Innovative ways to stimulate the economy: Let consumers deduct credit card interest

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This is the first in a series of Innovative Ways to Stimulate the Economy suggested by DailyFinance contributors.

As federal stimulus starts to take shape, various groups are loudly clamoring for their right to a piece of the pie. The financial services sector claims its right based on the need to improve liquidity in the markets and its supposed expertise in dealing with large sums of money. Meanwhile, people who are living paycheck-to-paycheck are pointing out that paying down credit card debt and avoiding foreclosure, while not necessarily flashy, go a long way toward keeping the economy afloat.

One solution that could help both these groups would be to allow consumers to deduct their credit card interest from their income taxes. On a base level, this would funnel money to some of the people hardest hit by the recession since they would pay less in taxes. It would also encourage them to keep paying their credit card bills.

The secondary effect of this plan would be to increase cash flowing into the economy. No doubt the people who can afford to spend would be freer with their credit card purchases. Plus, many of the people who would benefit most from the deduction would have some extra money to spend on necessities. Either way, the cash would quickly find its way back into the economy.

A third effect would be that, by encouraging people to keep paying on their cards, this move would also help boost the credit markets. As credit payments seemed more reliable, banks might be more comfortable with extending credit, and the ripple effect could help stabilize the economy. Regardless, however, the consistent flow of money into banks would help accomplish the same thing as pouring money directly into banks.

This would not be the first time that credit card interest was an acceptable deduction. In fact, until President Reagan signed the Tax Reform Act of 1986, interest on consumer loans, including credit cards, was deductible. Afterward, interest on home loans was the only consumer credit payment that remained deductible.

While the 1986 Tax Reform Act resulted in lower interest on credit cards, it also helped lay the groundwork for the overuse of equity lines of credit. It's also worth noting that some people have already figured out ways to deduct their credit card interest by purchasing business-related items. Being able to do this more openly, however, would encourage consumers to establish better relationships with their banks.

Do you think this would stimulate the economy? Tells us why, or share your stimulus ideas. And see more of our Innovative Ways to Stimulate the Economy.

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