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like 20 to 30% of every dollar uh that gets sent
back uh through the tax system is being eaten up
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by tax preparation costs. Wow. Right. And so we
have this like highly inefficient system of filing
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our taxes and it doesn't have to be this way.
Welcome to the Ripple Effect, the podcast that
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takes you on a journey through the minds of Warton
faculty. I'm your host Dan Looney and in each
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episode we'll be diving deep into the inspiration
behind the groundbreaking research that Wharton
00:00:31
professors have conducted and exploring how their
findings resonate with the world today. Well, we
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are in the middle of one of everybody's favorite
times of the year, tax season. But it is a time of
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the year which also gives us the opportunity to
try and better understand some of the behaviors
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that occur by individuals at this time of the
year. When you think about the preparation of
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your taxes, are you a procrastinator or not?
When you're thinking about potential refunds
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or payments, how do you deal with one or the
other? Lots to discuss and a pleasure to be
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joined by Wendy Dear Rosa, who's an assistant
professor of marketing here at the Wharton School,
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who also focuses a lot about consumer financial
decisionmaking. Hi Wendy, great to catch up again.
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How are you? I'm doing well. Excited to be here.
Thanks for having me. Yeah, it's great to talk to
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you. You know, it it it is kind of an interesting
component of the time of the year and I guess from
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a behavioral standpoint, uh it does give you
the opportunity to gain a lot of information
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and data about how people handle these situations.
It does. And what we what we know from prior work
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is that people tend to think about tax refunds
as windfalls. We don't incorporate it into our
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regular budgets. We think about this money as sort
of special money, which is odd, right? Because
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it's our money coming back to us, right? It's
it's not a gift from anybody. Um, but what that
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means is that we treat that money differently. And
often times what we find is that when people start
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um elaborating and deeply thinking about and
anticipating a tax refund, you start to allocate
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that tax refund multiple times over. So, you start
to tell yourself, hey, I'm going to use this to
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pay down debt. I'm going to use this to maybe put
a little bit of money in emergency funds. Hey, I'm
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going to use this to uh maybe buy myself something
that I've been waiting to buy, especially in this
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like, you know, sort of time period where prices
have been rising sort of rapidly over the past
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couple of years. And what ends up happening is
that you sort of mentally spend that money three
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times over. you've allocated across so many
buckets um that by the time the tax refund
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comes in and of itself, we then don't have a real
concrete plan. And so we, you know, we talked to
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a lot of people that sort of have a little bit
of regret on how there they ended up spending
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the money. There was sort of this gap between how
they planned to do it and how they actually did.
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Do you see more people focused on I'll call it a
negative in terms of paying down debt more so than
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thinking about buying themselves something nice?
Like that's the first thing they think about. If
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they know they have debt, they associate this as
an opportunity to pay that down. Yeah. So we have
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sort of this like uh bias in which when we tend
to think about our future selves, we tend to think
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about the perfect version of our future selves.
So in the future you're going to work out more,
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you're going to save more, you're going to
be a better parent, a better spouse, etc.,
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etc., right? Like we all turn into our individual
versions of Beyonce in the future. And so today,
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when I'm thinking about what I'm going to
do for my tax refund in a couple of months,
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I'm going to think about all of these things
that I think my perfect self would do. paying
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down debt or increasing my savings and putting
some money away for, you know, my child's 529
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account. What happens is when the future becomes
the present, I realize that I'm still the same
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imperfect self as I was yesterday. And so all of
the temptations that come into play sort of come
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right when the tax refund hits the account. And
so that's sort of the the tension that we have.
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So I'll tell you a little bit of an intervention
that we did with a company called Digit a couple
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of year now a few years ago where understanding
this tension this gap between what I intend to do
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and what I actually do when the time comes when
the rubber hits the road. We send people in this
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experiment one of two text messages. In one we
said hey you might get a tax refund if you do what
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percentage of it would you like to save early in
the tax season in January. So people didn't know
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if they were going to receive a tax refund or how
much. But if they did, they could say 10%, 20%,
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50%. And then if digit notice a tax refund on the
account, they automatically move that money from
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their checking account into a savings account. In
the other condition, we texted people and we said,
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"Hey, when they received their tax refund, when
did you notice that there was a tax refund?" We
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texted people and said, "Hey, what percentage of
it would you like to save?" and then you could
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tax any percentage and none then digit wouldn't
lose that money. That timing difference that
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will almost double the amount of savings rates,
right? And so here's a tool that people can use
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of saying let's precommit ourselves early in the
tax season and have a very concrete plan about
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how you're going to save that money or how you're
going to pay down debt and then create systems.
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digit is just one example where that money
then automatically flows in the way that you
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intend to in January, not in the way that
you intend to when right because you have
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the element of procrastination and I think
sometimes procrastinators tend to be people
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who feel like they're going to owe money when
they get their taxes done. And that dynamic
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then probably presents a higher level of pressure
on the individual because they're concerned that
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they've worked hard in the last 12 months. they've
done, you know, pretty much everything they can
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and yet they still owe when the tax return is
done. Yeah. You know, 85% of tax filers get
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a tax refund. And so, but you are talking about
sort of this 15% of the population particularly,
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you know, we don't tend to think about this, but
gig workers, 1099 workers, so your lift drivers,
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your Uber drivers, um, you know, their taxes don't
get withheld. And so a lot of them are sort of not
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just procrastinated but in shock of how much they
have to pay at at towards the end. I think this
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year in particular is sort of this unique year in
taxes because there's all of this discussion going
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around that people are going to see a larger
than than usual tax refund as a result of uh
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recent regulation changes um around the order of
$1,000. And what we're seeing in the data is that
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it's bigger, but it's not like I I want to temper
expectations. It's not that people are getting
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uh on average a tax refund that's high that's more
than $1,000 than what they used to do. You know,
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the the recent regulations, what they do is that
they have disparit impact. So, if you're higher
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income, you're actually going to be a little
bit more well off uh in terms of your tax refund
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than if you're lower income. And according to the
latest stats by the IRS, tax refunds are about 10
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to 11% higher this year than they were last year.
