Retailers regularly claim that credit card swipe fees are unfair. Of course they don’t say the fees are unfair to them, even as they as they want to accept Visa and Mastercard (because it’s great for their business) while having the government mandate lower fees (because they want to make more money).
Since they wouldn’t be sympathetic making this self-interested case explicity, they fund outside groups to argue that credit card fees are bad for poor consumers, that since credit cards cost money to accept prices have to be higher – and prices are higher for everyone, even poorer consumers paying cash.
That crude argument is basically wrong:
- Cash can be much more expensive to accept than credit cards (employees steal cash, give incorrect change, and heavy cash businesses can face higher insurance costs), so if anything credit card customers are subsidizing cash customers in many retail segments.
- Credit card customers spend more than cash customers and debit customers. It’s a convenience to customers to be able to shop without handling cash, and that’s attractive to the business.
- If there’s a subsidy in credit card rewards, it’s from those rewards card customers who pay interest to those who don’t (rewards cards are basically marketing tools from the card issuers to find consumers who will revolve balances).
- Mandating lower merchant fees has not lowered prices for anyone, let alone low-income consumers, anywhere that it’s been tried.
There’s a new working paper, though, out of Harvard Business School is getting attention. It makes a more nuanced version of the argument that there’s a subsidy from cash customers to credit ones.
You’re seeing scare headlines like,
Unaffordable America: How high-end credit card perks are hurting shoppers who pay in cash
However the argument in the actual paper is different than the headline result – it doesn’t actually say what retailers want it to say. One it looks debit, cash, and credit card customers not actually all shopping at the same merchants (obvious point!) and merchants not all paying the same interchange, they find a total transfer from cash and debit customers to card customers of $30 billion a year… but much of that is within income classes.
In fact, the total amount of ‘transfer’ between major income groups they can find is just $9.2 billion per year, and that is from households below $150,000 in income (not exactly poor) to households above $150,000. And that’s out of $12 trillion in retail transactions making this largely a non-issue, even in its strongest form.
And the paper makes a lot of assumptions that are clearly wrong just to get to their low estimate of transfers.
- It models redistribution relative to zero interchange, even though there’s no proposal for this and there would be no credit card transactions possible at zero interchange. (That would be bad for merchants, too!)
- They assume that 100% of any reduction in interchange gets passed back to consumers, even though this hasn’t happened in Europe or Australia where interchange is capped. The paper’s robustness table acknowledges that lower passthrough evaporates the claim. (Emphasis mine.)
The second row of Appendix Table A.6 shows that when both price and rewards pass-through fall to 70%, redistribution dampens proportionally: The total transfer to credit card users falls to around $20 billion. When price pass-through is low (70%), but rewards pass-through remains full, credit card users benefit more than they would in the baseline: Premium credit users gain $30.4 billion because they receive full rewards while bearing only partial price increases.
However, cash and regulated debit card users are still negatively impacted. When rewards passthrough is low (70%), but price pass-through remains full, the pattern reverses: Premium credit users gain only $0.5 billion because they face full price increases while receiving only partial rewards. Regulated debit and exempt debit users are hurt by more than in the baseline, while cash users’ losses are unchanged since they do not receive rewards. These scenarios illustrate that the balance between price and rewards pass-through fundamentally shapes distributional consequences.
- The paper misunderstands how credit card rewards are funded. It simply assumes that merchant fees raise prices and funds rewards, but ignores interest and fees and cross-subsidies by other bank products as issuers seek customers (Wells Fargo lost money on Bilt as they tried to build a cobrand business, Chase lost money on Sapphire Reserve but argued it was ok because they were finding premium banking customers).
Crucially, Senators Dick Durbin and Roger Marshall want legislative mandates on cards that limit interchange, following Durbin’s efforts during the Great Recession to place limits on debit interchange (‘the Durbin Amendment’ to Dodd-Frank Financial Reform). That policy eliminated debit card rewards (until a recent slate of products found a way around Durbin limits) and raised the cost of checking accounts, pricing many consumers out of the banking system.
This paper finds that Durbin-style interchange limits are actually regressive, hurting the poor. So even if you buy the subsidy argument, Durbin-Marshall makes things worse for the very people retailers pretend to want to help.
In the end, one price to everyone doesn’t mean there’s a subsidy. People are shopping at different stores (and where they overlap, like major grocery store chains and Amazon, interchange tends to be lowest). Cash isn’t free. Card customers spend more. Premium rewards cards are increasingly funded directly by the consumer in the form of $795 annual fees. And when interchange is capped, that flows to the merchant at the expense of consumer rebates (whether in cash or points).
(HT: Tommy)
Since I play the game, I share Gary’s bias in-favor of the points-and-miles hobbyist, the frequent flyer, and the responsible credit card user.
Yet, I can still appreciate the millions of low-income Americans who do not qualify for premium credit cards due to low credit scores, or who don’t have a bank account at all, because the “game” offers them, in-particular, near-zero benefits. Credit card processing fees act as an invisible tax built into retail prices. A consumer who is forced to pay with cash or a basic debit card is paying that baked-in price inflation without getting any cash-back or points in return.
@Gary: You have run this specious argument before. However, the same empirical regularities show that the spuriousness of the argument:
1) Cash has lower transactions costs that credit cards since we see ‘discount for cash’. not ‘dicount for credit’;
2) Credit card companies have made surcharges for credit card usage illegal in states where they have adequate political power. They wouldn’t need to spend resources lobbying for this restriction on free markets if they were cheaper;
Your article is bunch of noise to motivate, exprssing your deep concern at possibily losing the majority of your income. Well, use some of the millions you’ve made from these rules to fight back against changes.That”s how corrupt American politics works.
@L3: Your point 2 is strong evidence that credit card companies like it this way, but not necessarily evidence that the public as a whole would benefit from having surcharges. It’s somewhat analogous to banning junk fees on air travel. As to discounts for cash, I tend to see that at small retailers able to hide income from the government. It’s possible that encouraging less use of credit cards would cost the government tax revenue.
This issue is very far from black and white. I don’t know which way is better. Some countries have credit card surcharges and I don’t mind them. But those countries have a much lower fraction of credit card transactions. Even it works for those countries, it might not work for the US.
Credit card rewards have a built in cost and naturally will be offered to better score customers. As far as the poor. I’m old enough to remember when a low income consumer would have gotten laughed at if they applied for any credit card. That being said, many sub prime credit cards are designed to exploit consumers that will run a balance. It may have been better in 1975 when low income consumers had to rely upon cash.
This is a free country. You have a business and don’t like credit card fess? Simple, stop accepting credit cards as a payment form. Go cash only. But no, you want to have your cake and and eat it too: all the convenience and revenue of credit cards without paying anything in return.