Why Your Tax Refund Could Be Smaller This Year

It’s that time of the year once again: tax season.

Although the process of filing an income tax return is often arduous, the hope of a sizable refund from the IRS removes a little pain from the ordeal. But with an economy such as the one we have right now, Preston Brashers, a senior policy analyst for the federal budget at The Heritage Foundation, notes that it’s possible some Americans are going to see smaller refunds this year. (The Daily Signal is Heritage’s multimedia news organization.)

Several factors contribute to these likely smaller tax refunds, Brashers says, but “the big one that’s maybe being left out of this whole conversation is inflation.”

Brashers points out that the “IRS does do an inflation adjustment,” but says the “issue is they do that inflation adjustment in the fall of the prior year.”

“So I think most people can recognize things are a little bit more expensive now than they were in, say, September [or] October of 2021,” he says. “And so you’re effectively being taxed like you’re maybe 8% richer than you actually are, because the value of the dollar, essentially your purchasing power, has gone down.”

Brashers joins “The Daily Signal Podcast” to explain why Americans could get less back from the IRS this year and to discuss what Congress and the White House should do to lower inflation.

Listen to the podcast below or read the lightly edited transcript:

Virginia Allen: Preston Brashers a is Heritage Foundation senior policy analyst for the federal budget. Preston, thanks so much for being here. 

Preston Brashers: Thanks for having me, Virginia. Looking forward to talking. 

Allen: There’s a lot to unpack here, but I want to start with an NPR article that I came across just the other day. On Jan. 22, NPR published an article titled “Your Tax Return Will Likely Be Smaller This Year.” Well, of course, I think, like many Americans, I thought, “Oh, no, why?” Well, in NPR they lay out four different reasons why they argue that your tax returns might be smaller. I want to talk through each of these, starting with the first two. 

So they argue, No. 1, there’s no stimulus checks in 2022, so that will lead to smaller returns. And secondly, the enhanced child credit, which means that families receive a larger tax credit for their kids, that was during COVID, that’s no more.

So, Preston, let’s talk through these. The IRS, they’ve also said that tax returns could be smaller because of the elimination of the advanced child tax credit and no stimulus checks. Is this accurate? How exactly would this lead to smaller returns? 

Brashers: So, they’re right that for many Americans, and that’s the way the IRS worded it, as many Americans will see smaller refunds as a result of this.

You mentioned the stimulus checks. There were $1,400 checks that were sent out during the year. That’s not really going to affect your refund necessarily unless you didn’t get that refund for some reason.

So when we’re thinking about the refund you’re getting at the end of the year, obviously, depending on how much taxes you’re expected to owe, your employer is probably withholding a lot of the taxes during the year. And so at the end of the year, whatever you owe that you haven’t already had withheld, that’s going to be how they determine your refund, or if you get a refund at all, or if you’re paying taxes. 

So really the interesting one, though, is the child tax credit because, temporarily, that was increased for 2021 or the 2022 tax filing season last year. And that went up from $2,000 to $3,000 or $3,600 for small children. And so that went up significantly.

And so you think, “OK, since that goes back to pre-pandemic, then that means I’m going to get less of a refund. But that’s not necessarily true because most Americans got monthly checks. They sent those out as monthly checks during the last half of 2021. So by the time you actually got to the tax filing season for those people that were getting those monthly checks, they actually might see a little bit of an increase.

So it really is kind of a mixed bag on net. Probably, yeah, there’s going to be a little bit of a decrease, but it really depends on your particular situation. 

Allen: That’s fascinating. All right, so let’s talk about these other two points that were raised in this article from NPR. They said during COVID there was also a tax break for charitable deductions and that has now gone away. And then the fourth thing that they argue is that some will likely face taxes on investment profits.

Now, the tax breaks for charitable donations, that was different during COVID? How is that different during COVID? Because, of course, when you give charitable gifts, those are usually things that are not taxed if you’re giving to a nonprofit. 

Brashers: So, the charitable deduction, really the main beneficiaries of the charitable deduction most of the time are people that itemize their deductions. If you’re someone that takes the standard deduction, generally most years, at least post-Tax Cuts and Jobs Act, the way that works is essentially you’re not going to be able to double-dip and take the standard deduction and then add on the charitable deduction on top of that.

And so what they did for 2021 and 2022 filing season was they allowed a small amount of that deduction for people that were claiming the standard deduction on top of that. That’s not going to be a huge factor here, it’s a $300 amount that they allowed for a deduction, but then you multiply that by the tax rate. Depending on if you’re the 10%, 12%, 22%, you might be talking about $30, $50, $70 difference. So it’s not going to be a dramatic difference. 

Allen: What about in the area of investment profits? Because that’s always been the case, right? That if you make money on investments, you have to pay taxes on that. Why would that be more this year? 

Brashers: Yeah, so, I think that one’s a lot fuzzier for me, exactly what direction that’s going to go. Because a lot of people saw big losses, and so some people might be able to claim losses where they were claiming big capital gains in the previous year. And so it’s not clear to me exactly which direction that one’s going to go necessarily.

