An Urban Institute
Project Exploring
Upward Mobility
Opportunity and Ownership Facts
2100 M Street, NW • Washington, DC 20037
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No. 22, June 2012
Shifting Demand for Alternative
Financial Products
Instant Tax Refunds and Their Use by Military Personnel
C. Eugene Steuerle and Jessica F. Compton
Predominantly used by the economically disadvantaged, the alternative financial industry involves tens
of billions of dollars of annual transactions. Over the
years, federal and state regulators have attempted to
promote consumer protections that modify the costs
and risks associated with products such as payday
loans, auto-title loans, and rent-to-own transactions.
Regulators may use prohibitions, disclosures, and
APR caps in hopes of curbing product use and shifting
consumer demand to more mainstream savings and
credit products. Evidence demonstrates that some
regulations are associated with a reduction in the supply of alternative financial service products. However
it is not clear that regulation of one alternative financial product influences consumer demand for other
financial products (McKernan, Ratcliffe, and Kuehn
2010).
In this fact sheet, we provide one example of how
consumers shift their use among varying alternative
financial products. In general, dwindling supply of a
good can lead consumers to look for a substitute. Our
evidence shows that this type of substitution does
occur between two similar alternative financial products: refund anticipation loans (RALs) and refund
anticipation checks (RACs). These products enable
individuals to pay for tax preparation through their
anticipated refunds. By receiving a loan against their
refund, RAL users can walk out the same day with
their refund rather than wait for the IRS. RAC users
receive their refund in about the same amount of time
as tax filers with direct deposit but still often use a
RAC, particularly as a way of paying their tax
preparation bill.
Provisions in the Military Lending Act, which passed
Congress in 2006, prohibit financial service providers
from issuing loans with APRs of over 36 percent to
members of the military and their dependents. As a
consequence, RAL use dropped dramatically the following year, but RAC use among military members
increased dramatically. Using individual-level tax
data, we measure the use of RACs and RALs among
military members prior to and after implementation
of the act. Compared to use in tax year 2005, RAL
use among military members dropped precipitously
by over 90 percent (figure 1) in tax year 2008. Among
all tax filers, RAL use only decreased by 15 percent.
During the same time period, RAC use among military members increased by over 50 percent, which is
over twice the 20 percent increase among all tax filers.
Nearly 16,000 military members continued to use RALs
in 2010 while RAC use increased to more than 370,000.
Since 2007, further directives from bank regulators
and the IRS’s removal of a debt indicator1 (that helped
banks sort out which clients were better risks) have
led to market exits of six predominant RAL-providing
banks and rendered five major tax preparer chains and
countless independent tax preparers unable to provide
clients with RALs. From 2005 to 2010, combined use of
RALs and RACs stayed relatively steady (figure 2). Yet,
RAL use only accounts for 9 percent of total use in 2010
compared to 51 percent in 2005.
These findings do not necessarily mean that all individuals who previously used RALs shifted to RACs or
that the many individuals who stopped using RALs
were influenced only by the regulation. It does demonstrate the significant influence that policy can have
FIGURE 1. Number and Type of Returns among Active Military Tax Filers,
TY 2005 and TY 2008
RAL
RAC
400,000
350,000
Number of returns
300,000
221,900
250,000
200,000
335,400
150,000
100,000
168,200
50,000
0
15,700
2008
2005
Tax year
Source: Theodos et al. (2010).
on the behavior of individuals who rely on alternative
financial products.
In some cases, regulation that causes substitution
shifts can be good for consumers—the removal of soda
pop from vending machines at schools may mean
that students drink more water to quench their thirst.
However, we would also want to know the extent to
which they start imbibing fruit juices with high sugar
content.
Because product fees, compounded accumulated
interest, and process fees all cost consumers money,
further research is required to know the extent to
which shifting demand out of RALs—or out of any
particular alternative financial product—saves consumers money or leaves them better off over time.
For instance, tax preparation fees might be raised
as preparers lose the funds formerly provided
by RALs.
FIGURE 2. Number and Type of Returns among Tax Filers, TY 2005–TY 2010
RAL
RAC
Number of returns (millions)
25,000
20,000
15,000
10,000
5,000
0
2005
2006
2007
2008
Tax year
2009
Source: Authors’ calculations prepared for the National Tax Association 104th Annual
Conference on Taxation (New Orleans, LA), November 2011.
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2010
Policymakers may want to look toward other strategies for providing consumer protection in the arena
of RALs and RACs. For instance, might splitting
refunds in new ways allow tax preparers to receive
their fees from taxpayers without resorting to RACs?
Additionally, annual percentage rates are harder for
consumers to interpret on short-term loans. A fixed
cost allocated over 10 days might have a significantly
lower APR than one allocated over 8 days, but that
would not be a very meaningful calculation.
Notes
This fact sheet is drawn from “Characteristics of Users of Refund
Anticipation Loans and Refund Anticipation Checks,” a report prepared for the U.S. Department of the Treasury by Brett Theodos,
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Rachel Brasch, Jessica F. Compton, Karen Masken, Nancy M. Pindus,
and C. Eugene Steuerle (2010).
1. The debt indicator was a service that helped tax preparers and
banks mitigate risk.
References
McKernan, Signe-Mary, Caroline Ratcliffe, and Daniel Kuehn.
2010. “Prohibitions, Price Caps, and Disclosure Policies: A
Look at State Policies and Alternative Financial Product Use.”
Final report prepared for the U.S. Department of the Treasury.
Washington, DC: The Urban Institute.
Theodos, Brett, Rachel Brasch, Jessica F. Compton, Nancy M. Pindus,
and C. Eugene Steuerle. 2010. “Who Needs Credit at Tax Time
and Why: A Look at Refund Anticipation Loans and Refund
Anticipation Checks.” Washington, DC: The Urban Institute.
http://www.urban.org/url.cfm?ID=412304.
Given the chance, many low-income families can acquire assets and become more financially
secure. Conservatives and liberals increasingly agree that government’s role in this transition requires going beyond traditional antipoverty programs to encourage savings, homeownership, private pensions, and microenterprise. The Urban Institute’s Opportunity and
Ownership Project policy fact series presents some of our findings, analyses, and recommendations. The authors are grateful to the Annie E. Casey Foundation and the Ford Foundation
for funding the Opportunity and Ownership Project.
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