Tax refunds are bad because of the simple financial principle of time value of money, i.e. “money now is better than money later.”
Although a tax refund may have a great psychological feeling of a year-end bonus, it is nothing more than the government returning money that belongs to you in the first place, money that they (not you) have been using and making investments from for an entire year. The principle of time value of money states that had you been in possession of that money from day one, by April 15th it would have grown beyond it’s original value because you would have invested it in one thing or another.
Most financial experts agree that the best target to shoot for with tax burdens is to owe a small amount at the end of the year. This amount should be small enough so that the IRS does not penalize you for under-taxing during the year. In effect, this is an interest-free loan from the government for an entire year – you’ve flipped the table on Uncle Sam.
Your deductions from paycheck to paycheck can be adjusted with your employer using a W-4 form, which can also be changed during the year as needed. Many financial software programs like Quicken and Microsoft Money also feature tax projections that can show you how much you will owe or get back at the end of the year based on your current income and deductions. These are useful for making mid-year adjustments to your withholdings in order to stay on target.