Our decisions often are influenced by emotional and cognitive factors. These tendencies worked well for our prehistorical ancestors, whose instincts kicked in to help save them from predators. But these days, letting emotional or cognitive biases affect our decision-making process can lead to bad outcomes — especially when it comes to money. For instance, investors’ emotional reactions to stock market movements often lead them to sell at market lows and buy at peaks.
Our biases also lead us to place outsized importance on recent events. This recency bias may be what’s fueling some taxpayers’ dissatisfaction with the new tax rules. The TCJA has indeed lowered tax bills for most taxpayers. The problem, however, is that many taxpayers didn’t see those tax savings where they expected to see them — at the bottom of their tax return. As people finished their 2018 returns, social media lit up with stories of lower-than-expected refunds and bigger-than-expected tax bills. By mid-February, the average tax refund in 2018 was nearly 17% lower than in the previous year, according to the Internal Revenue Service.2
The drop in refunds is due in part to a change in the IRS’ withholding tables to account for many of the TCJA’s new provisions. That change meant workers kept more of their money from each paycheck. In effect, their tax savings were spread out over the year, rather than showing up as a lump-sum refund.
Unfortunately, our behavioral tendencies make us much more likely to respond positively to a big lump-sum tax refund than to smaller tax savings spread out over a full year. For many taxpayers, the annual tax refund is an every-year stimulus package that they can use to bolster savings, pay down debt or fund a big purchase or vacation. Meanwhile, the extra money in many workers’ paychecks was simply absorbed and then spent on regular daily expenses.