Rainy Day Refunds (#12 & 35)

Tax Day is upon us, and Senators Cory Booker and Jerry Moran have teamed up on a bipartisan proposal aimed at using tax refunds to boost Americans’ savings. Known as the Refund to Rainy Day Savings Act, the bill would give tax filers the option of setting aside a slice of their tax refund in an emergency savings account, to be direct deposited into their checking account six months later.

Under Booker and Moran’s plan, tax filers could elect to set aside 20 percent of their refund in a savings account, where it would accrue interest for six months before being transferred into their checking account. The idea is to smooth out payment to make tax refunds last longer and give families a cushion if a financial emergency strikes later in the year. “This bipartisan legislation would allow Americans to utilize a rare moment of financial flexibility that accompanies a tax refund to plan for the future, set aside savings for a rainy day, and invest in their own financial stability,” says Senator Moran.

On the whole, this is an encouraging idea. The brutal combination of rising financial pressure and stagnating incomes has left too many Americans treading water with their savings. More than 60 percent of Americans have less than $1,000 in their savings accounts, and one out of five doesn’t even have a savings account. Even when factoring in liquid assets like retirement accounts, 44 percent of Americans do not have sufficient  funds readily accessible to stay afloat for three months. Booker and Moran hope to capitalize on the momentary financial breathing room following a tax refund to help Americans build up their savings.

Booker and Moran’s bill is particularly concerned with building savings among the most vulnerable Americans. “Families living paycheck to paycheck endure the persistent threat of sudden financial disaster,” Senator Booker notes.

To that end, their bill is largely an adaptation of a policy proposal from the Center for Enterprise Development to reform the Earned Income Tax Credit in order to provide targeted help to these very families. The EITC is a refundable tax credit and one of our most important anti-poverty programs, providing up to $6,000 in additional income to working families annually. Under CFED’s Rainy Day EITC plan, families could shift 20 percent of their EITC refund into a savings account, getting it back six months later. (CFED’s plan also gave families a 50 percent match from the IRS to further incentivize saving.  Booker-Moran does not.) It’s one of several policy proposals attempting to spread payment of the EITC to alleviate the uneven “boom and bust” yearly budget cycle for low-income households getting a large portion of their income in a single tax refund.

I’m partial to a variation of this type of plan that advances half of a family’s EITC refund in four quarterly payments, rather than deferring it. This plan was authored by Brookings Institute economist Steve Holt and tested out in Chicago by the Center for Economic Progress. CEP found that families receiving periodic payments had  financial stability, reduced their debt load, avoided predatory loans, and accumulated savings.

Poor families have a hard time saving because their resources are already stretched too thin to meet regular living expenses. One study found that 40 percent of EITC dollars were used to pay down debt, while only 39 percent of families put any of their refund toward savings, tucking away on average of 15 percent of their refunds. Because families live in the red year-round, their tax season windfalls are disproportionately spent paying down debts accrued by just keeping up with the year’s expenses. Paying off these debts from budget shortfalls thus crowds out savings.

If we advanced EITC refunds to families, they could draw on this money throughout the year to avoid sinking into costly debt. Freeing up resources that are currently spent clawing out of debt would give families the chance to create meaningful savings.

CFED considered structuring their Rainy Day EITC as a periodic payment, but evidently determined that “monthly payments would be too small and would simply be incorporated into monthly budgets,” and that other periodic deliveries would be unduly complex. However, a structure like CED’s Chicago experiment, which pays half of a family’s EITC in four quarterly payments, would retain simplicity and make fairly sizable payments: a family due $4,000 in EITC would receive $2,000 at tax time and $500 every three months. Absorbing these $500 payments into their regular budget is precisely the point, allowing families to make ends meet without relying on debt.

In their study of EITC-recipient families in It’s Not Like I’m Poor, Kathryn Edin, Laura Tach—both of whom also co-authored the Rainy Day EITC proposal—and their co-authors found that these families approached tax season with tremendous anticipation and great relief when their refunds arrived. Tach and Edin laud the lump sum EITC for providing a rare opportunity for families to rise above scraping by to plan their finances, make investments, and indulge in middle-class treats. But the joy of these families at tax time is the joy of someone momentarily lifted above constant financial peril, resembling the desperate relief of a person starving for a year finally receiving a decent meal.

Indeed, Tach and Edin found that for these families, “[g]etting into debt and trying to dig out of it were near-universal experiences.” This financial whipsawing could be avoided by padding the budgets of these families year-round. Staving off debt is the first step to building the savings cushion needed to survive misfortune and financial shock.

The proposal from Senators Booker and Moran may well help do that. It’s a laudable effort to unlock the money due to American families from the strictures of the tax code. As a general matter, the resources owed to Americans should be made available to meet the actual timing of their needs, not tuned to the tax calendar.

But there might be more effective ways to help some of the most vulnerable families shore up their finances. When families wait on their tax refunds all year long as a chance to finally catch up, it’s hard to ask them to withhold this money for a rainy day. These families might benefit more from help today than they do from setting aside for tomorrow.

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