This article is a part of the The Law & Economics of Interchange Fees Symposium symposium.
In my first post I argued that consumers as a group would likely be made worse off as a result of artificially imposed reductions in interchange fees. This post considers a second line of attack—that even if consumers overall would be made no better off (or even worse off) as a result of regulating interchange fees, Congress should intervene in the name of “fairness” to regulate interchange fees. This “fairness” argument, however, is a red herring, especially when advanced by merchants purporting to speak for consumers. Indeed, the sincerity of the merchants’ concern is belied by their own behavior.
Merchants claim the current interchange price (typically about 1.75% of the price of the transaction) is “unfair” to those customers who pay by cash or check (and thus don’t incur interchange fees) because cash customers are essentially forced to subsidize credit users who pay the same retail price but incur this additional cost. Note first that whether a reduction in interchange fees would be passed through to consumers is a question of market dynamics. There is no evidence that Australia’s cap on interchange fees resulted in lower retail prices for consumers. Even if retail prices did fall there is no evidence that any retail price reductions offset higher credit prices to consumers or would benefit consumers equally. While capping interchange fees might eliminate the purported unfairness by making credit purchasers worse off, it is questionable whether it would actually make cash customers better off.
But merchant critics of credit cards on “fairness” grounds are playing with a stacked deck: cash and checks are both subsidized payment mechanisms. The government prints and replaces worn currency and the Federal Reserve clears checks at par. By contrast, credit card issuers bear the cost of maintaining their payment network. If merchants were serious about accurately allocating the costs of the payment network then they would insist that the government eliminate these subsidies from the system. And this doesn’t even count the deadweight costs to the economy of cash, such as the time consumers spend making ATM transactions or the cost of paying guards to drive around pieces of paper in armored cars. Studies find that consumers who write checks take twice as long at the check-out line as those who use payment cards—forcibly imposing an external cost on everyone in line behind the check-writer. Should check-writers be required to compensate the rest of us for our wasted time standing in line?
So it may be theoretically possible to imagine that credit cards are overused as a transaction medium. On the other hand, it may also be possible that consumers underuse electronic payments because they don’t consider the social benefits of electronic payments, such as increasing efficiency, tax compliance, reduced risk of theft (and the police force and judicial system that accompany that)—in which case, it is possible that credit cards should be subsidized, not taxed. Finally, it seems at least as plausible (probably more so) that consumers overuse cash and checks because those payment systems are subsidized by the government or that some of their costs are externalized, thus consumers don’t pay their full price.
Moreover, federal law expressly permits merchants to give cash discounts (some do). That most merchants choose to accept credit cards and charge one price for cash and credit reflects a simple business decision, just like offering free parking (thereby subsidizing those who drive versus those who walk or take the bus), manned check-out lines (subsidized by those who use self-check out), or free returns on merchandise or money-back guarantees (subsidized by those who don’t return products). Starbucks customers who drink their coffee black subsidize those who use cream and sugar. Movie-goers who attend primetime shows subsidize those who attend matinees. Consumers who pay full price subsidize those who buy the same product on sale a few days later. In a free economy we allow the scope of these cross-consumer “subsidies” to be set by free contracts, not governmental mandates.
The insincerity of the merchants’ fairness concerns is illustrated by their own behavior. Traditionally, many retailers operated their own in-house credit operations. This included large department stores, but also many grocers, tailors, furniture, appliance, and hardware stores that offered credit to customers on open-book or installment credit. Many an older lawyer has related to me the memorable experience of opening his first charge account at Brooks Brothers (or the local equivalent) when buying his first suit. Maintaining these credit operations were quite expensive—the retailer had to bear the operational costs (employees, billing operations, underwriting, customer service), the risks of non-payment and fraud, and the time-cost of money of the delay in receiving payments from the billing cycle and grace period. Despite this high cost, however, many merchants made a business decision to maintain credit operations because of consumer demand.
Today, many merchants (especially smaller one) have essentially outsourced their credit operations by terminating their in-house programs and accepting credit cards instead, a much less costly system. Credit cards eliminate the operational cost and non-payment risk associated with maintaining an in-house credit operation. Credit card issuers bear the cost of the delay in payment over the billing cycle and grace period. Outsourcing credit also allows small businesses to compete on equal footing with larger businesses that could afford the cost and risk of in-house credit operations. Some major retailers, however, continue to run their own proprietary credit operations, accepting the higher cost and risk in exchange for the benefits of retaining in-house control.
Why is this history significant? Because during these decades when merchants operated their own credit operations (and where they continue to do so) they consistently charged the same retail prices for cash and credit consumers despite the higher costs of credit customers than cash customers. Target’s proprietary credit operation, for example, has been battered by double-digit default rates on its credit portfolio—yet Target charges the same price for cash and credit consumers. Some merchants even offer “twelve months same as cash” and other promotions that subsidize credit purchasers. In a similar vein, empirical studies have found that during the 1970s when state usury laws limited the ability of lenders to charge market rates of interest on consumer credit, retailers responded by increasing the price of goods typically sold on credit (such as appliances), thereby burying the price of the credit in a higher price of the goods for all purchasers.
Thus, the merchants’ claim today that the interchange fee forces an unfair subsidy between cash and credit purchasers is a red herring: merchants were (and are) more than happy to force charge the same price for cash and credit—so long as the merchants were capturing all the benefits. The difference today has nothing to do with fairness, but that the merchants don’t get to keep all the profits. And that they want the benefits of credit cards (making the issuers bear the cost and risk) without the costs. Indeed, given that the merchants have outsourced their credit operations to credit cards precisely because they are less expensive, the size of this subsidy is probably smaller today than it was when merchants ran their own operations. And even this ignores the various costs associated with accepting and handling cash and checks that credit users implicitly pay as subsidies for those types of payment.
Merchants have made a business decision to accept credit cards because it is cheaper and less-risky than running their own in-house credit operations. As such, the cost of accepting credit cards is a cost of business, just like rent, utilities, and employee salaries. Let’s get the real issue clear then—the argument over interchange has nothing to do with fairness or benefits to consumers. Merchants are speaking for themselves, not consumers, when they demand to pay lower interchange fees. The merchants own behavior demonstrates the point. Congress needs to stay out of this issue.