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Smoke on Cars

Taxpayers May Be in for a Surprise This Spring

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The auto market and the broader economy depend on a seasonal bump provided by the more than 100 million Americans who receive tax refunds each spring. This spring, however, could be very different. Due to last year’s tax reform, some consumers may be surprised to learn they are receiving no tax refund, a smaller one than they expected or, worse, they have to pay more to the government.

The used-vehicle market sees the greatest impact from tax refunds within the automotive market. March and April have historically enjoyed 10-15 percent more used-car sales than the average month and 25-35 percent more sales than the slower months in the year. These months also typically see a spring bounce in used-car values.

The strong demand fueled by tax refunds causes used-car prices to appreciate each year when tax refunds are being distributed. The appreciation usually lifts prices by 3-5 percent at its peak. For a depreciating asset, this “spring bounce” is especially notable, but it is a reliable phenomenon thanks to the impact of tax refunds.

The IRS issued refunds for over 102 million (about 75 percent) of 2017 returns. The refunds totaled to $284.9 billion, which was approximately 6 percent of the size of second quarter GDP. The average refund was close to $2,800.

The Government Accountability Office issued a report in July warning that the rush to implement new tax tables following the Tax Cuts and Jobs Act of 2017 resulted in changes that will likely cause several million households to not receive a refund when they are accustomed to receiving one. Worse still, several million more households will end up owing more money than is typically the case.

Despite the efforts of the IRS to drive awareness of the need to check and adjust withholdings due to this foreseen issue, most consumers have likely done nothing and are unaware of the potential surprise awaiting them at tax filing time.

Cox Automotive conducted an analysis of its payroll records and found that there was no statistical difference in the percentage of employees changing their withholdings in 2018 compared to the percentage of employees who did so in 2017. The company’s findings are likely representative of the country, as the company has close to 30,000 team members across the U.S.

It is hard to estimate an exact impact on the used-car market as households in for the biggest surprises fall in several categories, like multiple income families, families with dependents 17 years of age and older, and tax payers who itemize, especially those who live in high property and income tax states. Some of those most likely to be impacted may fall outside the demographics of the traditional used-car buyer.

That said, we have had recent experience in seeing what happens in the used-car market when small changes occur in tax refunds.

In 2017, tax refunds shifted as a result of a delay that the IRS instituted in the filing time frame for households eligible for a tax credit. That delay resulted in a three-week change to when the bulk of tax refunds were issued. As a result of that change along with commercial consignors lining up record volumes of off lease vehicles to hit the market exactly when the market typically bounced, we saw used-car values decline for three weeks when they would normally have appreciated. Tax refunds did eventually hit that year, helping prices recover, but when the spring bounce finally came, it resulted in a peak in pricing that was less than half the usual peak.

Cox Automotive analysis of its employee withholdings indicated that the amount being withheld each paycheck for taxes is less than the tax-rate reduction should have produced. That means more take-home pay with each check, but also the potential for a surprise this spring.

Likewise, analyzing data on wages per employee from data from the Bureau of Labor Statistics relative to withholdings reported year to date by the U.S. Treasury also points to withholdings per employee being less than the new tax rate should have produced. Whether we look in aggregate at total wages and total withholdings or per employee estimates, the same trend is clear: Our analysis indicates that people are likely to be in a situation of taxes being underwithheld.

This means that fewer people are likely to get refunds. More people will likely owe taxes. The average refund is likely to be lower. Refunds in total are likely to be less and therefore have less of an impact on the auto market and the economy in general.

The risk is that the spring market may prove to be much less pronounced than normal, and as a result, the spring bounce could be disrupted like we saw in 2017.

If the majority of consumers are unaware, then it is highly likely they will be surprised at the time of tax filing. That surprise could take a total on consumer confidence.

A final concern relates to the poorly implemented changes to tax tables that produced this scenario. If enough Americans are negatively impacted, there will be a call to revise the W4 and related tax tables to limit the number of people impacted in future years. Therefore, if this year saw too little withheld, then the solution is to withhold more. In this scenario, many workers will see their net pay decline, thus cutting spending power throughout the year.

Ironically this year’s stronger economy was aided by higher consumer spending than otherwise might have been the case had withholdings been properly calculated. That means the market may get a double whammy when workers realize that some of their additional pay is actually owed to Uncle Sam and then see their 2019 paychecks reduced to prevent another surprise in April 2020.

With a government shutdown making the situation even more murky, there’s only one thing we can see clearly now: The tax season this spring will be one of uncertainty.

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