Their point was it was a really bad year, and so there may have been a lot of distributions, people kind of cutting their losses. Which may be the case, but I’m just not quite clear and I’m not sure that’s going to be a big driving factor. 

Allen: So everything we’ve talked through so far sounds like it’s not going to be too significant for too many Americans in relation to the tax return. But what is missing from this list? Are there other factors that aren’t talked about in this article specifically that you think need to be talked about, that could legitimately lead to many Americans receiving a significantly smaller tax return? 

Brashers: Yeah, there are some smaller factors. The article may have mentioned the child/dependent care tax credit as well, that is another factor. So if you had child care expenses, you’re not going to be able to claim as big of a deduction credit for that. So that is one.

But I think the big one that that’s maybe being left out of this whole conversation is inflation. And so how does inflation affect this? And then ultimately it comes down to the fact that people that don’t make as much money, they don’t pay as much income tax. And certainly in terms of dollar value, but also in terms of as a percentage. 

So if you’re a part-time worker, say low-income earner, and you’ve got a couple of kids, maybe three kids, you could be claiming an earned income tax credit that effectively gives you a negative 30%, 35% tax rate. So you go from a negative 35% and then, of course, as you move up the brackets again, 10%, 12%, 22%, 24%, 32%, 35%, 37%, and then there’s additional taxes for the very wealthy. People’s effective tax rate goes up as their income goes up. And that’s generally measured in nominal terms.

The IRS does do an inflation adjustment. The issue is they do that inflation adjustment in the fall of the prior year. So I think most people can recognize things are a little bit more expensive now than they were in, say, September, October of 2021. And so you’re effectively being taxed like you’re maybe 8% richer than you actually are because the value of the dollar, essentially your purchasing power, has gone down. 

Allen: I want to dive a little bit deeper into inflation in just a moment. But are there any groups of Americans who you estimate they’re actually going to see a bump and they would actually see a higher tax return this year or, by and large, are probably the majority of Americans indeed going to see a lower one? 

Brashers: It really comes down to what you’ve done for your withholding. So, as I was talking about before, the child tax credit part was important, but it wasn’t driving all in the same direction. So if you were one of the people that decided to opt out, absolutely probably going to be in rougher shape this year than you were last year, because last year you were getting a big refund.

But again, I think some parents might be a little bit better off if they didn’t have child care expenses, but they were claiming the child tax credit, if they were getting those monthly payments. At this point, when they’re filing their taxes, they may be a little bit better off. But in general, I would guess that we’re going to kind of revert back to a little bit lower, average refunds for most people. 

Allen: Well, let’s dive into inflation. That’s a big topic. There’s a lot to talk about here, and of course it’s on all of our minds as Americans, as we’re watching prices go up at the gas station, at the grocery store. What are some of the key factors right now that are really the drivers of inflation? 

Brashers: Well, I think what it all boils down to, what happened, we’re reaping what we sowed. We had this massive increase in federal spending, and then it was accommodated by the Federal Reserve, they came in. Because if you have all this new spending, that’s got to come from somewhere. And basically what the Federal Reserve did is they just made it easy. They essentially printed a bunch of money.

We have $7 trillion more of money supplied to make that possible. And that includes things like the stimulus payments that they were making. That includes things like payments to businesses, and specific credits for industries, and specific infrastructure. All these different things that they wanted to put money into that ultimately is going to bleed into inflation. And it doesn’t happen overnight and it’s something that’s with you for a very long time. And so, really, that’s what it boils down to. 

Allen: And what do you mean “with you for a very long time”? What are the long-term consequences and effects? 

Brashers: So, the inflation, we have seen it’s coming down a little bit now, but it’s not coming down on its own necessarily. It’s coming down because the Federal Reserve is now having to fight the inflation and they’re fighting the inflation by driving up interest rates. They’re essentially choking off the supply of money.

And what does that mean? It means it’s harder for businesses to get their hands on money. It’s harder for people that want to buy a house to get their hands on money.

What are you seeing? You’re seeing all these interest rates are going to be going up. If you wanted to get a mortgage right now, if you want to buy a house, it’s almost double the price after you factor in a 30-year mortgage because these interest rates are having to go up.

And so that’s one of the ways that it’s really going to be with us for a long time.

And you think about our national debt, we have a $31 trillion national debt. And so when you start talking about rising interest rates, 1% on $31 trillion, that’s $300 billion a year. So these things, again, they can be with you for a very long time and a lot of different ways.

Allen: And this year, is there any light at the end of the tunnel that we might start to see interest rates begin to drop, we might start to see inflation begin to fall? 

Brashers: Yeah, it’s a very good question. There’s so much that comes down to what the Federal Reserve does. Yeah, that’s really not the way that it should be. It’s kind of interesting just the way that markets respond to the Federal Reserve. It’s like you get bad news in the market, what should be bad news, and then the stock market goes way up because people are like, “Oh, the Federal Reserve is now going to cut interest rates.”

And so it’s kind of this backward thing where people are not, the markets are responding in very strange ways. So it’s hard to say necessarily whether there’s going to be light at the end of the tunnel in the short term.

