Money

Save or spend? Here's how you'll really use your tax refund

March 11, 2013 at 8:06 AM ET

If you’re like a lot of Americans, chances are you’re hoping you’ll get a tax refund this year.

What’s more, you may be planning to take that money and do something frugal with it, like put it in a savings account or pay down debt.

Here’s the good news: Most people who say they plan to use most of their tax refund to bulk up savings or pay down debt keep the vow.

But here’s the catch: They also tend to spend at least some of that money on something like a nice dinner out or a new pair of boots, whether they realize it or not.

“There’s still a significant spending (boost) among this group,” said Jonathan Parker, a professor of consumer finance at Northwestern University’s Kellogg School of Management who has done research on how people spend government payouts such as tax refunds and stimulus checks.

It appears a lot of taxpayers plan to use their refunds to improve their personal finances.

A TD Ameritrade survey released last month found that 47 percent of those expecting to get a refund plan to  bulk up their savings account with it, while 44 percent plan to use the money to pay debt.

About 28 plan to spend at least some on necessities and 15 percent plan to splurge on something discretionary. Respondents were allowed to pick more than one answer.

Using bank data and other sources, Parker has found that when people get money back from Uncle Sam, on average they tend to immediately spend a little bit more than usual.

“You often find a spike in spending right when it arrives – like, within a week of arrival – that’s sort of small,” he said.

The sudden jump in their bank balance may prompt some people to pay that bill that’s been nagging them, or it may make them feel like it’s OK to splurge on something small, like a date night.

After that, he said there’s sort of a delayed response. But over time, people who got money back do tend to spend slightly more overall, he said.

The people who say they are going to save most of their tax refund or rebate - or mostly use it to pay down debt - do use some of the money toward those goals, he said. But they also tend to spend more of it than they might think they did.

As for the people who said they planned to spend their tax refund? Parker said they mostly do what they planned.

“They were kind of right. They spent the whole thing,” he said.

When people get a bigger tax refund, there is often a bump in spending in August, he noted, suggesting that people are using the money toward a nicer summer vacation. Others who get a big chunk of money back from Uncle Sam, such as a check for over $1,000, may end up using it as a down payment on an even bigger purchase, like a car.

Even though people who think they are saving most of their refund or using it to pay down debt tend to spend some of it, Parker thinks the system of getting a refund can help some people budget.

“It’s a little bit like a helpful commitment to save,” he said.

Still, some taxpayers do complain about a tax system that can act like a forced savings plan – or surprise people with an unexpected bill.

Mark Zandi, chief economist with Moody’s Analytics, said that an ideal tax system would help people better predict their taxes through the year, so they didn’t end up at with a big payment or refund come April 15.

But given all the other complications of the nation’s tax code, he said it’s far from his top concern.

“I’m not sure I’d worry about that at this point,” he said.

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