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. It looks at 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.
I agree with most of your points, and I generally oppose government regulation in markets, but underneath this debate is a bigger, more dangerous one. The culture in the West generally, and the US specifically, is shifting away from what made it the most peaceful and prosperous in history. Among other things, this has to do with how culture views success. In the past, the success of a neighbor would motive someone to work harder, inspired by success and desiring to keep up. There is a growing shift toward an attitude common in the developing world, which is to view success as a threat. Instead of competing or celebrating success, the desire is to tear it down and punish those who achieve. This is a recipe for disaster.
@Regis — LOL. No, it is not completely “free”… nor should it be, because that’d be chaos. We have laws, contracts, terms of service, rules, norms, etc. Yes, even so, individuals, and consumers collectively, can and do ‘vote’ with our feet and/or our wallets. That said, there can and should be reasonable, sensible guardrails to prevent abuses.
Then why do credit card processors charge small businesses more when a reward card is used? That is extortion, forcing acceptance of more expensive rewards cards. The small business pays your eeward.
Also students and young earners cannot often get the 2% cash back no annual fee cards.
Hey Regis, small businesses should ne allowed to take regular cards but not higher cost rewards cards. Credit card companies offer rewards car d s but charge merchants sometimes 2% more when those cards are used.
@nsx at FlyerTalk: “As to discounts for cash, I tend to see that at small retailers able to hide income from the government. ”
I think this used to be an important factor but modern tax/audit systems make it much less prevalent. AI will reinforce that trend.
@Gene – meh, very much not a majority of my income, not even a majority of blog income, and remember i still have a full-time job.
@Gary Leff… workin’ 3+ jobs… and still just makin’ by with only spending billions of miles/year…
The problem is all these resellers are convincing merchants they can have their cake and eat it too – all of the benefits of taking credit cards with none of the costs. They then mark up processing rates and pass them on to customers as the “cost of processing”.
@L3 – discount for cash is often driven by tax fraud (they give a discount and take an even bigger discount from the government) but as i note cash acceptance costs vary significantly by industry. there are only ~ 5 states where surcharges are illegal in practice. and surcharges have very little to do with relative acceptance costs (see the Australia example where once those were allowed, the government came back later and capped them, because they were completely untethered to acceptance costs and largely became their own profit center).
Ask any small business owner why they prefer cash and the answer will almost always be the same. Sending less money to the government is ALWAYS a good thing.
In Europe – Visa/MC is accepted everywhere and the fees to vendors is way lower. Many vendors prefer cards to cash. Do they earn points? Generally, no. The volume is way higher though.
In NY/USA, most food establishments and many stores now charge a few extra percentage points for credit cards.
When the pandemic hit most airlines borrowed against their points programs to provide a cash infusion. Today, they’ve devalued their currency by double digit percentages year over year.
We are approaching the scenario where many points programs are simply not worth it. There are still bargains to be had, but sweet spots are closing and it’s only a matter of time.
I appreciate the paper’s argument – and certainly I’m biased in favor of rewards – but this fails to consider that there are many things that go into the cost of running a business or selling an item. Credit card interchange fees are a small part of that. Rent, utilities, wages, insurance, benefits, shrinkage/theft, spoilage, etc., are also contributors to the cost of an individual item. To single out interchange fees as the culprit is overly simplistic.
pretty much every restaurant and business by me, charges 3% extra for using a credit card, so i often pay cash or by debit as it adds up
@ Gary — Well, those non-profits must not be so non-profitable for their boards. But, that’s one more element of crooked America.
@Doug, the trying to beat out one’s neighbor is largely a US thing. Of note, in Japan, they have a saying “the tallest nail gets the hammer”. In Canada, the extraordinarily rich (who are celebrated in the US) are usually suspected of treating others poorly (who did they step on to get to where they are). For much of the world, not just developing countries, the rich and successful are expected to keep their great success to themselves instead of flaunting it. It is in the US that the rich are assumed to be good people, while the poor are viewed as unworthy and, often, criminal. Just look at US politicians, particularly the current president
@Gary: ” often driven by tax fraud “.
Too much of a glaring signal nowadays. An audit magnet.
In the past many grocery stores required their employees to be paid in cash in order to reduce the cash that was delivered to the bank by armored car, which cost 2-3%. I’m sure this has changed since a higher percentage is paid by credit card. Many grocery stores still encourage cash back to the customer for the same reason.
You cannot win this argument in the court of public opinion. Perhaps it makes sense to just ditch the entire card rewards system entirely, regardless of whether it helps or hurts the poor (a straw man argument in the first place). Political expediency has the cultural tradewinds blowing gale-force against the “rich” whomever that might be, usually anyone with more money than you.
