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FREE TO BE STUPID

August 17, 2006

Professor Maule noted a newspaper article about how H&R Block is drawing some heat for its refund anticipation loan services. The Professor weighs the propriety of granting refund anticipation loans and their effective interest rates, and finds both wanting:

Two questions popped up as I read the article. First, is it appropriate for the company that is preparing the tax return and thus calculating the refund to make loans based on that refund? Second, is it appropriate to charge interest at the rates being charged?

The first question should be answered in the negative because there is a conflict of interest. The higher the loan, the more interest income is generated for H&R Block. This puts the company in the position of trying to maximize the refund, when the company should be maximizing the client's compliance with the tax law. Every "close call" is going to be affected, subtly or not so subtly, by the impact on the lending activity. It's best to leave the refund anticipation loan to some other lender, to whom the customer can go after he or she is handed a copy of the return by the preparer. H&R Block, after all, should stick to tax return preparation and not open up a bank.

The second question must be answered in the negative. According to the story, and I've read similar reports elsewhere, the annualized interest rates on these refund anticipation loans are as high as 700 percent. SEVEN HUNDRED PERCENT? Toss in the fact that roughly 80 percent of the people using refund anticipation loans are low-income, and suddenly there is a recipe for all sorts of unacceptable situations.

There is no question in my mind that refund anticipation loans are sleazy. Should they be illegal? My firm doesn't do refund anticipation loans, and anybody who can do arithmetic knows that they're a bad deal, on a par with car title loans or "payday loans." Still, while I recoil at the practice, consenting adults should normally be allowed to engage in finance, foolish or not, if all terms are disclosed.

But should the preparer be allowed to make the loan? Dr. Maule is on firm ground when he points out the conflict of interest when the preparer who computes the refund benefits from the resulting usery. When effective rates approach 700%, a refund lender has a lot of incentive to generate a big refund. Dr. Maule makes a good policy argument for separating the preparation function from the loan-sharking lending function. Perhaps a 100% excise tax on interest income received by preparers from refund loans would do the trick.

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