Consumer Spending "Pothole" Ahead: IRS Refunds Tumble As New Law Delays Payments

A period of consumer spending, retail sales and housing weakness may be imminent, after federal tax refunds tumbled by 78% in the early part of February compared to 2016, the  result of a new law which requires the IRS to delay the printing of checks to households claiming specific tax credits.  The reason for the slowdown is that in late 2015 Congress passed a law forcing the IRS to hold back refund checks related to the earned-income tax credit and the child tax credit until at least Feb. 15. The delay would reportedly give the IRS more time to match tax returns with income data on W-2s filed by employers. Allegedly, such payments had become a tempting target for identity thieves and unscrupulous tax preparers, who falsify tax returns to get thousands of dollars.

The IRS has told affected taxpayers that they shouldn’t expect to receive their refunds until Feb. 27 because of weekends, holidays and bank delays.

While the Joint Committee on Taxation projected the law would increase federal revenue by $779 million over a decade, it may result in a period of stagnant spending until the calendar effects are wrinkled out and US households get the money they are owed. According to a WSJ analysis, refunds paid through Feb. 3 were only $13.2 billion, down almost 80% from $58.6 billion through Feb. 5, 2016. Additionally, the average refund also declined, to $1,994 from $3,385.

While perfect comps are impossible as the 2016 data includes four more processing days, the number of returns is down just 24%, far less than the drop in refunds.

The delay in cash disbursement could temporarily slow overall consumer spending, impact retail sales and delay mortgage payments. That’s because tax refunds are often the largest financial event of the year for low-income households, which make major purchases or use the refunds to pay off debts according to the WSJ. "Overall U.S. retail and restaurant sales in January and February 2016 totaled $814.48 billion, not adjusted for seasonal variations, according to the Commerce Department."

The good news is that after a period of initial slowness in the first half of the month, spending should pick up and compensate in the last two weeks of the month. According to Chris Christopher, director of consumer economics at IHS Global Insight, the IRS delays should push some spending back into February and March without affecting overall sales.

Still, according to a Goldman note, the refund delays could cause a “pothole” in consumer spending in February and said an expected decline of 40%-50% in February refunds would be “surprisingly large.”

Putin tax seasons in context, in 2016, the IRS paid out more than 111 million tax refunds for a total of $317.6 billion.