Fixing The Credit Card System
It's great for the well-off but increasingly problematic for the larger economy.
Former Obama Treasury official and Brookings scholar Aaron Klein assesses “What the Fight Over the Capital One-Discover Merger Misses About Our Terrible Credit Card System.”
A fight has commenced over Capital One’s effort to acquire Discover, a deal that would birth an enormous credit card company rivaling Visa, Mastercard and American Express. The resulting competition could, in the short run, lower some costs to businesses and consumers. However, over the longer term, the merger would keep intact the broken and predatory system in which credit card companies profit handsomely by rewarding our richest Americans and advantaging the biggest corporations.
Credit card companies increasingly generate money via swipe fees, or the money merchants pay issuers every time a credit card is used. Total swipe fees rose 20 percent in 2022 to an estimated $160 billion a year nationally. The pandemic changed how we buy things, significantly increasing the share of transactions put on credit cards rather than conducted in cash, adding to the swipe fees merchants pay.
On top of this, a 2018 Supreme Court ruling effectively forces merchants to accept either every type of card — from, say, a basic Green Card to the Platinum Card — from an issuer like Amex or none of them. And even though fancier types of cards generally demand higher swipe fees, the ruling also barred merchants from incentivizing consumers to use the cheaper ones. These facts combine in a way that makes it even more appealing for Capital One, a giant credit card issuer, to merge with Discover, which owns a payment system, and generate greater profits from credit cards, particularly higher-end reward cards.
So, Klein is using a classic pundit’s trick of leveraging a development in the news as a hook to tout a pre-existing policy preference. Indeed, it’s not obvious that a possible Chase-Discover merger would have much impact at all on this particular set of facts.
Still, his concern is a valid one and at least some of his policy solutions are ones I haven’t seen before.
Credit card companies found they could command ever-greater swipe fees from merchants while at the same time offering their wealthiest consumers more deluxe credit cards that reward big spending with cash back, travel points, access to fancy airport lounges and the like — and then pass on the cost of those rewards to merchants. Merchants must then choose whether to accept and pay the higher swipe fee demanded by these platinum expensive cards or not take any from that card company.
As a quick aside, I don’t read the above-linked SCOTUS decision the same way Klein does. The case seemed to be a narrow one: whether Amex’ policy of disallowing merchants to steer customers to non-Amex cards, which charge lower swipe fees, violates anti-trust law. In a narrow 5-4 case, the Justices said No. But it’s quite possible that subsequent litigation has expanded that interpretation. (And, regardless, it’s quite likely Amex’s policy that its merchants must accept all of their cards or none.)
In our increasingly digital economy, most merchants have little alternative but to accept the pricey versions and to pay for the privilege. Naturally, merchants pass on their increased cost to all of their customers.
That, of course, is ultimately the main issue. Although, as Klein notes, there are smaller and less obvious ones as well. More on those shortly.
That’s how the rest of us, whether we pay with cash, a debit card or a middle-of-the-road credit card, wind up paying more — because we are subsidizing these rewards cards for whom only the wealthiest qualify. One study from economists at the Boston Federal Reserve estimated that the highest-income households profit over $1,000 a year tax-free from the payment system, adjusted for inflation.
That seems quite plausible. Points on my Costco Visa pay for the annual executive membership with a couple hundred bucks left over. And my Amazon spending is slightly subsidized by my Amazon Visa—which I don’t even have a physical copy of and use exclusively for purchases with them. And I have yet another Visa with Marriot used almost exclusively for stays with them. It’s not exactly lifestyle-changing, but better than nothing.
Remember those “smaller and less obvious” problems? Here we go:
Because swipe fees include a fixed cost in addition to a percentage of the total cost, small-dollar transactions are extremely expensive for merchants. My research found huge costs for such transactions as buying a cup of coffee or paying for a bus or subway ride. One year my oldest friend’s small coffee shop paid more in card processing costs than for coffee beans.
Big companies can leverage their resources to lower swipe fees, giving them a leg up. Starbucks stole a page from the credit card playbook and built an app that gives consumers rewards on future purchases if they upload larger amounts of money from their credit cards, thus lowering the total fees Starbucks has to pay the credit card companies for each swipe.
