Devil on Their Shoulder: Will Taxpayers Splurge?

Even before they receive their rebate checks, a lot of taxpayers have gotten some bum news. The Internal Revenue Service this week said it sent letters to about 523,000 people overstating the size of their refund. But at least the checks really are on the way.

Starting next week, the first of 112 million rebates will be mailed, with a value of up to $300 per single taxpayer, $500 per head of household and $600 for dual-income families. The upshot: There's reason to expect that a good chunk of the $38 billion in federal tax rebates will be spent with due speed, in a manner befitting a nation that has a negative savings rate.

Working- and middle-class taxpayers are more likely than wealthy taxpayers to spend their upcoming rebates, buttressing the general belief that discount retailers will benefit. Employees in the bottom half of the income spectrum generally spend about half of each additional dollar they receive on top of their regular income, says Christopher Carroll, an economics professor at Johns Hopkins University. By comparison, average wage earners spend about 30 cents of each extra dollar and wealthier people spend just 15 cents to 20 cents -- or maybe nothing at all. Says Carroll: "If you give an extra $10,000 to Bill Gates, it just doesn't matter that much to him."

Even those with spending plans likely won't blow the whole amount. A recent report from Lehman Brothers predicts that Americans will spend about one-third of their money. In 1975, the last time taxpayers got a rebate, they spent about a quarter of the amount.

It's fitting that Americans are expected to spend more this time around. The percentage of paychecks that Americans save dropped from 10.6% in 1975 to negative 0.1% last year. At the same time, consumer confidence is stronger than it was 26 years ago. The Conference Board's consumer confidence index was under 70 in the spring of '75, according to Lehman; now it's 117.9.

Debt Buster

Not everyone has shopping on the brain, however. Kurt Barnard, a retail consultant and the publisher of Barnards' Retail Trend Report, predicts that as much as 80% of the rebate could go to pay off debt. "Only a very small fraction of that refund check will go to buy things at a retail store," he says. "The bulk will go to paying off the enormous credit debt, which consumers today are burdened with."

At least some retailers agree. "We believe that consumers have a number of concerns, including job security and paying down existing bills that will compete with new retail spending for those dollars. So we have not planned for promotions around [the rebate]," says Sears spokesperson Jan Drummond. "We have determined we will not see a significant lift at our stores as a result of people spending rebate checks."

Other stores, including Circuit City(CC Quote), Target(TGT Quote) and Best Buy(BBY Quote) are also downplaying the likely effects of the rebates and say they haven't planned any special rebate-related promotions. By contrast, Wal-Mart(WMT Quote) and Home Depot(HD Quote) have said they will cash rebate checks for free.

Though it's widely assumed the rebates will be spent in the third quarter, spending may actually take longer. It typically takes about a year from the time people receive extra income to when they begin spending it, Carroll says.

Whenever they decide to put the extra money to use, don't expect consumers to be swinging from the chandeliers. The $38 billion in rebates is just a fraction of the $100 billion in refunds issued as a matter of course during the most recent tax season.