New Paper Shows Credit Card Rewards Aren’t Benefiting Rich At Expense Of Poor

Rewards credit cards frequently cost merchants more money to accept than plain vanilla credit cards without rewards. Merchants want to accept credit cards – it’s good for their business – but they’d love to pay less for the service. Many associations of retailers turn to governments or the courts to try to force lower fees from Visa, Mastercard, and American Express.

One of the arguments employed by merchants, to disguise self-interested behavior (for instance pitched at federal policymakers in The Hill, is ‘concern for the poor’ claiming that the rich benefit from rewards while the poor face higher prices as a result. This is plainly false as I’ve shown several times. It’s not how credit cards work.

  1. Where interchange caps have been implemented, prices haven’t fallen Current prices are prices people are willing to pay at current volume of transactions (supply and demand). Capping interchange means lower costs to retailers but there’s no reason to expect those lower costs to be passed onto consumers. Prices didn’t fall in Europe or Australia when interchange caps were instituted, or as a result of the Durbin amendment capping debit interchange in the U.S.

  2. Accepting credit cards is cheaper than cash Depending on the business, accepting cash costs 5% to 15% which is far more than credit cards cost. That’s because, among other costs, employees pocket cash, they make incorrect change, having large amounts of cash drives up insurance costs and it attracts outside theft.

  3. People who pay by credit card spend more Even if credit cards were more expensive to accept, it’s well worth it because people paying by credit card spend more – they aren’t constrained by the cash in their wallet and may be less inclined to worry about smaller amounts of money. It’s one of the least expensive and most effective marketing expenses a business can incur.

  4. Higher prices aren’t driven by credit card rewards if you’re concerned with pricing trends you should be focused on inflation, not interchange, worrying about government spending and monetary expansion. And of course worry more directly about how you can increase access to the banking system. Encourage, rather than encumber, greater experimentation with financial tools that make electronic payments accessible to everyone.

A new paper from three scholars makes several further persuasive arguments on this point.

  • The idea that the ‘rich’ and ‘poor’ are buying the same things at the same store (necessary for the claim that higher prices are the result of higher interchange on rewards cards) doesn’t reflect actual store and consumer experience.

    [D]ifferent cohorts of consumers frequently shop in different places and often buy different things, depending on income. In this more realistic scenario, merchants are able to adjust prices based on the incidence of card usage, meaning the redistributive effect is dampened. In other words, rewards-card users largely pay for their own benefits.

  • Moreover don’t actually pass all of interchange onto consumers, “literature suggests a pass-through range of 22-74%, with a median of ~50% in the long run.” Reducing card interchange doesn’t actually pass through in reduced prices. In fact we know this from experience because prices didn’t fall when the Durbin amendment capped interchange on debit cards.

  • The rich versus poor story doesn’t rack with who has rewards cards, because lower-income consumers frequently have rewards cards! Rather “data suggests that rewards benefits are tied more to credit score than to wealth or income.” I got my first rewards card at a salary of $23,000. I frequently advised 22 year olds with starting salaries on the rewards cards best for them.

  • International experience suggests that capped interchange means higher annual fees on benefit-rich cards, putting better benefits further out of reach of ‘the poor’.

If you’re actually concerned for the poor in the financial system, you’d focus on things that push poorer people into shadow banking systems and deny them access to traditional bank accounts. The Durbin Amendment to Dodd Frank financial reform, for instance, capped interchange rates on debit cards and made offering checking accounts to poorer people unprofitable for banks. Banks could no longer make money by issuing debit cards to their checking customers, and so we saw fee-free checking options decline precipitously. That pushes people into alternatives with higher fees like check cashing stores.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. When someone has a greater than average vested interest in the bank card game continuing as is in the US, there may be a tendency for such beneficiaries of the status quo to latch onto any conceivable justification to defend the status quo that lines the pockets of some at the expense of others.

  2. @guwonder
    if you have any valid argument against what gary said you can lay it here, but just saying stuff without any alternative is just barking

  3. I’m fine with all of these arguments, except:
    “Where interchange caps have been implemented, prices haven’t fallen”

    That’s a strawman argument. We all know retailers have almost no leverage in negotiating interconnect fees and the cost of those fees has only increased in the past decade. Technically, the increased use of cards by customers should have decreased interconnect fees, yet that hasn’t happened. Therefore, the only way to ensure these fees don’t continue to increase (without justification) is to require caps.

  4. @doug,

    If you have any valid argument against what I said, you can lay it here; but just saying stuff without any alternative is just barking.

  5. Great points thanks, i learned a lot.heee.

    Just one nit–your thoughts on how the Durbin amendment ends up hurting the poor are not widely known. Therefore, i think it’s off base to imply that supporters of the law aren’t “actually concerned” about the poor. I know poverty advocates and most of them have really good hearts; there is no reason to question their motives when many if them have never seen these interesting studies that you are proposing!

  6. If “ Accepting credit cards is cheaper than cash ” is true, why are cash prices cheaper than CCs at gas stations (eg CA)?

  7. Gary – this is not a scholarly article that investigates the claims econometrically. This is an opinion piece. I’m not saying your/their opinion is incorrect, but there is no real data analysis here. And it’s published in a shitty journal. So don’t put much weight in their “conjecture” as they themselves call it.

