Your Brain on Taxes

Apr 18, 2018

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Think human beings are rational thinkers when it comes to money? Think again. An estimated two thirds of Americans have received or anticipate receiving a tax refund this year – and logic has little to do with how we will spend it. HPR Reporter Kuʻuwehi Hiraishi has more.

Last year, millions of Americans received a tax refund from the IRS averaging a little under $2,900 each. A tax refund means you’ve overpaid your taxes. People say they know this. But only 19 percent of Americans receiving refunds change their withholdings.

Lester Lusher (left) and John Lynham (right) are economics professors at the University of Hawai'i at Manoa who study behavioral economics - a field that melds psychology and economics.
Credit Ku'uwehi Hiraishi

“If you step back and think about it, I could be richer if instead of paying more taxes I paid less taxes and I put that in a savings account,” says Lynham, “I’d have the interest at the end of the year. I could pay my owed taxes and then I’d have the interest on that savings as a little bit extra.”

John Lynham is an economics professor at UH Mānoa. He says while refunds don’t give us the best return on investment, it forces us into a behavior

“It’s in some ways financially foolish but in other ways it’s recognizing that we have a difficulty in saving,” says Lynham, “And it commits us to putting money away that we can only access once a year.”

Lynham and his colleague Lester Lusher study behavioral economics, which aims to understand why humans make the economic decisions they do. How you choose to spend your refund has a lot to do with your view of money and time or what behavioral economists call time preference.

“When you are impoverished. When you are living paycheck to paycheck and you’re hungry, your brain goes through changes and very much changes sort of your – what we care about in economics, your time preferences,” says Lusher, “They become more much more short-term minded. They are only focusing on the next day, the next week and whatnot.”

Credit Ku'uwehi Hiraishi

They are more likely to spend their refund on things with short-term gain like everyday expenses or a night out on the town.

“Those people who tend to have very long view of their earnings and money are more likely to save it, invest it in something that has long-term benefits, so on and so forth,” says Lusher.

Lusher cites studies by behavioral economist and Harvard University professor Sendhil Mullainathan.

“That has implications because economists like to think hey maybe we need to train these people to save or do these programs to like incentivize them to do these things,” says Lusher, “I think what this literature is suggesting is it’s a mindset that they just can’t get out of. It’s a physiological thing.”

So does a deep understanding of behavioral economics have any implications on how these economist plan to spend their tax refund?

“I did my taxes last night cause I knew you probably were gonna ask me that question and I did get a small refund,” says Lynham, “I’m embarrassed to say this on the air but I’m probably just going to buy some new tires on my truck.”

Even though logically, a tax refund is simply the return of your own money. Emotionally, it can feel like a windfall. And windfalls are typically spent more frivolously and extravagantly than hard earned cash. Even if youʻre a behavioral economist.