Some big businesses negotiate discounted swipe fees. Costco is the most aggressive; there have been reports that the big discount retailer’s contract with Citibank and Visa lowered its costs to 0.4 percent while a local dry cleaner may be paying closer to 3 percent.
The problem isn’t limited to nonwealthy consumers and small businesses: Parking meters that used to run on coins now rely on credit-card-powered apps, which charge transaction fees that can be over 20 percent, such as 45 cents on $2. Public transit agencies can lose 7 percent of the money they generate in fares in card-processing fees. A growing gap between what users pay and local agencies receive could stress budgets and require higher taxes, increased fees or reduced public services.
This is indeed problematic.The issue of micropayments is one that hadn’t really occurred to me. Once upon a time—as recently as 10 or 15 years ago—it would never have occurred to me to pay for something under $20 with a credit card. Now, I do so routinely.
Even more recently, I would routinely withdraw $200 or $300 from my ATM every few weeks. Now, even though that amount has diminished in buying power, it’ll last months. Indeed, I can’t remember the last time I withdrew cash. I pay for pretty much everything digitally or with a physical credit card now.
Amusingly, while I get small bonuses for using various cards, it only impacts my purchasing habits at the margins—using the three aforementioned merchant cards when shopping with those companies. For example, a local gas station that I frequently fill up at on the way to work has typically offered a 3-cent-a-gallon discount for using a debit card rather than a credit card and I’ve thus used my debit card there. Yet my Costco Visa gives me 5% “cash back” on gas. When gas was $4 a gallon, I’d have been far better off getting 20 cents cash back rather than saving the 3 cents. That would be true even at $3 or, hell, $1 a gallon. Rather obviously, though, the seller desperately wants customers to make the opposite choice.
Klein thinks an intervention is in order:
To fix the problem, Congress should legislatively correct the Supreme Court’s mistake. For starters, give merchants the power to reject the priciest credit cards, and let’s see if their users are willing to pay the true cost of their rewards. This solution ought to have some bipartisan support; the idea was strong enough politically to be supported by states as diverse as Ohio, Texas and Maryland. Bipartisan legislation to overturn a conservative Supreme Court ruling may sound like a pipe dream, but in payments policy we’ve seen a few examples such as the Durbin Amendment to what became the Dodd-Frank Act, which lowered debit interchange fees, received 64 votes (including 16 from Republicans) in the Senate and made it into law.
This sounds good in theory but I’d be angry if a merchant rejected my card at the point of sale. And it would be incredibly awkward at, say, a restaurant where the transaction was already completed minus the payment. And I suspect most people don’t carry an array of cards.
Second, brave policymakers could start taxing reward points. The richer you are, the more likely you qualify for bigger rewards. Progressive taxation rates mean that exempting rewards from taxation makes them nearly four times as valuable to those in the top tax bracket as the bottom. Why is interest from my savings account taxed, but the cash back from card spending not? Once upon a time the value of frequent flier miles was hard to quantify; now the Points Guy has it down.
I must admit that it had never occurred to me that points should be taxed but it’s perfectly reasonable. But if someone is making a million dollars a year and getting a whopping “$1,000 a year tax-free from the payment system,” are they really going to notice—much less change their behavior—over a $372 increase in their tax bill? Most of them would likely forgo the $1000 entirely for upgraded travel perks.
Finally, we could require all merchants have access to the same swipe-fee pricing, regardless of size. Why should the payment system give big business another advantage? The electronic cash register should not tilt the playing field.
This seems the most obvious solution to the larger problem. But I suspect that the second-order effect would be some combination of 1) higher fees to join the network and 2) exclusion of smaller businesses from the network.
As to the Capitol One-Discover merger:
Our payment system’s problems will not be solved by allowing or stopping a combination of Capital One and Discover. Adding a fourth major issuer to compete with the big three will make little difference if the system’s rules remain the same. Capital One already seems to be competing with American Express for wealthy customers who like elite airport lounges and big travel perks, which are funded in part from higher swipe fees. The rewards have kept getting richer over the past 20 years. Simply adding one more company to earn large profits through the existing system will hardly stop it.
