Millions of Americans filling out their 2018 taxes will probably be surprised to learn that their refunds will be less than expected or that they owe money to the Internal Revenue Service after years of receiving refunds.
People have already taken to social media, using the hashtag #GOPTaxScam, to vent their anger. Many blame President Trump and the Republicans for shrinking refunds. Some on Twitter even said they wouldn’t vote for Trump again after seeing their refunds slashed.
The uproar follows the passage of a major overhaul to the tax code in December 2017, which was enacted with only Republican votes and is considered the biggest legislative achievement of Trump’s first year. While the vast majority of Americans received a tax cut in 2018, refunds are a different matter. Some refunds have decreased because of changes in the law, such as a new limit on property and local income tax deductions, and some have decreased because of how the IRS has altered withholding in paychecks.
Two things are going on here:
(1) A pronounced minority of taxpayers, most of them in blue states, are going to pay a higher effective tax rate, mostly because of provisions limiting the deductibility of state and property taxes, and mortgage interest.
(2) Far more people are going to pay a lower effective tax rate, but will believe that their taxes went up, because their refunds will be lower, or they’ll go from getting refund to writing a check to the IRS. Even many of those that realize their taxes didn’t go up — probably a relatively small number, as very few people calculate their effective tax rate — will still be angry because of what psychologists and behavioral economists call the endowment effect.
(None of this even touches on the fact that the tax cuts for individuals are temporary, unlike the permanent tax cuts for corporate entities).
The endowment effect is this: people put more value on what they think of as something they already have than they do on a mathematically equivalent situation that they think of as involving a potential gain. This in turn makes people risk averse when considering what they frame as gains relative to the status quo ante, and risk seeking when considering what they frame as losses.
A classic example from the work of Daniel Kahneman and Amos Tversky is this: Somebody gives you $1000, then gives you the option of getting $500 more for sure, or flipping a coin that will result in either an additional $1000 gain on top of the $1000, or no gain in addition to the initial $1000. From a risk neutral perspective these choices are equivalent, assuming no declining marginal utility of income. (.5 probability of another $1000 being equivalent to $500).
The vast majority of people take the extra $500.
But if the experiment is framed as you get $2000, then you either have to give $500 back, or you can flip a coin to determine whether you get to keep all $2000, or have to give $1000 back, the vast majority of people choose the coin flip. Again the expected value of either option is $1500, just as in the first example. But people hate to lose what they think of as already theirs more than they like to win what they think of as a possible gain.
This is a pretty good analogy for what is going on with the tax refund situation. People value a refund, and especially not writing a check to the government, far more than they value having extra money in their weekly or monthly paychecks. Right wing glibertarians will of course declare in their robot voices that getting a tax refund just means you gave the government an interest-free loan, but that’s not how actual people think.
What actual people think is that they were depending on getting a refund of X and now they’re getting a smaller amount, or worse yet having to write a check. The extra money they got in their paychecks over the course of the year, spread out over 52 or 26 or 12 installments, pretty much doesn’t exist for them, psychologically speaking.
Donald Trump could go on national TV wearing blackface and start screaming the N word repeatedly and it wouldn’t hurt the Republicans’ electoral prospects half as much as this is going to hurt them.