“1) Cash has lower transactions costs that credit cards since we see ‘discount for cash’. not ‘dicount for credit’;” Then, explain to us why numerous jurisdictions have passed or considered a requirement that businesses accept cash? Because many businesses were going cashless. If cash has lower costs, why would firms go cashless?
“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;” CC companies make money off of cards, not cash. So, of course they want cards used. Preventing surcharges being passed to consumers works in their favor. But none of this supports the working papers claims.
“I think this [cash tax frsud] used to be an important factor but modern tax/audit systems make it much less prevalent. AI will reinforce that trend.”
I know small business owners. The ability to do this under the radar remains pretty easy. You be stupid to try this a much larger levels for most businesses.
@Gene – that’s one heckuvan accusation sir
I highly doubt that ccd’s will change. Just look at how much money the airlines make (far more than what they make on flights), and they’ll lobby like crazy to keep things the way they are.
I never agree with Gary on just about anything… but he’s right on this. Try to understand something, the average credit card fee a retailer pays is in the 2% range. So, if the “cap” were to be imposed… it would be, let’s say, 1%. That means the retailer would pay 1% less than they’re paying now to MC/Visa when someone swipes. When you have a large retailer, real bottom line profits (EBITDA) is single digits at the end of the year. When you’re the size of Walmart… 1% to the bottom line is a gigantic number. Conversely, if ketchup is $3.99, you will not see ketchup go to $3.96 (1% discount). So, Walmart will see a gigantic profit boon and the consumer will never see lower prices. This is a scam… Durbin is probably receiving big money from the retail lobby.
@Mike P — Claiming ‘sovereign citizen’ is not a valid defense…
@Gene — Ooh, you got a ‘heckuvan’ outta Gary!
@ Gene
That how politics works
I live in CA, hopefully that is not one of the 5 states you say outlaws credit card surcharges. *Supposedly*, it is illegal in CA to surcharge for credit card usage. In practice, tons of restaurants/businesses do that. Over a decade ago when the practice wasn’t so prevalent, I was surprised to see a restaurant surcharge for credit card. I actually called Visa and asked about that. Visa even had a rule (in addition to the CA law) that if a place accepted Visa, they were not supposed to surcharge — but Visa told me there was nothing they could/would do about it other than drop the restaurant from use Visa (but they weren’t going to do that).
Today, surcharging for credit card usage is all over the place in the CA Bay Area. And many places even surcharge for debit card usage!! These are many restaurants (some of whom don’t even have it posted anywhere, and you don’t know until you get the receipt – that is if they even give you a receipt on those kiosks you have to order/pay all on your own). The DMV charges 1.95% to 2.3% ‘additional processing fee’ for using a credit OR debit card (AAA charges something just under 2% for DMV services) depending on where you’re paying. A local Super Taqueria charges 4% for credit cards. If it still is illegal as I thought it was in CA, no one is enforcing anything, or they are skirting the law by wording the surcharge in a certain way (they are not wording it as a discount for cash though, it is always worded as an extra fee/surcharge). Of course, I know I can always pay cash and/or just not eat out.
“Claiming ‘sovereign citizen’ is not a valid defense…’
Another ignorant comment from the resident retard.
@Mike P — The lady doth protest too much, me thinks…
@Melody from CA’s AG website: “In 1985, California passed a law (Civil Code section 1748.1) that prohibited merchants from adding a surcharge (an extra fee) when customers pay by credit card instead of cash. That law does allow merchants to give customers discounts for paying by cash, check, or debit card, as long as that discount is offered to all customers. The law was challenged by several businesses, and in January of 2018 a federal court held that the law could not be enforced as to the businesses which brought that case. (Italian Colors v. Becerra (9th Cir. 2018) 878 F.3d 1165.) The Attorney General will generally apply the Italian Colors decision to merchants that are similarly situated to the Italian Colors plaintiffs.
Merchants are still barred from misleading customers, such as by falsely advertising a lower price than they actually charge or hiding any differences between credit card, debit card, and cash prices.”
In the Italian Colors decisions, the court upheld the plaintiff’s argument that the choice between posting a cash price and adding a card surcharge versus posting a card price and offering a cash discount was a free speech issue.
@This comes to mind — For an Ohioan who likes to fly J to Europe and Australia, you sure do know your stuff about California… /s
Nothing makes me more annoyed than seeing businesses with surcharges for credit cards that they specifically say is just to “cover the transaction fees”…then are 4-5%
About time the cross-subsidy is made illegal.