Blocking the merger will fail to change the payment system that continues to drive greater rewards to those with the most money already, paid for by merchants and consumers who use cash, debit or lower-tier cards because they are not rich enough to qualify. As the economy continues to digitize with more micropayments, the credit card burden will keep growing, particularly on smaller businesses. Today’s large banks and payment companies will make more profit, sharing it based on who qualifies for elite status.
That strikes me as correct.
Klein concludes:
Until legislators are willing to change a system that showers tax-free rewards on the upper middle class, the cash register will continue to exacerbate the wealth gap and help big business get even bigger. It may feel great to stand up against a merger and fight those “big banks” — while enjoying a “free meal” at an exclusive airport lounge before taking a vacation using frequent flier miles. But if victory is more of the status quo, then the biggest losers will be those the government should protect the most.
I’m honestly surprised Klein, who’s considerably to my left on economic issues, didn’t propose a more radical but obvious solution: a government-run alternative. Given that digital currency has all but replaced traditional forms, it strikes me as perfectly reasonable for the Treasury to facilitate that new reality. There’s no reason it couldn’t back a digital payment network that charges an incredibly low break-even fee. It’s squarely within Congress’ enumerated powers under Article I, Section 8.
While the financial industry would obviously fight this tooth and nail, I don’t envision this totally supplanting credit cards, in that they would either be pay-as-you go (essentially debit cards) or at most a float (due at fixed intervals, as is the case with Amex and the practice most of us likely practice even with our points-earning credit cards; otherwise, they cost money rather than earn it). I would, for example, at a minimum continue using my Amazon, Costco, and Marriot cards when transacting business with them. Frequent travelers would continue building perks on cards designed for that purpose.
This would solve the micropayment issue, in that Starbucks and others who business primarily consists of transactions under $10 would presumably eschew all other payments unless they matched the government fee. And smaller merchants who can’t afford to pay exorbitant fees would do likewise and, since we’d probably all carry one, we’d get used to that pretty quickly. It sure beats “Cash Only.”
Another problem with processor consolidation is the big players increasingly using their market power to effectively enforce bans on legal activity that would never be allowed vua legislation:
22 Rights Groups Tell PayPal and Venmo to Shape Up Policies on Account Closures
In particular, the Visa CEO is a christian nationalist who’s used his position to enforce right wing social policy via the user agreements.
Most of the time that I was in Korea, I transacted most purchases in cash. It was only when I got to Luther University (4 years in), that I did business with a bank that would let me have a debit card rather than just an ATM card, so coming back to the states and regularly “charging” things was sort of a sea change for me and Covid-19 tipped the balance over to where I almost never even carry cash anymore.
Where I live, the credit/cash differential is closer to 20 cents/gallon and at all but a few stations, a debit transaction is counted as a credit card payment, so during the three months that Discover has 5% cash back, I almost always remember to use that card. Buying only 7 gallons in a typical transaction (a Spark has an ~9 gallon tank) the savings isn’t significant, but I was raised in a “watch the pennies and the dollars can fend for themselves” family. (And locally, I buy my gas at only one station.)
@Stormy Dragon:
Not a challenge of what you’re saying, I’m more curious having not read a user agreement on my credit card for ages (I’m less aggressive than others about worrying about “agree or leave” situations 🙁 ), but can you give me an example of a right-wing social policy that’s enforced via a credit card user agreement?
@Just nutha ignint cracker: Visa—but also MasterCard—won’t process payments for most porn sites, for example.
I can’t see this happening. The priciest cards usually have the most spendy people attached to them, I just can’t fathom merchants giving someone a hard time when they pull out their AMEX platinum card or whatever.
One of the local bakeries offers a discount for customers who use cash. She’s getting absolutely hammered by swipe fees, she’s been very open that they are killing her margins.
