In April, my accountant offered me a choice. I could base my estimated taxes on last year’s income or this year’s projected income, which was higher. Option 1 meant a lower tax bill throughout the year, but a big bill next April.
My response: “Are you asking me if I’d like a large interest-free loan from the government?! Yes, please.”
He told me I was unusual among his clients, that most people would rather pay in advance because they don’t like the large bill hanging over them. Even though many of these folks are well-paid, they struggle to pay a large bill when the time comes because they don’t have much savings. I assumed this was anecdotal; surely most people would take an interest-free loan if given the choice. But I was wrong.
Case in point: Nearly 270,000 people in Britain turned down an interest-free loan from the government in January.
Historically in Britain, everyone with a child received a stipend from the government known as the child benefit. A family gets £1,055 ($1,637) a year for one child and about £700 ($1,086) for each additional child. Up until this year, all British families got the stipend, no matter how much they earned. But under mounting fiscal pressures, the benefit became means-tested, meaning the payout depended on your circumstances. Families with income more than £50,000 ($77,595) will get a reduced benefit; if they earn more than £60,000 ($93,114), they get no benefit at all. In 2013, everyone will get the benefit but after this year, if you earn over the limit, you must fill out a tax return and pay the money back. Brits also had the option of not getting the benefit at all. They could voluntarily opt out in advance by filling out an online form or calling the child benefit office before Jan. 7. There is no financial penalty to receiving the payments and then paying them back at the end of the year.
The British government cautioned against opting out for families with income around the limit because of the hassle of reclaiming it. Still, it doesn’t make sense for anyone to opt out. You can take that money, invest it and keep the returns. True, returns to short-term, low-risk savings are paltry now, but it’s still free money. Besides money today is almost always worth more than money tomorrow because people discount future income and consumption.
Yet 270,000 of the 1.2 million Brits (the latter number is an estimate of those affected) opted out. What can explain this? Behavioral economics offers a few different explanations. A common reason for suboptimal economic behavior is inertia. People may not do the right thing if it involves effort or they can be goaded into better behavior if they have to opt out of it. This is why automatically enrolling people into individual pension plans has been so successful. But inertia can’t explain this because opting out was an active choice that took effort. If you had to actively claim the benefit rather than ask not to get it, even more people probably wouldn’t have received it. Perhaps the opt-outers wanted to avoid the paperwork associated with the tax filing, but there’s paperwork involved with opting out too.
Another behavioral economics phenomenon is hyperbolic discounting. That’s when people put too little value on consumption in the future and spend all their income now. That may be why people don’t save enough for retirement. But in this case the opposite is true: people turned down money they’d have to pay back later.
I suspect my accountant had the right answer all along: Many people simply don’t want to face a tax bill. Similar to that in the US, the British saving rate has been on the decline. The household saving rate was just 4.2% of disposable income in the first quarter of 2013. If Brits aren’t in the habit of saving, they may not feel confident that they can pay back the government at the end of the year.
That would be consistent with the findings of the 2009 TNS Global Economic Crisis Survey that surveyed Americans and Brits about their financial resilience. About half of Americans and Brits reported they’d probably not be able to come up with £1,500 ($2,327) or $2,000 ($3,103) within 30 days if they had to. That tends to be true more for low earners, but even many middle earners—about 25% of Americans who earned between $75,000 and $100,000—didn’t think they could come up with the money. People with children also expected to not have the cash. Research, based on the survey by economists Annamaria Lusardi, Daniel Schneider, and Peter Tufano, found Brits and Americans are among the worst in their ability to come up with a few thousand dollars compared to other developed countries. The survey was taken during the peak of the financial crisis, but saving has remained low since then.
Explaining the large number of British opt-outs requires further study. We need to understand the relationship between income and wealth of the opt-outers and their levels of financial literacy. A possible reason why some peopled opted out is that they under-save. So they opted-out to prevent themselves from spending the money and then not having it to pay back. If that is the case, it suggests a larger problem of low savings, which leaves many people vulnerable to economic shocks.