What Really Solves America’s Debt Woes—And Why Rate Caps Aren’t It

Free-marketers rightly criticize the Fed for manipulating interest rates, which serve as important price signals to entrepreneurs. Many stumble, however, in applying this same criticism to other forms of price controls, such as interest rate caps, which have been revived earlier this year.

The following article was originally published by the Mises Institute. The opinions expressed do not necessarily reflect those of Peter Schiff or SchiffGold.

Nothing brings Republicans and Democrats together like using simplistic, heavy-handed government regulations to attempt to solve complex problems. Unfortunately, the promise of easy solutions blinds policymakers to much more effective alternatives.

Recent proposals to cap credit card rates are a good example. In February, Republican Josh Hawley and socialist Bernie Sanders proposed a Senate bill that, if passed, would cap rates on credit cards at 10 percent. In March, Republican Anna Paulina Luna and Democrat Alexandria Ocasio-Cortez introduced a similar bill in the house that would establish the same rate maximum.

As enticing as this simple and allegedly easy fix might sound, it will actually make America’s debt problem worse. Rather than relieving their debt burdens, a rate cap will end up costing people access to their credit cards altogether, driving them to payday loans and other much less desirable credit arrangements. Instead of passing a counterproductive rate max, the government should focus on things that would actually provide Americans some financial relief, like extending the 2017 Tax Cuts and Jobs Act (TCJA) and reducing tariffs. These measures would save the average American more money than the potential savings from a credit card rate cap.

Set to expire later this year, the TCJA has been very beneficial for working Americans. Passed during Trump’s first term, the TCJA substantially lowered the corporate income tax rate from 35 percent to 21 percent. Though often maligned as “trickle down” economics, reducing taxes on corporations did indirectly help everyday Americans. Since businesses were able to retain more of their earnings, they invested more by expanding their operations, hiring more employees, and raising wages.

According to the Cato Institute, the average production and non-supervisory worker saw their wages go up about $1,400 per year as a result of increased economic investment. The benefits aren’t just temporary. One study found that extending the 2017 tax cuts would boost incomes for individuals across the board, with the bottom quintile receiving a 2.8 percent increase.

Unfortunately, the Trump administration is threatening to undo these gains by raising tariffs. Given Trump’s erratic behavior lately, it’s impossible to tell just how much his new tariffs will cost, but a few economists have provided good estimates. If the president’s April 9 revisions hold, the new import tax rates could cost American households as much as $4,400 per year.

This is far more than the potential savings from an interest rate cap. The average cardholder has a balance of $7,236 and the average rate is 21.37 percent, meaning that the typical monthly interest charge is $128.18. Forcibly lowering rates to 10 percent would generate an interest charge of $59.71, meaning that the average cardholder would potentially save $821.64 annually. This is far less than what Americans could obtain by extending the 2017 tax cuts or rescinding Trump’s new tariffs.

Alas, cutting corporate income taxes and tariffs wouldn’t make the same splash that new price controls on credit cards would. If it worked, a rate cap would have an immediate and very noticeable effect, whereas changes to the tax code and their corresponding effect on economic investment may take time to bear fruit.

But while borrowers might see interest savings on their statements, they would also receive letters notifying them that their credit card accounts are being closed. Despite what legislators want to believe, credit card companies will stop extending credit if the most they can make is 10 percent. That rate may sound high, but in reality it’s only 250 basis points above the Wall Street Journal Prime Rate—a rate widely used by banks as a benchmark for pricing loans and which is currently 7.50 percent.

Because they are unsecured, credit cards are notoriously risky. The proposed credit card rate max is lower than the average rate on a used car (11.62 percent), even though these loans have collateral that the bank can take if the borrower fails to pay. In contrast, if a borrower fails to pay their credit card bill there is little the bank can do about it. If a 10 percent rate max is imposed, most companies would cut off credit to all except wealthy borrowers with high credit scores. One recent study found that as many as 82-88 percent of credit credit card accounts would be closed as a result of the proposed rate cap.

Ultimately, interest rate caps would cost Americans access to a convenient and reliable source of credit. Instead of saving them money, a rate cap would push consumers into worse credit options, like high-interest payday loans, checking account overdrafts, or even illegal loan sharks. If members of Congress, like Hawley, Sanders, Luna, and Ocasio-Cortez really want to save their constituents some money, they would focus on policies that boost economic growth like cutting taxes and reclaiming Congress’ proper constitutional power to rescind the president’s reckless tariffs.