The value of exploitative loans

I show that the same bias that causes someone to take an exploitative loan may also imply that the loan benefits them by causing them to purchase a product or service that they should, but wouldn’t otherwise, buy. I demonstrate the importance of this effect in a study of tax refund anticipation loans. I find that regulation curtailing these loans reduced the use of paid tax preparers and the takeup of the earned income tax credit, which is the second largest federal transfer to low-income households.

That is from a paper by Andrew T. Hayashi, via the excellent Kevin Lewis.

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'The value of exploitative loans'

Well, obviously exploiting people brings a benefit to the exploiter - otherwise, those doing the exploiting wouldn't bother in the first place. Makes one wonder why any exploitative big business needs defending.

Why isn't the borrower being called exploitive? He's the one receiving the cash and potentially defaulting.

Yeah, the poor payday loan companies are barely scraping by

Point being, it stupid to call either side 'exploitive'. Example below is a $2000 loan for 2 months cost $47. Sounds cheap, but it's 36%. If the borrower needs a transmission, having use of his car for 2 months for $47 IS cheap. No one exploited. Service rendered and appreciated.

'Example below is a $2000 loan for 2 months cost $47.'

24 days, paid back in full.

Some people keep putting out this figure that the vast majority of payday loans are paid back promptly. Frankly, I doubt it. Or if so, they are promptly rolled over. again and again.

I also doubt they are used to fix car. I think they are most used for food and rent.

https://www.opploans.com/blog/5-alarming-stats-payday-loans/

The EITC was a terrible idea, a socialist redistribution of money. There should be a study of how that money is spent. Ask a car dealer and they will tell you that February is one of the biggest weeks to sell cars because of the EITC. How much of the EITC goes to drugs? Where is this "rob peter to pay Paula" gift spent. Wouldn't you think the government would want to know this???

The EITC was the conservative solution to welfare: rewarding work

Are you trying to claim no Democrats voted for it?
Regardless of who came up with the idea and who passed it into law it is still a terrible idea. AND investigating how irresponsible people use this rather large cash gift paid for by actual workers would seem to be necessary because it is such a huge waste of public funds.

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The EITC was a Republican proposal from the 1990s. It was the conservative alternative to welfare. Instead of paying poor people not to work, we created a wage subsidy program. This subsidy helped insure that people who worked a full time job did not end up in poverty.

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'He's the one receiving the cash and potentially defaulting.'

Well, first, if the intent is to receive money without paying it back at all, that is a crime, generally falling under the heading of fraud.

Second, the person deciding to loan the money is the one who decides who gets a loan - and of course, potential to default is part of the decision marking process.

But mainly, the person making the loan is a business, and like any business, dealing with potential losses is part of staying in business. After all, the person making the loan is only doing it to make money, and if they were worried about potential defaults causing a loss, they simply need not make any loans in the first place.

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Realizing that the entire paid tax preparation industry is itself a scam, this paragraph reads, "One exploitative industry can be beneficial because it forces poor people to use the services of a secondary exploitative industry, which incidentally also causes them to get more of a certain welfare payment which is itself non-automatic and underutilized."

You know what would be better for literally everyone other than the scammers? Just make the government prepare your taxes for you and/or give out the welfare payment regardless. Either way would be better for society.

The hassle factor of unnecessary processing for taxes and health care in America is grotesque immorality.

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'Realizing that the entire paid tax preparation industry is itself a scam'

Depends on what you mean. Someone like President Trump undoubtedly derives great value from having highly trained professionals prepare his taxes.

Though it is possible that in the near future, we will see that President Trump's tax returns were not prepared by highly trained professionals, thus demonstrating the value of competent tax accountants and lawyers.

Pretty sure Trump doesn't use a pop-up tax prep franchise located in a strip mall.

Then again, their advance refund loan program is pretty attractive. And he IS a strip mall kinda guy...

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Trump is most likely fine. AOC on the other hand.....

/boggle

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I've known a couple of Trump's lawyers and accountants (the ones who do the couth work, as opposed to a fixer like Avenatti). They are quite professional and competent. Just like his architects and contractors, whose work is more susceptible to ready evaluation if you care to visit some of his buildings.

