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Recently, researchers have begun to examine the financial service patterns of low- and moderate-income households. These behaviors are of interest because high cost financial services, barriers to saving, the lack of insurance, and credit constraints contribute to poverty and other socioeconomic conditions . Many low- and moderate-income households use alterna­tive financial service (AFS) providers, such as check cashers, for their financial services needs. Tax preparation firms are among the important financial service providers in the lives of low-income households. Such firms help households navigate the complicated process of filing their taxes, and many low-income households obtain sizeable tax refunds. At the same time, tax preparation is costly, and many tax preparation firms offer "refund antici­pation loans" and similar products that add to the costs and complexity of tax filing. In this paper, we examine financial service patterns among low- and moderate-income house­holds as these patterns relate to the tax system and the process of filing one's taxes. The federal income tax system provides an interesting and important context to study the financial service patterns of low- and moderate-income households for several reasons. First, an over­whelming majority of low- and moderate-income households file tax returns and are eligible for tax refunds. Given the societal goal of redistributing income to low- and moderate-income house­ holds through the tax system, optimal income redistribution policy suggests that policymakers focus on reducing the transaction costs associated with tax filing for low-income households. Second, households who face high transaction costs in filing their taxes often face other types of financial constraints, such as not having a bank account or access to credit. Any policy initiative to lower the transaction costs in filing taxes must also consider low-income households' financial services patterns and their use of AFS providers. Third, many low- and moderate-income house-holds receive a large, lump sum at the time of their tax refund. Tax return filing and refund receipt may be important moments for household decision making regarding saving, and thus for savings policy.


Posted with permission of the National Tax Association.