Why Do Taxpayers Leave Money on the Table?

My dad taught a teenage me an important lesson when he helped me file my first federal income tax return. I earned the minimum wage at a part-time job, and didn’t have to file. But he explained that I should file, knowing my effort would be rewarded. “You don’t earn enough to owe income taxes,” he said. “You’ll get your money back.”

IRS Commissioner John Koskinen tried to remind taxpayers of the same thing in March. The IRS was sitting on roughly $1 billion in unclaimed tax refunds from 2011 and the window was about to close on those who wanted to collect what was, after all, their money. About 1 million people who worked in 2011 were due these refunds, about half of which were for more than $698. They had taxes withheld from their paychecks, but didn’t file a return.

“Some people may not have filed because they didn’t make much money, but they may still be entitled to a refund,” Mr. Koskinen explained, channeling my dad.

And there may be many more than those 1 million non-filers. Researchers Jacob Mortensen, James Cilke, Michael Udell, and Jonathon Zytnick estimate that in 2003, there were 8.3 million non-filers whose tax withholdings totaled $15.9 billion.

Why didn’t they file? The IRS suggests that some don’t want to be found. Maybe they owed other debts to the IRS or a state tax agency. Maybe they were behind on child support, or were delinquent on federal debts like student loans. Some may have been  undocumented immigrants.

But what about the others: Did they understand that their taxes had already been withheld, even though they didn’t make much money? Did they find filing too difficult? Or was dealing with the IRS too intimidating? These questions are difficult to answer, because we don't know a great deal about non-filers who are owed refunds, except that they likely have lower incomes than those who turn in their 1040s.

We do know that people living in or near poverty might have an especially difficult time filing. Research out of Princeton University by Anandi Mani, Sendhil Mullainathan, Eldar Shafir, Jiaying Zhao suggests that “a person's cognitive function is diminished by the constant and all-consuming effort of coping with the immediate effects of having little money, such as scrounging to pay bills and cut costs.” In other words, being poor saps your brain power and focus, leaving you with less for things like “filling out long forms… deciphering new rules, or responding to complex incentives.”

The thing is, if all of your income is “wages” in Box 1 of Form W-2, and if you’re ineligible for refundable credits, we’re talking about filing this one-page form. The IRS and other tax preparation services make the chore  even easier. Many low-income people use walk-in preparers like H&R Block, use the IRS free file service, or visit volunteer centers to file their taxes.

When they do, they may discover they’re eligible for tax subsidies. And if they are, they nearly always apply.

Still, the IRS could do more to encourage them. Take the Earned Income Tax Credit: An upcoming paper by John Guyton, Day Manoli, Brenda Schafer, and Michael Sebastiani finds that if the IRS mails postcards or information flyers with explanations of EITC benefits to non-filers, the number of people who file tax returns and receive the the credit increases. Over the short term, at least, these  “nudges” can help, according to an earlier paper by Manoli and Treasury's Nick Turner.

The amount of  money at stake matters, too. A National Tax Journal article by Marsha Blumenthal, Brian Erard, and Chih-Chin Ho, found that EITC  participation grew  with the size of  benefits.

There’s another problem for the poor. What if the IRS has no place to deposit your refund because you have no checking or savings account? According to the FDIC National Survey of Unbanked and Underbanked Households, 9.6 million households representing 25 million people were “unbanked” in 2013. Why? More than a third said it’s because they couldn’t meet minimum balance requirements.

Treasury ran a temporary pilot program to see whether unbanked adults would use a prepaid card to receive their 2010 tax refunds electronically—a much less expensive way  to deliver refunds. An Urban Institute evaluation of the program by Caroline Ratcliffe and Signe-Mary McKernan found that people “most likely to be unbanked were three times more likely to apply for the card and nearly 2.5 times more likely to directly deposit a tax refund into the account than those who were more likely to have a bank account.”

Treasury abandoned the program after relatively few people signed up. But it could bring it back with some important changes such as including the card as an option on a tax form, lowering the cost, and perhaps allowing account holders to pay tax preparation fees out of their refund.

Think about that. If the program were expanded, previously unbanked taxpayers could file taxes and have a safe place to receive their refunds, and even save a little money.  That seems incredibly worthwhile.

Given all of its current problems,  the IRS may not be giving low-income taxpayers the  attention they deserve. And ultimately, if you’re leaving money on the table, maybe that’s on you.

But not everybody has a dad like mine to teach them about the benefits of filing. Maybe we could do more to help people understand that they may have paid more than they needed to. Maybe we could do more to help them get their money back.

The Tax Hound, publishing the first Wednesday of every month, helps make sense of tax policy for non-geeks and connects tax issues to the non-tax world. Need help? Have an idea? Post a comment.

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