Yes, I would hope that when they are doing eight and nine figure projects with other people's money, they didn't use Cohen for the doc prep.

Yes, of course, I meant Cohen.

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This is caused by the withholding of income taxes for salaried workers.
Employers have to pay someone to take care of withholding tax, then salaried workers must pay or do the work themselves to get their tax deductions back.

Would it be more efficient if the income taxes were not withhold in first place? That's quite different to the present arrangement and not sure if it works considering the US culture.

"Would it be more efficient if the income taxes were not withhold in first place? " May be a bit more work, but I'd bet government would be a heck of a lot more efficient (and smaller) if people had to physically write a check for their tax bill.

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You don't have to stop withholding taxed at all--you can simply have the government do your taxes for you and allow you to *optionally* file a return if you think you can do a better job with exemptions and deductions.

This has been talked about on the show Adam Ruins Everything (https://youtu.be/Fj4anUL-LvY), which actually has a very well sourced and concise description of the issue.

Fun fact: a bunch of other countries already do this (https://www.taxpolicycenter.org/briefing-book/what-other-countries-use-return-free-tax-filing).

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"Would it be more efficient if the income taxes were not withhold in first place? That's quite different to the present arrangement and not sure if it works considering the US culture."

The first year that this happened, tens of millions of people would suddenly find themselves unable to pay their tax bill. The government would be unable to collect on the tax debt and in all likelihood would suffer a huge budget crunch.

Tens of millions of Americans are living paycheck-to-paycheck. They're going to spend through whatever higher wages show up in their bank accounts. They're just not going to put away enough savings each month to cover their annual tax bill.

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I learned a couple years ago that most people in the UK don't even file tax returns. Weird.

Take a look at the 2018 1040. Much simplified. Higher standard deduction means tax calculations are now trivial for a huge number of Americans.

The whole idea that the tax preparation industry keeps us filing sounds like paranoia, but it might be true.

And maybe people outside the industry are more sympathetic to private profit than an expanded "government service."

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Form 1040 might be shorter, only if you ignore the new Schedules 1,2,3,4 and 5. I have to file three of them, so that part of my return is now five shorter pages instead two longer ones. A distinction without a distinction.

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Paid tax preparers can lend directly, cut the middle-man =)

Actually, they don't lend by most meanings of the term, they simply take another piece of the tax preparation pie, based on the money that they are involved in gaining from tax overpayment in the first place.

This is precisely my experience during the years I lived in Texas. You drive to the strip mall office, the tax preparer calculates the amount you can get back and their service fees are discounted from that amount.

However, the topic today is tax refund ANTICIPATION LOANS. It's not the same to get an income tax refund than take a loan where the collateral is an estimate of your tax refund.

On one hand, tax refund anticipation loans provide liquidity at the most critical time. The allow low income to people to use tax refunds as collateral for credit. Those lenders, such nice people.

On the other hand, if income taxes were not withhold in first place, people would have the liquidity when needed. Bye bye lenders. The business model of these guys depends entirely on the existence of the withholding tax.

'tax refund anticipation loans'

The details matter, of course, but this is not a loan in most senses. Basically, this is simply discounting the value of the refund, and only providing a portion of the actual refund to the person entitled to it.

Still exploitative, but in the same way that a bank will happily provide a lump sum payment for the right to receive a lottery prize that pays out over 20 years.

As for withholding - self-employed people often have real problems paying their taxes because withholding as such is not used (though it is not once a year payment either, of course), and a lump sum payment can be a serious burden.

Not that the American view on this isn't crazy by and large, but there are arguments for withholding that are rational enough.

I just went to the first site that offers RALs (refund anticipation loans) and found this:

"Loans offered in the amount of 25%, 50%, or 75% of your expected tax refund from $500 - $6,000. Loan in the amount of 25% of your expected refund has an Annual Percentage Rate (APR) of 0.00%. Loan in the amounts of 50% or 75% of your expected tax refund have an APR of 36%. For example, $2,000 representing 50% of expected refund borrowed over 24-day terms, total amount payable in a single payment is $2,047.34 including interest. "

Lower loan/tax refund ratios have lower interest rate. So, interest is charged according to loan period and risk. It looks like a loan, quacks like loan......could it be a loan?

