Behavioral Economics: How Taxes Don't Dictate Spending Habits

Much of the field of economics can boil down to a central tension in how humans behave: There are some objectively reasonable ways to spend money, such as doing so when you have it and not doing so when you don't, but people do not like to spend money reasonably. We always make decisions on a complex matrix of factors, which often leads to counterintuitive results.

A professor of finance at Ohio State University wanted to look into how this tendency manifested in relation to a known annual factor: paying taxes. A new study just released examines Americans' standard of living and how it changes (or doesn't) when we owe taxes or receive a refund. Economists often claim that when members of a household come into a windfall through a tax refund, they immediately start spending that money. That would suggest that paying taxes would curb a household's spending, but that's not what the researchers uncovered.

"What we found is that owing money to the IRS did not disrupt normal consumption in our sample of American households," lead author Itzhak Ben-David said. "They found ways to use money from savings accounts or other reserves to keep up their spending in years when they had to pay the IRS. They didn't cancel their vacations."

In short, we don't tend to budget for taxes, and when we get money back from the government, we treat it like a bonus or sudden windfall. That said, budgeting for taxes can help stave off nasty surprises when you file. Look over your returns for the last few years and estimate how it could change your spending going forward.