Tax-refund delays could be enough to send U.S. into recession

Tax-refund delays could be enough to send U.S. into recession

Congress seems bent on simultaneously debating the fiscal cliff, where the remedy is a short-term widening of the deficit, and the fiscal crisis, where the remedy is a long-term narrowing. Difficulties of reaching an agreement over both problems at the same time make it increasingly likely that the fiscal cliff, or more accurately the tax shock, will not be averted before January.

One part of that shock has so far gone little noticed: Tax refunds may get delayed until the second quarter, with more than $200 billion at risk. In the first quarter of this year, the Internal Revenue Service cut checks totaling $212.8 billion to 75.3 million taxpayers, with each check averaging $2,826. Similar figures apply to first quarter 2011.

The risk of a delay in sending out these huge sums is not based on mere speculation. Paul Cherecwich Jr., chairman of the IRS Oversight Board, warned in a Nov. 19 letter to the Senate Finance Committee that “more than 60 million taxpayers would have to wait until late March or later to file their returns and receive a refund.”

If, as the IRS official warned, any substantial portion of those refund checks gets deferred to the second quarter, there could be a noticeable hit to consumer spending in the first quarter. Over the past four quarters, consumer spending in nominal dollars has increased by an average of $90 billion per quarter. If $100 billion in refund checks gets deferred, that alone could put consumption in negative territory.

While there would no doubt be a bounce-back in the second quarter, when the money would get sent out, it might not be enough to offset the first-quarter effect. Now add the automatic hit to paychecks from the rescission of the payroll-tax holiday, which will reduce take-home pay by an average of $30 billion per quarter. Add also that, another part of the tax shock, the rise in rates on the 2% of taxpayers, worth about $25 billion per calendar quarter, will probably not be reversed.

Even if all other parts of the tax shock get blunted early next year, you have the makings of an economic downturn in the first quarter.

The problem faced by the IRS, as Acting IRS Commissioner Steven T. Miller explained in a detailed letter of Nov. 13 to the House Committee on Ways and Means, is a classic example of how a key agency of government has to engage in educated guesswork — in Commissioner Miller’s words, “a risk-based decision” — on what the politicians will do next. It mainly involves the alternative minimum tax, or AMT. Geared to exact an extra tax on incomes above a certain threshold, the AMT has been consistently “patched” to prevent it from being imposed on middle-income taxpayers. Accordingly, Miller “instructed IRS staff again this year to leave our core systems ‘as is’ with respect to AMT.” Unless the patch is reinstated, “the magnitude and complexity of the changes” required would take “until late March, if not even later,” to take effect. For that period, nearly everything else would grind to a halt.

In a talk he delivered Dec. 6, Commissioner Miller was asked how soon he would need to get new guidelines on the AMT. His reply: “As soon as possible would be great.”

Source: Barron’s