GoKawiilAmerican Express has famously touted that “membership has its privileges.” For wealthy consumers today, those benefits total $9.2 billion each year, subsidized by middle- and lower-income households.
As inflation-weary businesses raise prices to cover credit card interchange fees, the pain isn't universal, says research by Harvard Business School Professor Mark L. Egan. Because merchants charge everyone the same price regardless of how they pay, those fee costs are factored into prices for all shoppers. However, credit card users get that money back and then some through rewards, while cash and debit users get little or nothing.
The result: People paying cash face the equivalent of a 26% higher sales tax than premium credit card users shopping at the same store.
Collectively, interchange fees shift an estimated $30 billion from those paying with cash and debit cards to credit card users at similar merchants annually, Egan and his fellow researchers estimate in the April working paper “Who Pays for Payments?” That windfall is as “economically significant” as government policies that support low- and middle-income Americans, such as the Earned Income Tax Credit and unemployment insurance.
“It's just the way the market was set up,” says Egan, the George E. Bates Professor. “It turns out to be unfavorable to people who use cash and debit, and those who happen to be people with low incomes.”
Egan’s research shows how consumer policies, banks’ need for fees, and buying behaviors have converged to facilitate a massive wealth transfer. The findings arrive amid a widening schism between the country’s richest and poorest residents, as wealthy households gain from surging stocks and many lower-income families struggle to afford basic necessities.
Egan coauthored the paper with Gregor Matvos and Lulu Wang, professors at Northwestern University, Stanford University Professor Amit Seru, and Georgia State University Professor Vincent Yao.
How did this system evolve?
One factor stems from an amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 at the crest of the global financial crisis. The law includes a provision known as the Durbin Amendment that caps debit card interchange rates charged by large banks.
The law, which went into effect in 2011, aimed to protect consumers and merchants from excessive interchange fees on debit cards. However, the policy ended up hurting debit card users, who lost rewards and perks like free checking as banks made up the lost fee revenue. And while cash users benefited, the biggest winners were credit card users: lower debit interchange fees reduced the prices merchants charged, and credit card users enjoyed those lower prices while their rewards remained untouched.
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