As the tax season begins in earnest, the Woodstock Institute, a nonprofit community development group based in Chicago, released a timely report that analyzes the use of refund anticipation loans (RALs) in Illinois. RALs are short-term loans that allow tax filers to receive their refunds as quickly as a few hours or days after they file their tax returns. Tax filers also usually use RALs to pay for the upfront cost of tax preparation.
The problem with RALs is that they typically come at very high cost and are targeted at low-income tax filers. According to another report released the National Consumer Law Center and the Consumer Federation of America last year, fees for RALs are typically over $100 and have triple digit annual percentage rates (APRs). If you add additional fees that some providers charge, such as application fees, and the cost of tax preparation on top of that, tax filers often end up paying several hundred dollars in total fees. According to the Woodstock Institute report, tax filers in Illinois spent over $114 million on RALs in 2006.
Low income tax filers who receive the Earned Income Tax Credit (EITC) are much more likely to take out RALs. The EITC is a federal tax credit for working low- and moderate-income tax filers that helps millions of poor families each year. High-cost RALs weaken the effectiveness of this important anti-poverty tool and make it harder for these families to build the assets that they ultimately need to get ahead. 60 percent of Illinois tax filers who took out RALs were EITC recipients and they spent a total of $68.9 million in fees.
RALs also don’t necessarily help tax filers get their refunds that much faster. Tax filers who e-file and elect for direct deposit typically receive their refunds in less than two weeks. Additionally, other recent research by the Treasury Department has shown that RALs are not always available as quickly as consumers might expect. According to the study, only 41 percent of RALs were available in one to two days and 18 percent took 11 days or longer.
The findings of the Woodstock Institute report are consistent with other recent research on RALs and they paint a grim picture. In Illinois, more than 27 percent of EITC recipients utilized RALs, compared with 3.2 percent of non-EITC recipients. In African-American communities these numbers are even worse; 40.1 percent of EITC recipients utilized RALs. Among non-EITC recipients, African-American communities still had a higher percentage of RAL users, 11.6 percent, than the statewide rate, which was only 3.2 percent.
RALs have come under increasing scrutiny in the last several years by federal, state and local governments. The Internal Revenue Service (IRS) recently announced plans to study the issue and some federal banking regulators have taken action against financial institutions that provide funding for the loans to tax preparers. These are good first steps, but more needs to be done to move low-income tax filers away from these high cost, low-value products and toward more productive and affordable asset building alternatives.