We’re all sick of fees, from checking accounts to overdrafts to foreign transaction charges. According to the Wall Street Journal, another might be on its way: Merchants might soon, under a settlement with Visa and MasterCard, be able to assess a surcharge on credit card-holding customers. Is this yet another attempt by Big Retail to squeeze money out of already struggling consumers? Maybe. But is it a bad thing? Not quite.
Background: Why Visa Raises Gas Prices
The heart of the lawsuits, which pit big-box retailers and various attorneys general against card networks Visa and MasterCard, lies in interchange fees – the charges levied on a merchant every time a customer uses plastic to make a purchase.
These fees usually amount to about 1-2% of the purchase, but are a greater percentage of small transactions. This is why you see (technically illegal) signs saying, “Minimum $10 for credit cards.”
In numerous lawsuits filed over the past seven years, plaintiffs (including the big-box retailers that lobbied for the Durbin Amendment) accused the card networks of price-fixing, discouraging competition on swipe fees by requiring that a Visa card, for example, only be processed on Visa’s network. There is some truth to this: card networks have no incentive to increase fraud protection, because high fraud losses justify high interchange fees.
The status quo: A regressive wealth transfer
Currently, merchants cannot charge extra for credit cards. This means that the higher interchange fees are built into the prices for everyone. Credit cardholders earn rewards, which offset the higher price of their purchases. Non-credit cardholders are left with raised prices and no compensation.
In the current state, non-credit cardholders subsidize the plastic swipers, much like those who hate airline food subsidize the free-lunch-eaters and restaurant-going vegetarians subsidize their carnivore companions.
But in this case, the division is more significant. First, prices are higher on essentials as well as indulgences: from a latte to winter coats. Second, there socioeconomic divide between credit cardholders (especially the high-end rewards credit cardholders) has only been exacerbated by the financial crisis. Prime customers, whose cards command the highest interchange fees, are courted with unprecedented rewards offers. Anyone with less than stellar credit has to confront skittish lenders with tightened purse strings.
Interchange fees create a subsidy from the poor to the rich. The lucky ones who can get rewards use them, raising merchants’ costs and therefore prices for everyone, not just the customers who caused the high prices.
What will the expected settlement do?
The Wall Street Journal predicts that the settlement will allow merchants to tack on a surcharge for customers who use Visa and MasterCard credit cards (American Express and Discover tie their fees to the other two, so the deal will effectively cover all credit cards). Simple enough. Here’s how it will likely affect the different constituencies:
Merchants: If this were Econ 101 or fairyland, allowing surcharges would work like this. Prices would go down to reflect merchants’ lower cost overall. The surcharge would exactly cover the added cost to the merchant, so he would be indifferent to the payment method. Customers would then be able to pay for the good itself, and decide whether it’s worth it to use credit.
But we’re talking about the market, not The Market. It’s entirely plausible that some of the savings will pad merchants’ pockets, or that credit card surcharges would be greater than the interchange costs by a just a little bit, enough to escape consumers’ notice. But overall, the rules of The Market dictates that the base price of goods will fall.
Banks and card networks: Without question, banks and credit card networks will lose out if surcharges are permitted. Consider the losses from just the debit interchange fee cap:
- Bank of America lost $430 million of debit card revenue in the fourth quarter of 2011 alone, primarily due to legislation.
- JPMorgan Chase estimates it will lose $600 million a year as a result of the Durbin Amendment.
Card networks will suffer as well. Visa and MasterCard have a virtual duopoly on credit card processing, and breaking that control will inevitably lower their profits.
Consumers: Consumers stand to gain the most. Those without excellent credit will see lower prices, making everyday goods more affordable for the population struggling most. Those with excellent credit will benefit as well. Banks offer rewards partially to encourage spending, and thus interchange fees. Faced with this new disincentive to use plastic, banks will have to kick up their rewards programs if they want to earn the same interchange revenue.
It’s easy to paint the possible credit card surcharge as another consumer-gouging fee, an extra weight on the cash-strapped everyman. But oddly enough, the surcharge might just be beneficial – and in any case, it will remedy the backward situation where the poor pay for the rich.