How credit card finance charges serve to reduce IRS tax collections for US Treasury

I received a notice from a bank that issued a credit card to me advising that that they were going to raise my interest rate. I contacted them to question their action knowing well that they could impose such increases as a result of my agreement with the institution. However, I thought it unfair considering that I always paid my debt, was never late and never over limit. I pointed this out and asked that my rate be reduced to reflect the previous lower rate. I received a letter telling me what a valuable customer I was, how they valued my business, etc., but “no,” they would not lower my rate to its previous lower rate.

Being a bit piqued at their decision, I thought, OK, I’ll get you.

But how was a poor ol’ country boy, not long off the watermelon wagon, peering through the tall grass at a huge multibillion dollar bank going to do this? The only way would be to hit them at their bottom line. But how could this be done?

Here’s how: I sent the following concept to the IRS Commissioner, the U.S. Treasury Secretary and the Chairman of the Federal Reserve. Shortly thereafter I received a telephone call from two economists at the Federal Reserve who after reading my theory presented below said, to my utter astonishment, “You know, Mr. Stewart, we never thought of that!”

Here’s the issue I pointed out:

The grossly exorbitant interest rates charged millions of Americans has a little recognized but profoundly serious adverse influence resulting in reduced tax revenues generated for the U.S. Treasury. The practices of many card issuing companies and their parent banks have caused great financial damage to our government’s revenue base.

Now that the U.S. government is a partner in the ownership of many of America’s major banks the matter discussed below should be the subject of a congressional inquiry.

Most economists and bankers would agree that a fair and reasonable rate for the rental of borrowed funds in the form of a personal loan such as provided by the use of a credit cards issued to, and used by, “prudent and responsible” borrowers to be about 6 to 7 percent annually. This is referred to as the “real rate.” To this rate must be added an additional percentage equal to the estimated annual rate of inflation to compensate for the reduced purchasing power of the funds over, or throughout, the period until full repayment.

Thus, while the real rate of interest should normally be about 6 percent as mentioned above, the “nominal rate” would be 6 percent plus the expected rate of inflation, say, for example 4 percent (at least in terms of the Consumer Price Index). The two factors make up what is known as the nominal rate. (The average annual inflation rate in 2008 was 3.85 percent.)

Thus, a fair and reasonable rate to an honest and qualified borrower (as described below) should be around 10 to 11 percent as the annual percentage rate (APR). Contrast this charge with APRs (to prudent and responsible) borrowers as high as 29.9 to 30 percent as regularly levied by many card-issuing companies.

The difference between the fair and reasonable rate of 10 to 11 percent and a 30 percent APR is 19 to 20 percent when paid and is equal to the sum removed from the disposable income of consumers.

More seriously for the U.S. Treasury, the excess payment equal to 19 to 20 percent “soaked” up by the card companies and removed from circulation by the consuming cardholder is not otherwise available to act as a multiplier effect throughout the economy since these funds are not available for other purchases by the cardholder. This flow of funds through the economy—in and out, up and down, round after round—is based upon the fact that one person’s expenditure is another’s income and taxed at every round of exchange by the government.

Since 20 percent or so has been effectively removed from the pockets of many consumers by the card companies and not available for personal expenditures it does not generate the tax flows that should normally accrue to the U.S. Treasury. When multiplied by millions of honest cardholders one can readily see that millions of dollars in tax revenue is lost to the Treasury. The result being the multiplier effect on the economy is less when allocated as corporate profit than that compared to a much more significant impact resulting from millions of broad based individual consumer expenditures taxed at every purchase.

Of course, there is some multiplier effect resulting from bank expenditures, e.g., payroll, material purchases, building expansion, corporate yachts, Swiss chalets, business conferences on the Riviera, etc., but I dare say the effect is far less pronounced within the American economy than would otherwise be the case if the interest rates were lower resulting in more money left in the pockets of the average consumer.

Note: The above observation is confined solely to credit card holders who carry a balance and exercise due diligence; do not abuse their credit privilege; make payments on time and in amounts not less than the minimum required and do not exceed their credit limit.