Bigger Tax Refunds Likely to Power the Economy

0:00Welcome to Thoughts on the Market, and Happy New Year. I'm Heather Berger from Morgan Stanley's U.S. economics team. On today's episode, why U.S. consumers can expect higher tax refunds and what that means for the overall economy. It's Friday, January 2nd at 10 a.m. in New York. As we kick off 2026, it's not just a fresh start. It's also the time when tax refund season is right around the corner. For many of us, those refunds aren't just numbers on a page. They shape the way we budget for many everyday expenses. The timing and size of our refunds this year could make a real difference in how much we're able to save, spend, or get ahead on bills.

0:39In the wake of the One Big Beautiful Bill Act, this year's tax refund season is shaping up to be bigger than usual. The new fiscal bill packed in a variety of tax cuts for consumers. It also included spending cuts to programs such as SNAP benefits and Medicaid, but most of those cuts don't pick up until later this decade. Altogether, this means that we'll likely see personal income and spending power get a boost in 2026. Many of the new deductions and tax credits for consumers in the bill were made retroactive to the 2025 fiscal year. These include deductions for tips in overtime, a higher child tax credit, an increased senior deduction, and a higher cap on state and local tax deductions, among some others.

1:21The retroactive portion of these measures should be reflected in tax refunds early this year. Overall, we're expecting these changes to increase refunds by 15 to 20 percent on average, and different groups will benefit from different parts of the bill. For example, the higher state and local tax cap is likely to help high-income consumers the most, while deductions for tips and overtime will be most valuable to middle-income earners. Historically, U.S. consumers receive about 30 to 45 percent of tax refunds by the end of February, with then 60 to 70 percent arriving by the end of March. Because of the new tax provisions, we're anticipating a noticeable boost in personal income during the first quarter of the year.

2:02While we do also expect this legislation to encourage higher spending, it's unlikely that we'll see spending rise as sharply as income right away. According to surveys, most consumers say that they use their refunds mainly for saving or paying down debt. This can lead to healthier balance sheets, which is shown by higher prepayment rates and fewer loan delinquencies during the tax refund season. When people do choose to spend all or some of their refunds, they typically put that money towards everyday needs, travel, new clothes, or home improvements. Looking ahead, we do still see some near-term headwinds to spending, such as expected increases in inflation from tariffs and the expiration of the Affordable Care Act credits, which will most affect low-income consumers.

2:46As we progress throughout the year, though, we're anticipating steady growth in real consumer spending as the labor market stabilizes, inflation decelerates, and lagged effects of easier monetary policy flow through. On top of that, this year's larger tax refunds should give another lift to household spending. The boost to spending, along with other corporate provisions in the bill, should give the broader economy a push this year too. We expect the bill as a whole to support GDP growth in 2026, but it then becomes a drag on growth in later years when more of the spending cuts take effect. Thanks for listening.

3:20If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

3:30Heather Berger:The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.