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American Economic Journal: Economic Policy: Vol. 4 No. 1 (February 2012)

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Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds

Article Citation

Jones, Damon. 2012. "Inertia and Overwithholding: Explaining the Prevalence of Income Tax Refunds." American Economic Journal: Economic Policy, 4(1): 158-85.

DOI: 10.1257/pol.4.1.158

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)

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Authors

Jones, Damon (U Chicago)

JEL Classifications

D14: Personal Finance
H24: Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
K34: Tax Law

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