Interest on Tax Refunds

Cite this Article
Bill Sjostrom, Interest on Tax Refunds, Truth on the Market (March 06, 2006),

I worked on my tax return this weekend and will be getting a fairly sizable refund. I’m well aware that this means I have essentially made a tax free loan to the IRS, and it does bother me. But I guess it does not bother me enough to do anything about it in light of some other considerations. First, my non-salary income fluctuates a lot from year to year so it is difficult to figure out the correct withholding number. Second, over withholding results in forced saving–we have a tendency to spend all available cash. I could set up a similar forced savings mechanism through a financial institution that would generate a return. I’ve often thought of doing so but just can never seem to get around to it. Finally, I wouldn’t want to end up in the situation where I under-withhold and therefore have to cut a check to the IRS. This would just be devastating. So here’s my solution (it’s probably not original, but I’ve never run across it before): the government should pay interest on refunds based on the 90 day T-bill rate. It would not be a straightforward calculation given withholdings are taken throughout the year, but I’m sure someone could figure out an appropriate algorithm. Oh, and to be fair, people who under withhold would have to pay the government interest on money owed.

As an aside, I suspect many professors make similar tax free loans to their institutions by electing to be paid over twelve months instead of nine. Because I’m well versed on the time value of money, for my first three years in academia I elected to be paid over nine months. However, I found it quiet uncomfortable to go with no paycheck in the summer and have concluded that the discomfort outweighs the time value of the money. Hence, this year I elected to be paid over twelve months.