I worked on my tax return this weekend and will be getting a fairly sizable refund. Iâ€™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. Iâ€™ve often thought of doing so but just can never seem to get around to it. Finally, I wouldnâ€™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 hereâ€™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 Iâ€™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 Iâ€™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.