What’s wrong with an interest-free loan to the government?

U.S. Capitol

Every year, amid the discussion of taxes and rebates and the like, there is usually a talking point that goes like this:

“Getting a rebate of any amount is a bad idea, because all you’re doing is giving the government an interest-free loan.”

I’d like to unpack that, and see how that argument holds up.

Control over your own money

The argument suggests that you want to pay tax in advance such that you don’t overpay. So because you can’t get your taxes exactly right, that you would either owe a little or a lot.

But why do people feel so strongly about it?

The way I see it, the reason to not overpay tax in advance is that you don’t have the ability to utilize that money during the time that it’s not in your hands. Even if you eventually get it back again, you’ve lost precious time with that money.

To take an example, let’s say that I have $1,000, and I invest that in a mutual fund or similar product, and the fund returns 6% for the year. That means that I now have $1,060.

If instead I gave you that $1,000 for a year, you could do whatever you want with it, but when you gave it back, I’d have $1,000, and no more.

So it seems like you would certainly have more money when it’s in your possession for longer.

Control has its limitations

But look closer. Since this is a short term benefit (as in, you have a year or less before you need to pay up that money), any benefit that you would realize from having this money would fall under short term capital gains. So that $60 that you earned would be taxed at ordinary income rates.

Or, okay, you could withdraw the $1,000 only, and keep that $60 in the account for longer. Either way, this isn’t a lot of money we’re talking about here. Is this really a big deal?

What about scale? Yes, you could underpay $10,000 (theoretically), and then you’d have $600 in our scenario. And you could do this every year, and that $600 could start to compound.

This is also assuming that you actually earn that 6%. In the short term world, volatility is normal, so you could just as easily earn -20%, netting you a loss.

Or you could forego volatility altogether and put the money in a savings account, making 1-2%.

Is this all really worth it? I don’t think so.

The evil gubmint

In theory, I admit that it sounds better to keep your money longer, even if (as we’ve seen), it doesn’t really translate into all that much gain.

But the strength of the argument stems from what I consider standard knee-jerk anti-government opposition. The kind of “keep the gubmint from taking my hard-earned money” idea that is all-too-prevalent these days.

Let us not forget that paying taxes does net us a few things. As one site that’s geared toward younger readers notes:

The money you pay in taxes goes to many places. In addition to paying the salaries of government workers, your tax dollars also help to support common resources, such as police and firefighters. […] Tax money helps to ensure the roads you travel on are safe and well-maintained. Taxes fund public libraries and parks. Taxes are also used to fund many types of government programs that help the poor and less fortunate, as well as many schools!

Or, for adults, the Center on Budget and Policy Priorities published the following chart:

From the CBPP. Click for source.

Now, we can disagree on some of these priorities (16% of defense while only 2% on each of education and transportation infrastructure seems almost precisely backwards to me), we can all agree that at least some of these are important.

I believe that keeping the government from your money is generally an ill-informed, emotion-based judgment that really doesn’t stand up to scrutiny. Especially when we’re only talking about a short term situation.

And frankly, even if you believe that the government mismanages its money, that doesn’t mean that the solution is to give them less.

What about a big rebate?

Now with all that in mind, why not just overpay and get a big check back at the end of the year? Since underpaying doesn’t really get you much of any benefit, why not go in the other direction?

If you were to do this, you would in effect be lowering your monthly income so as to get an extra amount of money at the end of the year. It’s kind of like an enforced savings plan, which I’ve argued can be a good thing.

Depending on what you do with that extra windfall could determine if it’s a good idea or not. If you’re the type of person who gets a bonus check and blows it all frivolously, then I might caution against this.

But if you can put the money to good use (perhaps adding to your buckets or paying down your debt), this hardly sounds like the worst way to handle things. It pushes you to live on less than you earn, something we could all benefit from.

And even though it’s not actually extra money, it feels good to get what feels like extra money.

I’m not suggesting that you specifically overpay in order to get a big refund back at the end of the year. I’m just saying that if you want to, and assuming you make a plan for the money, it’s hardly the worst thing to get a rebate. There can be some benefits for an interest-free loan to the government, and not a lot of downside.

But enough about me. How do you handle tax payments? Do you try to pay as little as possible in advance, or do you go for a big refund ?

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