In a time when social justice issues are daily headlines, the injustice created and perpetuated by the U.S. payment system has been largely ignored. Aaron Klein, former Treasury deputy assistant secretary for economic policy, has asserted that lower-income consumers subsidize wealthy consumers by helping fund credit card rewards programs that disproportionately benefit the wealthy. This transfer of wealth from the poor to the rich is a real-life “reverse Robin Hood” effect — the opposite of robbing the rich and giving to the poor.
Card networks such as Visa and MasterCard assess interchange fees (also known as “swipe fees”) on merchants for payment card transactions. These fees vary dramatically based on the nature of the card used to pay for goods and services. Debit card swipe fees may be as low as $0.25 and credit card swipe fees can be sixty times as high for the same transaction. The incremental fees paid for credit transactions unjustly fund rewards programs that benefit the rich at the expense of the poor.
The only viable solution is to enact legislation that forces competition in the U.S. payments ecosystem.
Credit card interchange is foundational to a shift in wealth from the rich to the poor.
Klein’s insight resonated with Congress and helped pave the way for the “Durbin amendment” to the Dodd-Frank financial reform legislation. In the Boston Fed’s public policy discussion paper titled “Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations,” the regressive transfer of wealth driven by the U.S. interchange system is fully described and incontrovertible. In short, the “extra” interchange related to credit card purchases over debit card purchases predominantly funds rewards programs associated with those credit cards.
Most economists accept that costs of goods sold and selling costs are the most significant factors in determining the prices consumers pay for goods and services. In fact, in Visa’s own “Open Letter from Visa to Cardholders and Merchants in Canada,” the company essentially agreed that both merchants, as well as merchants’ customers, benefit by lowering interchange fees.
Bank networks compete for banks, but banks don’t compete with each other.
As noted by European regulators (and as equally applicable in the U.S.), “Usually, competition leads to lower prices since companies compete by offering lower prices than their competitors. In the case of interchange fees, the opposite occurs ... Interchange fees are, therefore, indirectly paid by consumers ... In addition, cardholders are encouraged through rewards offered by their bank to use cards that generate higher fees for the bank.”
Everyone pays more.
Certainly, merchants agree that all customers, not just lower-income customers, pay more due to the supra-competitive interchange fees attached to every credit card purchase. Those customers who do not pay with credit cards pay even more dearly than the wealthy who gain a rebate due to their credit card rewards.
In 2010 this transfer equated to $24 billion, according to the Boston Fed’s Policy Paper.
One can only imagine how this unjust transfer of wealth has increased in 2021.
Variable pricing for credit and non-credit purchases is virtually impossible for merchants.
Although merchants can indeed offer discounts for cash, it is operationally impossible for merchants with hundreds or thousands of products to do so. The patchwork of anti-surcharge laws across the U.S. and complex acceptance agreements add to the complexity for merchants who might want to charge fees for credit card purchases.
None of this is meant to say that card issuers do not create value that helps allow for ubiquitous acceptance and some additional, limited (but ever diminishing) benefits. However, the current system enables issuers to artificially inflate swipe fees in a way that clearly and indisputably leads to a shift of wealth from the poorest to the wealthiest and to the detriment of the U.S. economy as a whole — all for the benefit of issuing banks and their most affluent customers.
This unjust system needs to end.
The only viable means to remedy this injustice is through legislation that forces competition amongst issuers in the U.S. payments ecosystem. Competition will demand that all participants in the system bear a fair share of costs and have the opportunity to earn their fair share of benefits in a “Next Generation” U.S. Payments System.
Dean E. Sheaffer is an executive consultant with 30+ years of experience in the U.S. payments ecosystem. He has testified before the U.S. House, Senate, and many states on payments-related matters, including emerging payments. He served on the Board of Directors of the Merchant Advisory Group and as chair of the National Retail Federation’s Credit Executives committee for nearly a decade.