Every year around this time, those familiar words start to pop-up. The words are “tax refund” and “deduction” usually heard in association with other words like “big” or “more”. It is as if some marketing agency is trying to convince us that a tax refund is a good thing. In fact, many people do believe the myth that a tax refund is a good thing. The truth is that a tax refund, (or any refund for that matter), is simply our own money that we are allowed to have back.
People talk about refunds as big windfalls, free money, or a lottery win. They are nothing like that. Consider this, if a person purchased $20 worth of grocery at the grocery store, and paid for it with a $100 bill, do you think he would get excited when the clerk gave him $80 change? He would be more likely to get excited if he got less than $80 change. To make the analogy better, consider if we paid our entire year’s grocery bill only once a year. Each month during the year, we paid small installments on the big bill and then, in the middle of April, we settled our accounts. Isn’t that a lot like how it is done with income taxes? The average income tax refund is around $2400. Would we get as excited about a refund that big if it were coming from the grocery store? If we divide by 12, we see that we overpaid our grocery bill by $200 a month. That would surely raise my eyebrows, but people do not seem to think much about it when it is their income taxes, and rather seem to look forward to it. It seems to me that money could be better spent or put to better use even if it were only put in an interest bearing savings account. It is true the interest would not amount to a whole lot, but at least it would be money earned and not just our own money given back to us as if it were some great prize. We can also look at tax deductions in much the same light.
People see tax deductions much as they see tax refunds. It is as if these things are our rich relations come to visit once a year bearing gifts. A tax deduction is simply an amount of our own money that we are allowed to exempt from taxation. It is not new money and it is not a gift. Just like a refund, it is money we already earned and already own. Depending on a person’s tax bracket, a deduction is only worth as much as the percentage rate of taxation. For example, using the tax rate schedule from page 84 of the IRS booklet of forms and instructions for Form 1040, it shows people pay either 10%, 15%, 25%, 28%, 33% or 35% with the lowest earners paying the least and the highest earners paying the higher percentages. That means a person in the 10% category with a $100 deduction saves $10 on his tax bill. The same $100 deduction is worth $35 to the man in the highest bracket, but it is still not worth $100. Even the standard deduction of $5150 only means the government allows the person in the lowest bracket to keep $515 of his own money. Of course, the same deduction is worth $1802.50 to the man in the 35% bracket, but it is difficult to believe that a person earning over $336,550 a year will get too excited about $1802.50.
Now, please don’t get me wrong. I love my country and I understand that income taxes pay for many of the things we all take for granted. Thus, I make every effort to pay the exact amount I owe, and I am happy to do it, but I only try to pay my bill when it is due, not 12 months in advance. I long ago realized that the myth of the tax refund is really a legend of poor fiscal management, and I invite you to examine your own situation if you haven’t already. This year, while you are looking over your taxes and thinking about the year to come, consider how well you manage your tax bill. In the end, you will have more money, the government will spend less money writing and mailing refund checks, and the entire country will benefit from the windfall. Help make this the year we finally dispel the myth of the tax refund.