What does that translate to? It means like 300 an
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extra 300 to $400. That's not chunk change, right?
The average tax refund this year is about $3,600,
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which if you're earning minimum wage in the United
States, that's the equivalent of more than three
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months of your gross income, right? So these are
real dollars that have real consequences and one
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of our largest poverty alleviation programs is
created through the tax system. The component
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of planning when people are thinking about their
taxes. Are people savvy enough to think about that
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this is not in many cases something that you think
about after January or you know when February
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rolls around that there are elements of this tax
preparation that are things that probably can be
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considered throughout the course of the year. Oh
don't get me started about the inefficiencies of
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our tax prep program. Um, you know, I think
one of the most like heartbreaking stats,
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um, I've come across is for our tax system is sort
of the biggest tax system we have, for example,
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to fight poverty or to help our seniors, uh, to
help working parents. And the heartbreaking stat
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that I read is basically like 20 to 30% of every
dollar uh that gets sent back uh through the tax
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system um is being eaten up by tax preparation
costs, right? And so we have this like highly
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inefficient system of filing our taxes and it
doesn't have to be this way. In fact, um there
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are many organizations including code for America
who have like helped build up like easy and free
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filing tax tools. But your second question comes
like why is it so hard? Why is it so hard to plan?
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like you know one of the reasons why people are
getting a higher than average tax refund this year
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which again people treat as a windfall but you can
conceptualize this as a loss right this is money
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that you're not earning any interest on that it's
your money you could have gotten it earlier in the
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year is really because the inefficiencies in the
system. So for example given recent regulations
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there were changes to the tax code but there were
no automatic updates to people's withholdings.
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Yeah. Yeah. like that's an inefficient system and
so you're withholding more money even though you
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know that the regulations have changed that
the system itself has changed but there was
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no automatic update to withholding rates and so
that's part of the reason why people are getting
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a a higher than average refund and if we had a
system in place from employers for example that
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really sort of put at the forefront employees
financial well-being and sort of got ahead of
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this I think we would help in the planning process
much Then I I'll ask a version of a question that
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I think everybody every expert's being asked
right now. Do you think then that artificial
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intelligence will have will be able to play a role
in making this better as we move forward? Listen,
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AI is going to touch every aspect of our society
and it's already having a pretty sizable impact in
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the accounting field. What I will say is that even
in the world before AI, we had tools available
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to us such as the free filing tool uh under a
different administration where people could file
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their taxes for free directly with the IRS. It had
an MPS score in the '90s. Like when was the last
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time you saw a government tool where people said
had an NPS score in the '90s? And that was before
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AI. Um, and so while I think AI will be helpful
in hopefully making life easier for accountants
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and making our lives easier as we file our taxes,
a lot of the frictions, the main frictions that
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we're talking about, like there's no, we don't
need artificial intelligence for we just need
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sort of will from our legislative bodies, from
consumers to say it doesn't have to be this way.
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It doesn't have to be this hard. I don't need
to get my CPA in order to file my taxes, right?
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Um and and we've done it. What do you think then
are are there a couple of components, strategies
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that people should really think about? And it's
probably again a a thought process that may you
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know pop up from time to time over the course of
the year so that they can be better prepared in
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terms of when they get to tax time so it doesn't
become this pressureful you know bomb ready to go
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off type of time of the year. Yeah. And so one of
the things that um is fascinating is that there
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are very predictable patterns in tax filing rates.
that you have is sort of this inverted U. Like
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right when people there's a bunch of people that
as soon as they get their W2, they go and they
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like talk to their accountants and they go and
they file their taxes uh because they're either
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liquidity constrained or they're expecting a large
refund or you know what, they just want to get it
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out of the way and then there's a big lol um that
happens basically in the first couple of weeks of
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March. we're in the law right now. And then you
have the bunch of people who are like, it's April
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14th. Oh man, I better start thinking about my
taxes. Um, and so if if think about who you are
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and I would say create your environment in a way
that makes your life easier easier for you. So as
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you're thinking about setting up the appointment
with your tax collector, put a reminder in your
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phone in January to make that appointment in
March. one, your tax accountant is probably
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going to have more time in the in early March
than, you know, mid mid April. Um, but then two,
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you start to set structures in place of saying,
"Here is my plan, you're making it more concrete."
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The second thing I would say is we know that
when we try to reach our goals, especially our
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financial goals, having a buddy, having a partner,
and vocalizing it really matters, right? And so
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think about talking to your friend and say when
I get my tax refund I am going to do X. Have that
00:13:53
accountability with your buddy. But then the third
and this is where technology and again it doesn't
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have to be AI but just like technology it can be
helpful is create a system in place where you can
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precommit. So there are companies and and fintech
startups that just allow you to say look when
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there's a deposit from the IRS automatically send
whatever percentage makes sense for you to either
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paying down debt to saving to whatever you want so
that you don't have to be in the seat when you're
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the most tempted to spend to make these decisions.
Wendy, always great to talk with you. Thanks very
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much for your time today. Oh, always a pleasure.
Take care. Thank you. Wendy de la Rosa, assistant
00:14:34
professor of marketing here at the Wharton School.
Thank you for listening to the Ripple Effect. We
00:14:39
hope you found this episode informative and
engaging. Don't forget to subscribe and leave
00:14:44
us a review so that we can continue to bring
you the best insight from the Wharton School.
