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Not that long ago, people could get a tax break from their credit card bills. That's right -- all those pesky finance charges on credit card bills could be deducted.
All that changed with the Tax Reform Act of 1986, as personal-interest deductions on everything except home loans were tossed out, in part, to get people to save more.
Unexpected results
"The deductions were a means of encouraging consumer spending to stimulate the economy," said Keith Leggett, a senior economist with the American Bankers Association. "However, what happened was it discouraged people from saving. Removing the deductions was one way to move people from being spenders to being savers."
But that didn't happen. People kept spending.
"All of us who studied it at the time were amazed that it had almost no impact," said Lewis Mandell, author of The Credit Card Industry, A History and dean of the School of Management at the State University of New York at Buffalo.
Lots of Americans base their financial choices on the amount of money they have on hand and their available credit. They take little notice of government policies or tax changes, even those that save -- or cost -- them money.
"For a lot of consumers the issue is, 'Do I have enough credit to pay for these things?' " said David A. Levy, economist and director of forecasting at the Jerome Levy Economics Institute in Mount Kisco, N.Y.
And keep in mind, credit card debt in the late 1980s and early '90s -- when the deductions were completely phased out -- was not nearly as high as it is today, so deductions and the subsequent tax savings for most consumers proved modest.
"For most individuals, they weren't getting that much back," Mandell said. "After a year or so, the whole fuss died out and people more or less accepted it."
Politics, taxes and savings
The removal of the deductions was part of the politics of the time, as President Reagan pushed for simplification of the tax code and a flattening of the tax rate. The cutting of interest deductions on consumer debt was part of the deal.
There was also some concern that Americans weren't saving enough and the deductions, which encouraged spending, apparently seemed inappropriate to legislators. With a huge federal deficit looming, savings and cutbacks were the catchwords of the day.
Experts point out that it takes an awful lot for a government policy -- even changes in the tax code -- to change the way consumers spend their money.
"Such things have to be pretty drastic to have a significant impact on people's behavior," Levy said. "Tinkering with the tax code and some deductions have relatively little effect."
For example, in 1979 the Federal Reserve Board decided to fight double-digit inflation by hiking the prime rate from 12 percent to almost 20 percent within a year. With the cost of credit so high, people tucked a little more money into savings, but very little..The personal saving rate inched up from 7.5 percent in 1979 to 8.5 percent in 1980.
Even the introduction of IRAs in the mid-1970s wasn't enough to spur additional saving, experts say.
"It didn't really get people to increase savings. We just put it in different forms, but we didn't really increase the national savings rate," said William Dunkelberg, professor of economics at Temple University in Philadelphia.
The savings rate has declined through the 1980s and '90s, despite the introduction of 401(k)s and Roth IRAs, Levy says. In fact, recent U.S. Commerce Department figures show the U.S. personal-savings rate hit an all-time low in September.
The shift to home equity
A similar shift happened when American adjusted their habits in response to the Tax Reform Act of 1986, not by cutting back on their spending but by moving their credit card debt into low interest rate and tax-deductible home equity loans and lines of credit.
"Eliminating the interest deduction on consumer debt has caused a change in the composition of consumer borrowing," Leggett said. "The Reform Act spurred the development of home equity loans and lines of credit, in part because you were able to deduct the interest against your taxes."
Americans borrowed $182.9 billion in home equity loans and lines of credit in 1986, roughly one-third of all consumer borrowing, excluding mortgages, according to the Federal Reserve Board. By 1997, that figure had jumped to $697 billion, more than half of all consumer borrowing.
However, much of that growth can be attributed to the loosening of home equity loan standards in the past decade. In short, more people can get loans and banks have been quite aggressive in advertising them.
But even people savvy enough to consolidate credit card debt into a low-interest, tax-deductible home equity loan or line of credit may not be ready or able to rein in their spending.
According to a 1998 study by the market research firm Brittain & Associates, 4.2 million American households converted $26 billion of credit card debt into home equity loans or lines of credit from spring 1996 to spring 1998. Two-thirds of those surveyed charged their cards back up again in less than a year.
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