Early average tax refunds are bigger, but may be misleading

If you saw more money in your federal income tax refund this year, you're not alone. White House officials reported earlier this week that it appears that the average federal income tax refund has increased by 10% this year. The average federal income tax refund for 2009 is $3,036, according to early data from the Internal Revenue Service. Last year, refunds averaged about $2,770.

The White House claims that the increase is largely due to tax benefits from the most recent stimulus package, known as the American Recovery and Reinvestment Act (ARRA). Specifically, refunds have been affected by the Making Work Pay Credit and the First Time Homebuyer's Credit. Those two credits alone can boost refunds by as much as $8,800 for families.

The IRS agrees that ARRA is driving increases in tax refunds, with Commissioner Doug Shulman saying, "The Recovery Act is a major factor behind these larger, record refunds."

Vice President Joe Biden also lauded ARRA for the increases, claiming that bigger refunds will help working families recover from one of the worst recessions on record and urged Americans to take full advantage of the credits. Biden cited the stats as "welcome news for an awful lot of Americans." He went on to say, "For hardworking folks, this extra cash in their pockets in tight times can make an astounding difference in terms of their attitudes as well."

I agree that it's nice to have some extra cash in your pocket. But it's also worth noting that with few exceptions (the homebuyer's credit and the Earned Income Tax Credit among them), many credits are predictable. Adjustments to withholding during the tax year would have resulted in extra cash in your pocket all year long -- and not just at tax time. Remember that a refund isn't meant to be a windfall: it just means that the government had the use of your money a little longer. Planning for a smaller refund (or better yet, none at all) means that you'll have the use of your own money during the year.

That said, I would argue that these statistics are a bit misleading. Taxpayers who are expecting a refund tend to file earlier than other taxpayers -- most everyone would rather get money back quickly as opposed to paying early. While the data that the IRS is touting is good news for early filers, more than half of taxpayers haven't filed yet. So far, the IRS has processed just under 68 million individual tax returns; in 2009, the IRS processed 117,014,000 returns for the tax season. It's been my experience that most taxpayers (like me) who aren't expecting a refund will wait until later in the tax season to file.

There may be other issues at play, too, such as changes in financial circumstances. Taxpayers who were employed at the beginning of the year but found themselves unemployed by year's end may receive a refund because of their withholding rate. Withholding tables are based on amount and frequency of pay as expected over the year. Taxpayers who have a high rate of withholding at the beginning of the year may find they have over-withheld if they are unemployed at the end of the year -- especially if they were receiving unemployment benefits, a portion of which would be exempt from federal income tax.

It will be interesting to see how these stats hold up through the end of tax season. My guess is that when the dust settles, the total refund amounts won't be quite as high as the numbers would indicate today.

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