of them them being income tax witholding. This will let them save up enough to purchase something expensive, which they would not otherwise be able to do.

That is: few of us are fully rational all the time–in fact, when considering the troika of money, food, and sex, scarcely anyone is fully rational about all of them. It is rational to use external mechanisms to compensate for your known irrationality.

If you like, you can think of this as using your long-term planning abilities to defeat your short-term instincts.

1 Comment »

  1. fche said,

    September 28, 2007 @ 5:37 am

    Up here in the land of ice and flappy heads, ordinary employees get little say about how much tax withholding they suffer. The feds engineer the numbers to assure an overpayment on average. No wonder the peons celebrate the return of the tax.

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