Excellent comment supported by facts. Also, Behavioral Finance 101

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'Lower loan/tax refund ratios have lower interest rate.'

Would I would be more curious about is what fees are involved, regardless of amount, but that is mainly because I am a very cynical person when it comes to someone handing me money apparently for free. To be honest, I would not trust this formulation - 'total amount payable in a single payment is $2,047.34 including interest' - when what they are advertising is apparently - 'For example, $2,000 representing 25% of expected refund borrowed over 24-day terms, total amount payable in a single payment is $2,000.00, without interest."

However, (I have little interest in discovering just how much sewage has piled up in the U.S. over a quarter century by searching), I thought it was various tax preparation firms that offered loans on the anticipated refund. Are they now two different 'industries'?

This is the link I read: https://www.taxnetfinancial.com/

I won't spend several hours reading the lengthy terms and conditions.

I assume fees are a given since the business model of this industry is deception.....and charging interest.

Thanks - but it does appear that things are more or less as I remember in this area.

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See below from rayward. Likely, the 'fee' is that the taxes have to be prepared - for a fee obviously - by the company making the loan.

And I would really wonder about that paid back in full in 24 days, unless there is some guarantee that the refund would be provided by the Treasury within that time scale (honestly have no idea about that aspect).

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I'm going to propose a corollary avenue of research:

those who expand their welfare-enhancing consumption without taking out an exploitative loan can receive the benefit of the consumption without the negative effects of the exploitative loan.

can i haz research $ now?

Not from the Mercatus Center.

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I really wish people wouldn't use "exploitative" or any of its derivatives in economic discussions. Within the field of economics, the word is meaningless. People use it because it appeals to emotion. It provides a means to avoid actually producing an argument and defending it ("HOW CAN YOU DEFEND EXPLOITATION??? OF COURSE EXPLOITATION IS BAD!!!").

If a law is being broken, describe the criminal act. Exploitation is subjective, not objective. As such, it has no place in economics. Exploitation is in the eye of the beholder, and oftentimes the beholder is a presumptive, smiley, know-it-all do-gooder.

+1 for objectivity

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Agreed. If a lender charges somewhere between 2% and 25% for, say, a 30 year fixed rate mortgage, at what rate of interest does it pass from "expensive loan" to "exploitative loan?" There is no objective answer to that question.

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Maybe Brazilians are forcing people to accept exploitative loans. I mean, everything else is Brazil's fault.

bueno puente
sorta like how the meme zombies& milbank etal@washingtonpost.com today blame congresswomyn omars silly behavior/words on the donald

the washington post not so good on correlation vs.causation

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ribby
you ever notice how harvard "mental health/media professionals"
diagnose politicians they don't like with "psychopathology"
but if its a politician they like
they call it spin instead of psychopathy https://www.salon.com/2019/03/04/harvard-psychiatrist-donald-trumps-actions-are-signs-of-a-severe-continuous-mental-disturbance_partner/

The English term "redpoint" is a loan translation of the German Rotpunkt coined by Kurt Albert in the mid-1970s at Frankenjura.

"loan translation" is a new phrase to surlyjoe
surlyjoe gonna culturally misappropriate it

Online daters are 32% more likely to commit than their offline counterparts.

surlyjoe extremely skeptical of internet doctors

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doctor jess,
so whats the deal withthose cold&flu tablets you get at walgreens
the instructions say take 2 tables every 4 hours with water
which is 12 tablets/day
but then the next instruction says don't take more than 8 tablets in 24 hours?
looks like its one or the other

but

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The tax preparers themselves are making the loans, taking a pledge of the tax refund as collateral. Most taxpayers qualify for the easy form of tax return that requires neither tax expertise nor a tax return app. What's complicated (for most people anyway) is electronic filing; something intended to make the process simpler, just helped preserve an industry (the tax return preparer industry) that shouldn't exist. The government doesn't prepare electronic tax returns because doing so would jeopardize the tax return industry.