@Just nutha ignint cracker:
Gumroad canceled a large number of creator accounts just yesterday, largely due to pressure from Visa threatening to revoke their merchant agreement.
@James Joyner:
While they often describe it as a porn ban, it usually is more an adult content ban, and as we’ve seen in the whole library book ban thing, “adult content” can often be stretched to ban huge swaths of content.
I’m not a small child and I don’t wish to live in a world limited to only what’s appropriate for small children.
@Stormy Dragon: @James Joyner: Thanks!
@Stormy Dragon: Oddly, a number of states–including my own Virginia, which is purple trending blue—have passed laws requiring websites with “adult content” to implement adult verification for the state’s users of the sites. How that’s legal, I haven’t the foggiest. But, since most people don’t want to share credit card information or their drivers license photos with said sites, it’s effectively a ban on adults–at least those who don’t use VPNs.
I found I couldn’t focus on the post itself because I got stuck on the subhead. Specifically wondering if there is anything at all in the country about which you couldn’t say “It’s great for the well-off but increasingly problematic for the larger economy.”
The fundamental problem is having a third party (retailers) paying fees that primarily benefit the consumer and doing so untransparently.
The way to solve this isn’t through some complicated regulation; it’s through cost/price transparency. Require adding the credit card processing fee to every transaction and every bill, just like with taxes.
Once consumers understand the true cost inherent in the convenience and fringe benefits of a credit card, the rest will work itself out.
@Just nutha ignint cracker:
It’s a two-edged sword; Paypal was also in the crosshairs a few years ago for denying services to organizations with right-wing views.
IMO, Financial services ought to have common carrier provisions. Otherwise, ideologues will inevitably lobby for opponents to be denied access while complaining when allies are denied.
An adult content ban? I got my start writing stories for a website where much if not a majority of the stories are erotica aka Stroke fiction. We’ll call it FM.
I eventually branched out to three other websites. CR, SD, and BC.
None of these websites involved subscriptions*. SD is defunct now, CR inert after the creator lost interest/moved on/ whatever. BC and FM remain and the first takes volunteer donations. The latter has some advertising. BC and FM are respectively based out of California and Germany.
Wouldn’t these websites be considered adult content ones? Their content fits the description but if they are required to comply with some government laws, I’d expect they will shut down first. That would be sad. My only visits to those websites now are to notify readers there that I have a new ebook out. FM and BC both have message boards.
Note- I have had most of my stories removed from BC and FM. I had a negligible presence at CR and none of what’s up there is ever going to re-published as will what is still at FM and BC.
*- There is a subscription website, which I never contributed to, that I have long since forgotten any details about or know if it is still around. In addition there is a little publisher that sells print books in the genre. I did try writing for that company once, in 2006, but pulled out before anything was printed.
Retailers son’t just pass on costs to consumers, but to suppliers as well.
Supermarkets charge, or demand discounts, for better shelf placements, for example. When you see offers on any product, be it a straight discount, a 2 for 1, etc., the supplier discounts the same from its sale price to the store.
It works differently online, but ti’s there as well.
As usual, it’ all in the real Golden Rule: who has the gold makes the rules.
@Andy:
I think we would need to regulate the shit out of a proposal like that, as it will become common practice to ratchet up the transaction fees at random, and ensuring “certain people” are getting the worst cards.
330M people, each having to navigate a complex and variable landscape of transaction fees on every purchase is an amazing opportunity for abuse, wealth extraction and just plain grift. Or “innovation” as it is more and more frequently called.
I think the basic idea — pass the fees onto the consumer — is right, but it would need a lot of regulations.
@Gustopher:
It wouldn’t need to be complicated at all.
Consumers would know what the fee would be when they signed up for the card—it would be disclosed like the interest rate. You wouldn’t need complicated regulations to stop credit card companies from arbitrarily jacking these fees—on the contrary, simple rules would be much better, such as not allowing the fee to change at all or only allowing it to change, say, once every five years.