  8. The article about the supposed 5-15% cost of cash is written Mark Miralles, Merchant Services Manager. The guy’s job by definition is to get more people to use cards. That invalidates any supposed neutrality on the subject. @Gary, please don’t continue to use these spurious arguments on the cash vs. credit debate. Your rich versus poor argument has some validity, just don’t try to tell me that I’m paying 5% or more on my cash sales simply by accepting cash – that’s factually incorrect.

  9. @ABC

    There is a distinction between small businesses and larger retailers which make up the majority of where credit cards are used for purchases. A pizza shop or gas station is a cash centered business as most customers use cash. There is usually one or two registers with one or two cashiers. There is no cost savings for these businesses with credit cards because there isn’t enough volume. That’s why many of them charge a credit card fee. The pizza shop here charged 3% and the hair salon charged 2.7% to use a credit card. Of course, owner operated shops love cash because they can more easily pocket it instead of report it (which I support 100% and cheer).

    It’s a completely different story with larger retailers like supermarkets, department stores, and drugstores (Walgreens) where many use credit cards. Management doesn’t have to take as much time auditing registers, accounting for the money, depositing it, ordering cash to be delivered or picked up by an armed guard, and there is less opportunity for theft by cashiers. It’s much easier for credit card payments to be recorded and it’s easier to reconcile customer returns.

  10. GUWonder, it’s true that typically there are beneficiaries who fare best when the status quo is maintained. That doesn’t mean keeping the status quo isn’t the best option.

  11. Lol I’m sure this is extremely unbiased reporting “Presented by Capital One.” This article is so heavily laced.

    When I worked at Capital One they were trying to develop machine learning algorithms to skirt anti discrimination laws. F credit card companies they are nothing but a private company adding a silent tax to transactions.

  12. @Sean: “Therefore, the only way to ensure these fees don’t continue to increase (without justification) is to require caps.” Which you have already been told, doesn’t work. And it is certainly not “the only way”. That categorical statement shows that you aren’t thinking.

    The thing most likely to reduce interchange fees is financial innnovation. FinTech and Defi.

  13. @ABC: Dead right. That is the single most telling counterfactual against the view that cash is expensive.

  14. The conclusions in the article are mostly non-sequiturs or straw men, and there is a conflation of the argument about capping fees and an entirely separate point about providing transparency.

    What is the reality: Today, a merchant has to absorb the cost per sale whether the buyer uses a debit card (costing the merchant x) or a card giving maximum benefits (costing it 5x), half an order of magnitude difference on a purchase with a slim margin. Unless – and only unless – the merchant can reduce the price for the debit card transaction and increase it for the credit transaction, the former must subsidize the latter. This is a microeconomic certainty. Whether the gross amount of revenue changes for certain cardholders or not is immaterial: Real costs are being hidden for the sole purpose of obscuring the subsidy to return benefits to card holders. If there was no controversy here, then transaction costs would be publicly known, including the difference in cost between variations of cards. That they are not is the plainest answer to the question of the poor benefiting the rich.

  15. Most good-hearted poverty advocates have been trained to believe regulation helps the poor. Regulation actually helps the incumbent regulated business by shielding it from competition. Competition helps the poor more than it helps the rich.

  16. From the Federal Reserve Bank of Boston:

    “Who Gains and Who Loses from Credit Card Payments?
    Theory and Calibrations
    Scott Schuh, Oz Shy, and Joanna Stavins
    Merchant fees and reward programs generate an implicit monetary transfer to credit card
    users from non-card (or “cash”) users because merchants generally do not set differential
    prices for card users to recoup the costs of fees and rewards. On average, each cash-using
    household pays $149 to card-using households and each card-using household receives $1,133
    from cash users every year. Because credit card spending and rewards are positively
    correlated with household income, the payment instrument transfer also induces a regressive
    transfer from low-income to high-income households in general. On average, and after
    accounting for rewards paid to households by banks, the lowest-income household ($20,000 or
    less annually) pays $21 and the highest-income household ($150,000 or more annually)
    receives $750 every year. We build and calibrate a model of consumer payment choice to
    compute the effects of merchant fees and card rewards on consumer welfare. Reducing
    merchant fees and card rewards would likely increase consumer welfare”

  17. Folks, this is a very misinformed article. Before I address each of these points, I also want to point out that the major way rewards cards harm poor people is by perpetuating a system where disadvantaged individuals who need access to credit have to pay crazy high APYs which in turn are what funds the lucrative rewards earnings we all get on our fancy travel cards. No such thing as a free lunch, your lunch is paid for by poor families paying 25.6% per year on a $1000 unpaid balance. I believe buy-now-pay-later and other no/low interest unsecured lending providers are going to decimate the credit card industry over the coming decades. Now addressing the remaining points in order:

    1. Unsound research methodology: Asserting an impossibly broad and vague trend and linking it directly to a single variable. In fact, look at Kroger who often will stop accepting visa cards at many locations to get Visa to lower its interchange rates. Most retailers don’t have the luxury of this leverage, but they will all tell you that interchange rates are an increasingly significant OpEx item over the last several years.

    2. This is a strawman, compared to debit and prepaid cards, credit is vastly more expensive.

    3. So we want to encourage people spending beyond their means and making poor financial decisions?

    4. See #1

  18. @Former card industry consultant : What is the $ value of CC interest payments by low income individuals and what is the dollar value of CC rewards, and the datasources for both?

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