This reminds me of an experience many years ago while I was in college. I took a course on Marx, taught by a professor everyone supposed had to be a communist; he even dressed the part, in all black clothes. Anyway, one Saturday I was at the mall during tax season and there was the communist, dressed in black, preparing tax returns, facilitating the collection of taxes from the oppressed working class.

Interesting. Reading that, it occurred to me that I would expect the IRS or at least AICPA to ban preparing tax returns while also making loans on the outcome as a conflict of interest for tax preparers.

Why a conflict? Making the loan would give the tax preparer incentive to get the largest return possible, as is his fiduciary responsibility.

It also creates the opportunity to push too hard on deductions/shelters and even fudge, to not look too hard at receipts, etc. All frowned upon and even illegal.

Surely you know that.

"Treasury regulations governing ethical standards applicable to practice before the IRS, deals with conflicting interests at Section 10.29 (31 C.F.R. §10.29). It forbids federal tax practitioners from having conflicts of interest, defined as .... representing a client in circumstances creating a significant risk that the representation of one or more clients will be materially limited by the .... personal interest of the practitioner.

Those are already illegal. We don't need another law to say that is more illegal. The law is for combining two other wise legal activities like selling time share real estate for some tax advantage and preparing the taxes.

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Think in terms of an orthopedic surgeon that also owns an imaging machine.

You may be right, but I'm not sure if that's the same. The tax preparer is sticking his neck out if he falsifies the tax return. He has to sign too.

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That money was the State's already. He was just facilitating.

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Reduced userious loans lead to reduced utilization of the EITC in pretty much the same way reduced opiate use leads to reduced visits to the emergency room.

Which is to say they are bad for the GDP.

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Those who use the word "exploitative" to describe a loan really need to define what qualifies as "exploitation."

My guess is that the "qualification" is just the raw interest rate. But what if the interest rate is reasonable considering the relatively high cost of processing small loans, and the overall risk of default?

And then there's free will, agency, and compulsion. Charging someone high interest for a loan to cover the rent when the alternative is homelessness, or to obtain life-saving medical treatment when the alternative is death, might be considered exploitative. But what if the borrower just wants the money now in order to buy some new furniture, or the latest 4K HDR big-big TV? Is it exploitative to lend to someone who wants the money now for no reason other than having an apparently high discount rate?

Government regulation reasonably might start at disclosure. Not all borrowers understand compound interest for graduation from high school does not require an understanding of exponential functions, and anyway one need not be a high school diploma is not required to borrow money. But just about everyone can understand, "This loan will cost you $XX that you won't have to pay if you wait for the money instead."

But beyond disclosure, in a culture that seems to value personal autonomy, who's to say what's a bad deal and what is not? If the borrower considers having the latest entertainment equipment (or perhaps 'Veblen goods') right now worth the extra cost, and so long as the borrower knows this cost, who's to say the borrower is somehow wrong in choosing this?

(Although perhaps the situation becomes more complex if the borrower's poor judgement makes the borrower "needy" and thus deserving of taxpayer-funded financial assistance that might otherwise not have been necessary ...)

Perhaps the question is not whether welfare states can afford relatively open immigration but whether welfare inevitably must compromise personal freedom? Because mostly I don't care if you eat that giant greasy 2,000 calorie superburger every day, but if you demand I pay for your medical care then suddenly I find I'm a lot more interested?

Of course, we never discuss the cost to the taxpayers or costs to the depositors for making these small loans. These are also unsecured loans which demand a high interest rate. Credit card rates are very high. Repaying these loans teaches people the need for budgeting . Schools no longer teach anything about finance or economics. These loans are as much a measure of the failure of the schools as well as society which destroys the family structure.

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The proper pronoun for "someone" is not "they."

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What is the liquidity cost of denying these loans, assuming the person has a job stream of income?

Maybe these borrowers should just rob people on the street.

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