This article analyzes the probable effects of recent deregulation of consumer credit markets and tax reform on household credit-use decisions. The results of the analysis suggest that deregulation of rates of charge for consumer credit contracts accounts for a substantial portion of the increase in consumer credit outstanding relative to household income since 1982. The effect would not originate from the extention of credit in newly deregulated markets to households that had not been able to get credit before (widening of credit use). Rather, it would come from the provision of greater amounts of credit to borrowers in general (deepening of credit use). With regard to tax reform, the probability of debt use is significantly higher for those households most likely to itemize deductions for federal income tax purposes. Holding the level of interest rates constant, tax reform that removes the deductibility of consumer interest is not expected to affect the amount of credit used relative to income but is expected to have a significant effect on the type of debt used by such households. They will likely be early adopters of home equity lines of credit. Their shift from consumer to mortgage credit is expected to have a long-term negative effect on the credit quality of consumer credit portfolios.
The market for consumer credit in the United States has historically been highly regulated in terms of allowed prices for contracts and licensed providers--conditions that limited potential competition and credit availability. At the same time, the use of consumer credit was encouraged by federal income tax policy that allowed the deduction of interest paid for consumer credit in the calculation of taxable income for those households that itemized deductions.
Interest rate ceilings and the tax treatment of consumer interest represent public policies that potentially influence the availability and cost of credit and, therefore, consumers' incentive to use credit for consumption purposes. In the last decade, many of the legal restrictions on the maximum allowable rate of interest charged for consumer credit contracts were either totally eliminated or raised to such a level that they were not binding. This deregulation--widespread by the end of 1982 was initiated by the combined forces of the deregulation of deposit markets and the high inflation of the late 1970s and early 1980s. More recently, the Tax Reform Act (TRA) of 1986 initiated a schedule for phasing out the deductibility of consumer interest in the calculation of federal income taxes. By 1991, none of the interest paid in association with traditional forms of consumer credit (e.g., auto loans,credit cards, etc.) will be deductible.