The courtship and the marriage are often so different. So it is with credit card companies. They promise 4.9 percent interest rates while seducing you. But after you say “I do” and then make one little mistake, you sure pay for it. Your rate can skyrocket to 30 percent or more.
A group of Washington state legislators who are tired of this bait and switch have come up with innovative legislation designed to fight fire with ... taxation. The bill would tax any credit card earnings from interest rates of more than 12 percent at triple the normal rate. The proposal will be debated in the Washington Legislature on Tuesday.
But well-intentioned efforts by state legislators to rein in the credit card industry have been doomed for years, and, unfortunately, this proposal may meet the same fate. Federal laws and courts trump state legislators at nearly every turn. In this case, it's not clear that Washington state can tax credit card firms at all. Still, the proposal shows just how far some state lawmakers are willing to go in an attempt to rein in credit card firms, and just how frustrated their constituents are.
It's a question nearly all of us have asked at one time or another. How can they get away with it? How can credit card issuers charge those outrageous rates? There ought to be a law — and in fact, there are several. But state laws limiting interest charges don't apply to most credit card firms, which won the right to write their own rules several decades ago.
In many states, 30 percent interest rates run afoul of usury laws designed to prevent outrageous lending terms. But in 1978, a federal court decision effectively gave the credit industry a flier on state usury laws, ruling that credit card firms are subject to usury laws only in their state of origin. Tax-hungry South Dakota quickly raised the top rate to near-infinity. Citibank and a flood of followers suddenly fell in love with the Badlands and moved there, and consumers have been paying for it ever since.
Annoyed by industry policies like universal default — miss a payment on one credit card, and all your credit card interest rates go up — Rep. Marilyn Chase, a Democrat from the Seattle suburb of Shoreline, and a group of Washington state legislators have developed their clever end-around to re-impose state usury laws.
"We have so many callers who are outraged that all of a sudden their interest rate has gone up to 30 percent," Chase said. "Any other business that tried this would be immediately hauled on the carpet."
Chase says the industry has yet to respond to her initiative, but the response will be predictable. Limit an issuer's ability to charge high rates, and you'll limit its ability to balance its risk. That in turn will prevent it from lending to riskier consumers and ultimately restrict the flow of credit.
To that, Chase says, "Amen." There's too much credit, and too many credit card applications, anyway. Her bill would bar those pre-approved applications, too.
Those pesky federal laws
But to show how hard it is for state consumer protectors to exert themselves, Chase's well-meaning legislation may not be viable. Federal law — namely the Fourteenth Amendment and the Commerce Clause — prevent states from taxing out-of-state companies.
But what's an out-of-state company? Citibank's Visa may be accepted everywhere, but it's based in South Dakota. There may be 5 billion credit card applications being mailed to every citizen in America — and even to some family pets — but does that fit the definition of "doing business" for state taxation? It’s unclear, experts say.
"The law is very open on this issue. It's currently being litigated," said Richard Pomp, a tax law professor at University of Connecticut School of Law. "There's a lot of money on the table."
Revenue-starved states obviously have an incentive to interpret the law broadly. But Chase says she has another motivation. Congress and the federal courts have done nothing to rein in the industry, so state officials have to do something to drag the firms back under their regulation. Chase says that's what her law is designed to do.
"Taxation is all we have left," she said.
The central issue in the state tax debate is known as "nexus" to tax lawyers. Companies that have it must pay state taxes; companies that don't do not. In the past, establishing nexus was simpler — generally, bricks and mortar told the story. Physical location established nexus. If you were located in Delaware, you had nexus in Delaware, paid Delaware state taxes, and that’s that.
In 1992, a federal court ruled that companies without a physical presence in a state did not have nexus in that state and were not required to collect sales taxes. That ruling today lets consumers get away with not paying sales taxes on out-of-state Internet and catalog purchases. (Tax law requires consumers to pay such taxes themselves, but few do.)
That same precedent is often invoked in the state corporate income tax debate, and back in 1999, it helped convince a Tennessee appeals court that J.C. Penney National Bank did not have to pay state taxes there. While its credit cards were used all around the state, the court said that wasn't enough to establish "nexus."
That ruling has prevented states from cutting themselves a slice of the credit card industry's fees and interest earnings for years. Ever since, banks have successfully argued that they do not have nexus anywhere but their home state. That's bad news for Chase. In Washington, a tripling of state business and occupation taxes would mean a tripling of nothing. That threat isn't likely to make Capital One lower its interest rates.
At least you can still buy your books at Amazon.com without paying sales tax.
A glimmer of hope
But the discussion is far from over; and there may yet be some hope for a credit card rate luxury tax. Last year, a West Virginia state court ruled that the state could collect corporate income tax from MBNA. The mere fact that MBNA could use — and has used — West Virginia courts to collect bad debts from consumers convinced the court that nexus had been established. In other words, MBNA's pursuit of consumers who couldn't pay their exorbitant interest rates was eventually the company's undoing, and led it to owe state taxes to West Virginia.
According to the Washington State Department of Revenue, out-of-state credit card companies aren't paying taxes there yet. But they may start, if Chase has her way. Expect quite a fight from the industry before that happens. No doubt, lobbyists will argue that it's unfair that the rules are being changed midstream, that the tax amounts to a new fee.
That argument should have a familiar ring. And while higher taxes may likely end up costing consumers more — the industry will no doubt just pass along the costs — it’s somehow satisfying to see someone trying to charge the credit card companies an extra fee for once. If only our lawyers were as good as theirs.