Honestly, if interest rates are going down, that may not be a good thing because if the interest rates are going down, that’s probably because the Federal Reserve has decided that the recession has gotten so bad and layoffs have gotten so bad that now they have to start cutting rates. So it’s a little bit of a double-edged sword. 

Allen: It is a double-edged sword. It’s kind of discouraging to hear.

Well, you mentioned the $31 trillion debt that America has. And of course, recently in January, America hit its debt ceiling of $31.4 trillion. And now Congress and the White House, they’re sort of having conversations about, what do we do next?

We know there’s a lot of disagreement there. As we know, Republicans are saying, “OK, if we’re going to raise the debt ceiling, we have to cut our federal spending.” And the White House, Biden is saying, “No, this isn’t up for a negotiation, it’s not up for debate.”

If you were advising Congress and the White House right now on the budget and how to lower inflation, what would your advice be? 

Brashers: I mean, with this debt ceiling discussion, one of the words that’s been thrown around is irresponsible, right? They’re talking about it as if it’s irresponsible for us not to just simply extend this line of credit up—$31.4 [trillion], let’s keep it going.

I think households, when you have a large amount of credit card—which, by the way, Americans are increasingly dealing with more and more credit card debt. You don’t just simply get to extend that line of credit forever. You need to start making some changes. 

And so, again, the federal government, when it’s got $31.4 trillion of debt, these are securities, people are buying up this debt. That’s essentially going to make it harder for a business to get the funds that they need to pay for a new factory, to pay the salaries for their employees. It’s going to make it harder for homeowners to buy a new home. Because, again, the federal government is essentially crowding out all this space in this economy, all this debt is going to the federal government instead of into other investments in the economy.

And so it’s imperative, I think, for the economy and for the private sector, for households, for businesses that we do get this under control. And what’s irresponsible is to just continue down the track that we’re on right now, letting that debt just go without doing any sort of reform. 

Allen: And that is what we’re seeing right now, what we’ve seen for so long, is kicking the can down the road, as there really aren’t firm decisions being made about the budget and setting those caps. And there’s a debate raging right now in Congress between Republicans and the White House. If you were guessing, obviously, impossible to know, but what would you guess is the likely agreement that Republicans and Democrats can reach related to the budget and the debt ceiling? Because both sides right now appear pretty dug in, but a solution has to be reached by June in order for them to raise the debt ceiling. 

Brashers: I think it’s important that [House Speaker Kevin] McCarthy and Congress have a very united front. They have very specific things that they want to get out of this. Because the more they’re divided on this—there’s one faction over here that wants one thing, there’s another faction that over here that wants another—it’s going to be easier for the other side to pick that apart.

Versus if you have a specific plan that you’ve worked out, you’ve worked out within your caucus and within the folks that want to actually do some reforms—and there’s lots of different ways to go about this. They want to point to certain types of cuts you want to do. But there’s lots of different ways to reform, to put us in a better situation for the debt ceiling. 

We can talk about regulatory reform. That’s another thing. The regulations that are being imposed on the American people, I mean, you can talk about trillions of dollars that that’s imposing on the economy. And so that, ultimately, if you want to have that as part of what you want to do, I think that’s an important part of the conversation to be had.

You talk about the student loan debt forgiveness. They want to talk about irresponsible, they’re doing all this, they’re talking about the extraordinary measures that they’re having to take. The treasury secretary is talking about extraordinary measures to keep from default. Well, maybe if you weren’t forgiving all this debt, things like that, there’s a lot of different ways to go. But the point, and the important part, I think, is that they have a united front that they’re presenting on this. 

Allen: So, McCarthy needs to get everyone on the same page. That’s critical. Now, when we talk about defaulting, is that actually really something that could possibly happen? Because we’re seeing some Democrats kind of use that almost as threatening language of Republicans, “You better get your act together or we could default.” And Republicans are saying, “We’re not going to default, that’s just not going to happen.” 

Brashers: Yeah, there’s a lot of brinkmanship and talk about this. The idea that we’re going to default on the debt, that we’re just going to simply not pay our debt, if that were to happen, that’s completely on the other side in terms of they’re choosing to do it that way. They can make sure that we’re paying our debts. So I think that’s unlikely. I don’t think anyone wants that. I think we’re just trying to make sure that we’re not continuing to come back to this, the same debate, and having to have this conversation over and over and over again. 

Because eventually you do get to that point. You do get to the point where you just simply can’t pay your debts if you don’t somehow get some control over this debt that is just piling on top of itself. And again, $300 billion a year for every single point interest rate increase, things can get tight really quickly. And so things can spiral out of control and we don’t want to see that. And so if you care about not defaulting on the debt, you should care about getting some reforms and getting some cuts now. 

Allen: Well, Preston, thank you. We really appreciate your time and I encourage everyone listening to visit The Heritage Foundation website to read more of your work there. But Preston, we truly appreciate your knowledge of the federal budget and you being willing to share it with us today. 

Brashers: Thanks a lot, Virginia. 

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