What will be the effect of ‘big beautiful’ tax refund checks?
By David Enna, Tipswatch.com
Last week I read a report by David Kelly, chief global strategist at JPMorgan Asset Management, that mirrored some of my concerns that sizable federal tax refunds could set off a short-lived inflation surge in 2026.
Kelly’s report is titled, “The Investment Implications of the Refund Surge.” It begins with this:
On August 7th, with little fanfare, the IRS announced that, as part of its phased implementation of the OBBBA (One Big Beautiful Bill Act), it would not be adjusting W2 or 1099 forms for the current calendar year but would provide guidance and new forms, in due course, for calendar 2026.
This seemingly innocuous statement confirms that we will see an even larger crop of personal income tax refunds early in 2026 than was anticipated when the OBBBA was passed. These higher income tax refunds should work much like a new round of stimulus checks, adding to consumer demand and inflation pressures early next year.
Kelly notes that at the same time the refund checks will be flowing, the Federal Reserve may be cutting short-term interest rates, creating a “sugar rush” of consumer spending. He theorizes:
When their effects fade, it is quite possible that Washington will provide yet another round of stimulus to boost demand ahead of the mid-term elections.
Measuring the surge
Kelly notes that most of the OBBBA’s tax breaks are backdated to Jan. 1, 2025, but the IRS will not be issuing new W2 withholding schedules for 2025. The result is that “far too much money will have been withheld from taxpayers and refunds will surge in early 2026.”
But how much? Kelly theorizes: “(T)he total cost of these provisions for fiscal 2027, at $116 billion, should be very close to the amount owed to taxpayers for calendar 2025, deflated by, say 8%, for the growth in income in between – so roughly $107 billion.”
JP Morgan estimates the average tax refund in early 2026 will be $3,743, up about $500 from the 2025 level.
Looking at the overall economic impact, if we assume that 80% of these extra refunds are spent, this amounts to roughly 0.27% of GDP. If this money were spent evenly in the first six months of 2026, it could boost annualized real GDP growth by over 0.5% in the first quarter. If we add to this the impact of lower withholding that should finally kick in at the start of 2026, it could add 0.8% to real GDP growth in the first quarter. ….
If consumers generally use this money quickly, then by the third quarter of next year, consumer spending could slow again and, by the fourth quarter, it could slump. …
It could well be that, faced with this possibility, Congress approves some further fiscal stimulus such as the “DOGE dividends” that were floated earlier this year or the more recently proposed “tariff rebate checks”.
And then what?
Kelly speculates the Federal Reserve will lower interest rates by 25 basis points on Sept. 17, which seems fairly locked in. He adds, “Such a move is unlikely to spur faster economic growth in the short run, setting the stage for another rate cut in October or in December or both.”
So … two or three cuts to short-term interest rates could come just months before the bigger tax refund checks begin rolling out through the first half of 2026. Kelly concludes:
(I)nvestors might doubt the Fed’s commitment to stable inflation, potentially leading to a steeper yield curve, a lower dollar and lower stock prices. For investors, this underscores the need to have a greater allocation to international assets denominated in foreign currencies and the importance of having alternative assets with lower correlations to U.S. stocks and bonds.
My thoughts
It was my theory that several of the OBBBA provisions had the potential to be inflationary in the near term — no taxes on tips, no taxes on overtime, larger senior standard deduction, a new break for auto-loan interest, higher state-and-local tax deductions. The result: more money for consumers to spend.
Kelly’s assumptions make sense, in that a $500 boost to income tax refunds (along with other tax breaks) could trigger more aggressive consumer spending, which in turn could spur inflation higher. Plus, once 2026 begins, W2 withholding levels will be adjusted, giving many consumers an increase in take-home pay.
Will consumers rush to spend? I recall, unfortunately, the sudden explosion of hot-rod vehicles on Charlotte streets during the COVID stimulus roll-outs. For some people, the money was going to down payments on a depreciating asset. Not good.
Or, we could hope, people would try to pay down personal debt. In mid-2025, the average American family was carrying $6,371 in credit card debt, the highest level since the New York Fed started tracking this in 1999.
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