By Matthew J. Razzano*
When you hear the phrase “structural inequality” you might not immediately think of payments systems. The choice of whether to purchase a television or a meal with cash or a credit card might not feel like a monumental decision, but it has significant economic consequences because balancing the interests of credit card companies, merchants, and customers proves challenging. Much has been written about underbanked communities and predatory lending, especially in the wake of the 2008 financial crisis. But given the empirical challenges of measuring payment systems, the connection between inequality and card use receives less attention. Courts and policymakers have struggled to offset this imbalance through a variety of different programs and proposals, but to little avail.
When a customer pays with cash, the merchant retains the entire sum immediately. This provides businesses with financial security, as well as flexibility in managing their balance sheets. Cards involve a few intermediary steps, where merchants contract with third parties to accept and process customer payments. Accepting cards promotes customer convenience and additional transactions, but this convenience costs merchants a few extra cents on each transaction. Consumers won’t directly feel the difference between methods. They usually pay the same amount regardless of the payment method chosen because merchants are often contractually restrained from charging different prices based on the payment method. The merchant prefers cash, even though card fees are only a small percentage of each transaction.
In 2018, the Supreme Court took up the question of whether American Express could contract with merchants to prevent them from steering customers against particular payment methods. The Court ruled, in the credit card company’s favor, that such measures did not violate the Sherman Antitrust Act. The decision received criticism for favoring credit card companies over merchants since the latter must pay the transaction fees but can’t control how customers spend. Lacking in much of this discussion, however, is the consumer—falling victim to higher prices that merchants use to compensate for the transaction fees.
On a related note, credit cards were also criticized as inequality-promoting instruments in the wake of the American Express decision. Credit cards used to pay for goods or services often include rewards programs, which favor credit card customers over cash users. This is because when merchants raise prices to cover transaction fees, customers all pay the same price at the counter, but rewards programs give cash and gifts to credit card users that soften the burden of raised prices. Thus, cash users end up subsidizing credit card transaction fees and rewards programs.
Data from 2010 confirm that less wealthy customers disproportionately use cash. For instance, credit cards account for 25% of transactions for those who make over $100,000, but only 11% for those earning under $100,000. With that, households that frequently pay with credit cards receive a $1,133 annual subsidy from cash users. Roughly similar proportions were found in 2016. Payment systems have underlying inequalities baked in, and American Express illustrated some of these disparities. Yet, even with such recognition, no simple solution exists to protect consumers and correct for this inequality.
One suggestion to equalize payment systems is to allow merchants to steer customers to certain payment methods. This helps protect merchants from losing a portion of their proceeds to fees, and customers benefit by avoiding surcharges that merchants might add. Australia attempted such a program in 2003, permitting merchants to add surcharges to credit card purchases and signal the preferred payment method. The result was mixed, however. Card-using customers paid these surcharges in the form of added fees from credit card companies. And merchants charged surcharges in excess of the fees they paid the card issuers, revealing that most economic decisions were not made with consumers in mind.
Another option involves lowering card-related fees. The Durbin Amendment as part of Dodd-Frank sought to do precisely that with debit card fees. Although cash users do not subsidize debit card users to the same extent as credit card users, merchants still feel the difference between the two payment methods. Thus, they still raise prices to account for the added fees, resulting in cash purchases subsidizing card purchases. Lowering these interchange fees saves merchants money, and consumers should hopefully benefit through lower prices.
The problem is that with those provisions were implemented, data suggest that merchants benefit from lower fees, but they don’t pass along those cost-savings to consumers—though this point has been contested. To make matters worse, another study showed that banks introduced checking account fees to recoup lost revenue from the loss of debit card fees.
The key for policymakers is to balance the divergent interests of the three primary stakeholders: banks, merchants, and customers. There is no simple answer to these complex problems, as pulling one lever often creates another problem. Allowing consumer payment steering may save merchants money, but credit card companies raise fees on consumers. Reducing rewards programs may help equalize payment methods, but it may result in fewer credit card transactions and limit development of new payment technology. Lowering interchange fees should lower prices, but merchants take in most of the cost-savings. It seems that steering and reducing rewards risk decreasing transactions and limiting the beneficial network effects accompanying new payments systems. Such detrimental economic effects probably outweigh any consumer benefits. Thus, polices become a matter of prioritization.
If the goal is to help consumers, policymakers need to change their focus to consumers. Some commentators have called for the Durbin Amendment’s repeal, but fully unchecked markets won’t help consumers either. Rather, better regulation around adjusting the fee cap to account for different sized retailers may help small businesses and consumers who’ve been disproportionately neglected by Durbin. Additionally, tax incentives could help promote additional pass-through savings. Regardless of the option taken, it is clear that striking the right balance proves difficult, but it’s time that consumer interests move up the priority ladder.
* Matthew Razzano (J.D.) is currently a law clerk in the District of New Mexico.