NCPA - National Center for Policy Analysis


March 21, 2006

Americans are enjoying their biggest tax refunds ever -- and it's costing them billions of dollars. Taxpayers overpaid their federal income taxes by a record 29 percent in both 2003 and 2004, according to a USA Today analysis of Internal Revenue Service data.

That has pushed refunds above $200 billion a year. Final figures aren't in for the 2005 tax year, but the average refund so far is $2,423, up 4 percent from last year. The fatter refunds are the result of taxpayers withholding nearly twice the traditional safety margin from their paychecks to avoid a year-end tax bill.

The extra withholding gives the government an interest-free loan worth more than $10 billion a year, equal to about $100 per tax return.

  • The increasing use of tax credits and deductions caused the jump in overwithholding.
  • Changes in tax rates automatically revise withholding levels, but changes in tax credits and deductions do not.
  • Workers getting expanded credits or deductions must fill out new W-4 forms to change the amount of money deducted from their paychecks.

The child tax credit, which rose from $500 to $1,000 per child in 2001, is the biggest reason for a jump in excessive withholding. More than 25 million tax returns claim this credit, worth $55 billion in 2005.

Tax credits are available for a dozen purposes, including college education, adoption assistance and child care expenses. The portion of returns claiming at least one credit rose from 13 percent in 1995 to 31 percent in 2003. Credits reduce the tax owed dollar for dollar.

Source: Dennis Cauchon, "Refunds grow fat on tax changes," March 21, 2006.

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