Tax Reform Could Add to Woes of Credit Card Firms
Elimination of the tax deduction for consumer interest payments--a provision of the tax-overhaul measure passed by Congress and awaiting President Reagan’s signature--could have a significant effect on the credit card industry by encouraging more cardholders to pay off their balances without incurring finance charges.
A recent survey of 500 affluent consumers, conducted by Synergistics Research Corp. of Atlanta, reported that 30% of those who now use revolving credit said they expect to almost always pay in full in the future. Another third (37%) would try harder to do so, while the other third would not change their practices, the survey found.
If only a quarter of the respondents acted on their stated intentions, they would save an estimated $2 billion a year in finance charges. That amount represents one-fourth of the credit card interest that Americans deducted from their 1983 income taxes.
Feeling the Squeeze
It also represents about 10% of the annual interest paid on revolving credit issued by banks, retailers and gasoline companies. A cutback of this size coming at a time when an expanding industry is becoming increasingly competitive could put the squeeze on smaller credit card marketers, according to Synergistics Chairman Bill Adcock.
Two-thirds of those who use revolving credit or have an auto or personal loan and take a tax deduction for the interest told Synergistics pollsters that they would trim their use of credit. Among car owners, 44% said they would not finance a new purchase unless the interest were deductible.
Industry representatives, however, say they do not believe that eliminating interest deductibility will have any effect on cardholders’ habits. “We don’t expect any changes,” said Richard Woods of MasterCard, whose 51 million cardholders ring up more than $5 billion a year in finance charges.
Ron Schmidt of Visa predicted “minimal impact” and said the average annual charge of $210 is too small to affect behavior.
Sears, Roebuck, issuer of the new Discover card, declined comment.
Stephen Brobeck, executive director of the Consumer Federation of America, also doubted that many people would live up to their announced intentions to cut back on revolving credit but added: “I would hope they do; consumers are purchasing too much on their cards.”
Sensitive to Rates
John Pollock, publisher of Bank Credit Card Observer, noted that since cardholders are becoming increasingly sensitive to lower interest rates and annual fees--which are starting to take hold due to declining market rates and competition--they also probably will become sensitive to what the lack of an interest deduction will mean on their taxes. “I think more people will pay their bills with cash, checks or travel and entertainment cards,” on which full payment is due in 30 days, he said.
The Federal Reserve estimates that the outstanding balance on all forms of revolving credit amounted to $125 billion in July. Annual interest payments on that run about $20 billion. According to Internal Revenue Service statistics for 1983, the latest year available, 22 million returns, or 23% of all returns, showed deductions for credit card interest. Total deductions claimed amounted to $7.8 billion, or an average of $350 per return.
A decrease in interest income for the industry might not happen immediately because the interest deduction will be phased out--65% would be deductible the first year--and cardholders likely would scale back accordingly.
The Joint Taxation Committee has projected that the government will save $26.2 billion during the next five years by eliminating the interest deduction. In making its calculations, the panel projected that there would be a falloff in use of credit--or a shift to deductible types, such as home-equity loans. However, it is not yet clear how much of that $26 billion would come from non-deductible credit card interest and how much from other types of consumer loans.
Any decline in use of credit by cardholders would not be welcomed by the industry, which has been growing rapidly and might face a slowdown even without the tax bill.
Some experts say the credit card market is saturated, the American Banker reports. The trade publication noted that there already are 96 million Visa cards in the United States, 73 million MasterCards and 17 million American Express cards, plus numbers of others such as Choice, Diners Club and ones with less familiar names.
In the past two years, the credit card market has been extremely lucrative because of the growing spread between the issuers’ cost of funds and the annual interest rate that they charge their customers. With a return on assets in the 5% range, bank card sales are growing at an annual rate of 20% as more banks, thrifts, credit unions, retailers, oil companies and even non-financial organizations crowd their way into the field.
Sears, the latest entrant in the field, has put 4.7 million cards into circulation and hopes to increase that number to 10 million to 12 million by the end of next year. As incentives, Sears has waived its annual fee for customers for two years, offered rebates for frequent card use and negotiated lower fees for merchants.
Predicts Heavy Losses
Discover is not yet operating in the black. Losses for the first half of 1986 amounted to $46.8 million. In fact, H. Spencer Nilson, publisher of a credit card newsletter, predicts that the Discover card will be “a dismal failure,” with losses to Sears of $500 million in the next two years.
Nevertheless, the parent company’s reputation as a marketer was high enough to prompt Visa this summer to warn banks about the Discover card’s potential threat. Banks issuing Visa cards were instructed to warn merchants against accepting Discover cards because the merchants would not get their money for at least one week, Dan Brigham of Visa said.
In the year since the Discover card was launched, two major card issuers have started rebate programs. Citibank allows its card customers to accumulate “Citidollars” toward the purchase of merchandise, and Bank of America offers bonus points for the same purpose.
Plain vanilla credit cards are passe, Nilson said. Much of the activity in recent years has been in premium bank cards that offer upscale customers easy, accessible lines of credit plus a variety of services, such as free travel insurance. Taking a cue from the airlines’ frequent-flier programs, some card issuers have started offering substantial discounts on hotels and merchandise. Continental Airlines recently announced that using its Visa card, issued by Bank One in Columbus, Ohio, earns the cardholder mileage toward free flights, hotels and car rentals.
The growth of these come-ons reflects the cards’ increasingly fierce competition for market share. However, Nilson and others doubt the effectiveness of some of the latest offers.
Get a Household International Homecard and get 10% to 30% discount on exterminator services. American Express will double the warranty on appliances, just the thing the typical executive--American Express’ primary customer--needs, Nilson said. “This person would just throw away a toaster and buy another,” he said.
Another twist is the merchant discount club tied to a bank card. For example, with a Smart Card from Transmedia Network, a person can get a 25% savings at 150 New York restaurants, deducted from a Visa or MasterCard bill.
‘Affinity Card’
Another trend is the affinity card. This is a Visa or MasterCard that a university, union, club or some other group issues to its members.
“The private-label, co-branded bank card seems destined to become the late-1980s version of the (colorful) designer bank checks that appeared 15 to 20 years earlier,” said the American Banker. “The new generation bank cards will be corporate image makers, customer-sales inducements and free advertisements, all packaged on one small piece of plastic.”
Subaru of America recently became the first company to have its product, a car, pictured in full color on both sides of a Visa card.
In exchange for its name, logo or product on the card--along with, of course, the card’s name--the sponsoring organization frequently negotiates to receive a percentage of the annual fee on each transaction. All the servicing and risk are borne by the bank that issues the card. For the customer, an affinity card frequently offers a lower interest rate.
For the bank, marketing a card through a group to its members is a more efficient and less costly alternative to direct mailing to the public. More important, customer screening by the sponsoring organization helps reduce delinquency and default. This is important at a time when bank card losses are mounting.
According to Joel Friedman, a card expert at Arthur Andersen & Co. in San Francisco, losses now amount to 3.5% to 4% of outstanding balances, or about $2.8 billion. This is unusually high for a period of economic stability. He attributes the losses to the consequences of a mass-mailing campaign by banks eager to attract new customers. The result of only cursory credit checking is an abnormally large percentage of deadbeats.
Mounting losses, increasingly fierce competition, together with a possible rise in interest rates next year and the non-deductibility of interest payments make some observers feel that the golden cycle of the credit card industry may have peaked. “There are over 4,000 issuers of credit cards in this country,” Friedman said. “Surely there is going to be a shakeout.”
