When I first started I took weeks (maybe months) trying to figure out exactly how I was going to handle every situation.
Then after ~500 sales I had my first complaint, and it was during the Christmas rush,
I just refunded everything and let them keep the item. I just didn't want to deal with it since I was so busy. Doing that shut them up immediately, and stopped any negative review.
My products all sell for $20 + shipping, but my actual cost to make and ship is only $7. So even refunding everything and letting them keep it only lost me $7. I can live with that.
And since it happens so infrequently (3 times now in 3 years and over 2,000 sales) I just don't care. So I lost $21 in 3 years? But I made over $40,000. It's not even a question for me.
I do however leave my "official policy" up on my site so I don't attract scammers. But I have never made a fuss about the shipping or refunding.
My official polity is
"If you are not 100% happy with your purchase simply return the item for a replacement item or full refund less shipping and handling"
But when it comes down to it the second I get a convo that is in any way unsatisfied I just say, "I'm sorry, would you like me to send out a new one or issue you a refund?" Then when they answer (Some never do and you never hear form them again) I do whatever they chose and I tell them to just keep the original product.
I wold say that there is a direct correlation between how much I care and how much money I am making. More money = less caring.
When I wasn't making a lot I was anal about almost everything and super "by the books", now that I have a pretty steady stream of cash coming in I just nip it in the bud immediately and let the customer get their way. I don't really care for the drama and I understand that you simply cannot please everyone. And when one of "those" people enter my life I do whatever I can to get them out as quickly as possible.
You can tell in the first 10 words of a convo if it's "One of those". I don't even read it, I just Ctrl/V my response. I don't ever address their problem, just say "Return it and you get a replacement or a refund"
Just don't take anything personally and if your product is good, your pics are very good, and your listing is very thorough complaints are going to be very few and far between, and the more stink you make when you get a complaint the more chance of a bad review. And how Etsy works, bad reviews are killer, so unfortunately we need to avoid them at all costs.