David Rothstein comments on Refund Anticipation Loans in Mother Jones
Mother Jones - April 1, 2011
JOHN HEWITT WASN’T seeking to turn the working poor into cash cows when his father and some friends helped him buy a six-store tax-service chain in Virginia Beach back in 1982. A 33-year-old college dropout who’d recently left his post as a regional director for H&R Block, Hewitt bought the Mel Jackson Tax Service hoping simply to break his old employer’s near-monopoly on the market. “We’re going to be bigger than H&R Block!” he liked to boast, though his operation was a mere tadpole challenging a leviathan with 7,000 stores in middle-class neighborhoods across the country. Hewitt renamed the company Jackson Hewitt and bet that his early embrace of computers would give him a leg up on his former bosses. But it wasn’t until he began offering something called a refund anticipation loan (RAL)—a product aimed at down-market customers desperate for cash—that his chain really took off.
Over the years, entrepreneurs and corporate executives have devised any number of clever ways for getting rich off the working poor, but you’d have to look long and hard to find one more diabolically inventive than the RAL. Say you have a $2,000 tax refund due and you don’t want to wait a week or two for the IRS to deposit that money in your bank account. Your tax preparer would be delighted to act as the middleman for a very short-term bank loan—the RAL. You get your check that day or the next, minus various fees and interest charges, and in return sign your pending refund over to the bank. Within 15 days, the IRS wires your refund straight to the lender. It’s a safe bet for the banks, but that hasn’t stopped them from charging astronomical interest rates. Until this tax year, the IRS was even kind enough to let lenders know when potential borrowers were likely to have their refund garnished because they owed back taxes, say, or were behind on child support.
Hewitt didn’t invent the refund anticipation loan. That distinction belongs to Ross Longfield, who dreamed up the idea in 1987 and took it to H&R Block CEO Thomas Bloch. “I’m explaining it,” Longfield recalls, “but Tom is sitting there going, ‘I don’t know; I don’t know if people are going to want to do that.'”
But Longfield knew. He worked for Beneficial Corp., a subprime lender specializing in small, high-interest loans for customers who needed to finance a new refrigerator or dining-room set. His instincts told him the RAL would be a big hit—as did the polling and focus groups he organized. “Everything we did suggested people would love it—love it to death,” he says.
He also knew Beneficial would make a killing if he could convince tax preparers—in exchange for a cut of the proceeds—to peddle this new breed of loan on his employer’s behalf. Ultimately, Longfield persuaded H&R Block to sign up. But no one was as smitten as John Hewitt—who understood that people earning $15,000 or $20,000 or $25,000 a year live in a perpetual state of financial turmoil. Hewitt began opening outposts in the inner cities, Rust Belt towns, depressed rural areas—anywhere the misery index was high. “That was the low-hanging fruit,” he says. “Going into lower-income areas and delivering refunds quicker was where the opportunity was.”
Customers wanting a RAL paid Jackson Hewitt a $24 application fee, a $25 processing fee, and a $2 electronic-filing fee, plus 4 percent of the loan amount. On a $2,000 refund, that meant $131 in charges—equivalent to an annual interest rate of about 170 percent—not to mention the few hundred bucks you might spend for tax preparation. “Essentially, they’re charging people triple-digit interest rates to borrow their own money,” says Chi Chi Wu, a staff attorney at the National Consumer Law Center.
In 1988, the first year he began offering the loans, Hewitt owned 49 stores in three states. Five years later, he had 878 stores in 37 states. And five years after that, when Cendant Corp.—the conglomerate that owned Avis, Century 21, and Days Inn—bought Jackson Hewitt for $483 million, his earliest backers received a $2 million payout on every $5,000 they’d invested. Today, with 6,000 offices scattered across the country, Jackson Hewitt is more ubiquitous than KFC, and has about as many imitators.
There would be no refund anticipation loans, of course, without tax refunds. And by extension there would be no RALs without the Earned Income Tax Credit, the federal anti-poverty initiative that served as the mother’s milk nourishing the instant-refund boom. Welfare reform was the catalyst for the EITC, which was aimed at putting extra cash in the pockets of low-income parents who worked. What motive does a single mother have to get a job, conservative thinkers asked, if there was scant difference between her monthly take-home pay and a welfare check? It was Richard Nixon who first floated the idea that led to the Earned Income Tax Credit; Ronald Reagan dubbed it “the best pro-family, the best job creation measure to come out of Congress.” In 2007, the US Treasury paid out $49 billion to 25 million taxpayers.
“It’s a beautiful, beautiful thing that Richard Nixon gave the country,” muses Fesum Ogbazion, founder of Instant Tax Service, the country’s fourth-largest tax-prep chain behind H&R Block, Jackson Hewitt, and Liberty Tax Service—the outfit Hewitt founded after leaving his eponymous company. On this year’s sliding scale (PDF), a single mother of two making $16,000 a year gets a $5,000 tax refund; if she earns $25,000, her windfall is $3,200. “People basically start bombarding us with calls at the end of December,” Ogbazion says. They all ask the same few questions: “‘Can I do my taxes with my pay stubs?’ ‘Do I have to wait for the W-2?’ It’s nuts.” The IRS starts accepting returns around January 15. By mid-February, Ogbazion will have filed on behalf of more than four-fifths of his clients. “By the time the rest of the world is starting to get serious about their taxes,” he says, “I’m already thinking about next year.”
Ogbazion is a native of Ethiopia whose family moved to the United States when he was nine years old. He opened his first tax-prep shop when he was a sophomore in college. By that point, several large banks had jumped into the business. Ogbazion began brokering RALs on behalf of Bank One, now part of JPMorgan Chase. By 1999, when he sold his chain to Jackson Hewitt for $3 million, Ogbazion was up to 26 shops, all in the greater Cincinnati area. Just 27 at the time, he decided to start a new chain, Instant Tax, setting up headquarters in Dayton, Ohio. By that point, the most desirable spots—those in the city’s poorest precincts—were taken, so he started opening stores in working-class suburbs. “I moved to where opportunities were still available,” he says with a shrug when I meet him at his stylish office in one of Dayton’s pricier downtown towers. Today, Instant Tax boasts about 1,000 outlets, mostly owned by independent operators who pay Ogbazion a one-time $34,000 franchising fee, plus 20 percent of their gross revenues.
“We recommend that you locate your office where the household income is $30,000 or less,” the Instant Tax manual counsels. Each franchisee attends a week of training sessions where “unbelievable emphasis was put on poor minorities,” according to former franchisee Habtom Ghebremichael, who recalls a trainer telling his group, “We cater to the ‘hood.” His archetypal customer, Ogbazion says, is an assistant manager at a fast-food restaurant earning $19,000 a year. “They’ve burned the banks,” he says. “They’ve bounced too many checks. They’ve mismanaged their finances.” Experience has taught him that a few amenities (a ficus tree, free coffee, TV in the reception area) go a long way in making customers feel welcome. “At the check-cashing place, they’re talking to someone behind bulletproof glass,” Ogbazion continues. “The welfare building—you can imagine what that’s like. Here, we treat them well, and they want to come back.”