Alternatively, if you want to keep the system where the cost is determined and negotiated between the merchant and credit card company instead, then the merchant just needs to disclose what the fee is prior to the transaction. This is probably the easier way to transition from the present system, but credit card companies would no longer be able to charge a different fee based on the type of card. It would have to be one fee – for example, all Visa cards are 1.5%, all Mastercards 1.75%, etc.
Obviously, both methods have tradeoffs—like everything else. Either way, this would inject competition into credit card processing fees, which are absent now. If it’s consumer-based, consumers can shop for a card based on what fee, interest rate, and other factors matter to them, and if it’s merchant-based, merchants will have more power to keep fees low for customers because customers will see what the credit card companies are actually charging.
@Stormy Dragon: Or rather in the world of American litigation, and Visa international being an enormous sprawling organisation, pubicly listed with operations literally in every country not under financial sanctions, rather than the motivated reasoning you so typically show, Visa Inc the organisation is extremely risk averse and porn/adult content is an area where there is real serious risk of litigation, particularly civil for vicarious liability – never mind avenues of rep risk from activists of all stripes in public attacks. Easiest solution is to eliminate the risk by removing such transactions, regardless of moral feelings.
Of course for persons with a poor grasp of the Visa corporate structure, ascribing the 35k plus staffing organisation and multinational sprawl that is visa to the “right wing views” of the CEO is a fine Lefty Just So Story. (And on what basis the assertion that Ryan McInerney, CEO of Visa Inc since last year (Feb 23) is a “right wing christian nationalist” is made… one rather suspects this comes from the frothy conspiracy mongering Lefty online discussion circles without proper foundation)
In real world – as Mastercard and other payment providers have essentially identical approach – the real explanation is Corporate bureaucracy, listed company risk aversion to scandal and a payments provider whose international operations are as important as its American one, where even most markets are notably more conservative in mores than urban Left uni educated desire to realise.
And online platforms with signficant jurisdictional spread and risk leakage are a red flag risk area for corporate risk management bureacrats.
Of course one can decide to tell Just So tales about conservative morality of a CEO, ignoring the layers or bureaucracy, the multijurisdicational spread of Visa – and the near identity of the payments processesor rules (aligned more to bureaucratic risk aversion and afraid of prudes legal attacks than any single individual).
Otherwise, in terms of the US Left intellos going after Rewards cards and assertions on the economics of the same: while I am not a consumer finance specialist, it rather strikes me that that unless one has the financials on the analysis of the products, it is quite the leap for the conclusions. Certainly the product and pricing arguments presented strike me as not abstract from actual financial company internal ecomomics and rather Just So as to the overall costing and pricing.
Perhaps Rewards cards provide a political opening – the real challenge is not such Rewards cards but an effective duopoly in such cards payments and pricing between Visa and Mastercard (perhaps one can say an oligopoly allowing for the other operators) as duopolies or oligopolies are generall not optimally price competitive…. on the other hand there are economies of scale.
@Andy:
Informational transparency for the transaction fees has a theoretical basis but I question to what degree becomes actionable in an effective duopoly of Mastercard and Visa. Disclosure to consumers is not likely to be actionably transparent as the transacting fee is built into the existing cost structure typically.
Of course what is often ignored by small merchants is the implicit cost and “shoe-leather” cost – which they typically ignore and don’t realise – of handling cash, which itself is not free but is a typically non-visible cost.
So people end up comparing Apples to Potatoes.
@Andy: Some retailers have figured this out. Last week I took the starter from my John Deere tractor for a rebuild . The proprietor had a sign which added 2 1/2 percent charge for any credit or debit card.
@Lounsbury:
I was speaking of Alfred F. Kelly Jr., who was for quite sometime the Chairman and CEO of Visa, although I missed that he’s “only” Chairman now.
He’s a self described “guardian for the Council for Inclusive Capitalism with the Vatican, which answers the call of Pope Francis to apply principles of morality to business and investment practices.” So yes, I assume the guy explictly telling us he applies his religious views to the business he controls may in fact be applying his religious views to the business he controls.
And even if you’re correct about the source of the crackdowns being legal liability concerns rather than social conservatism, that’s still a reason why we’d be better off with more smaller processors instead of a handful of massive ones that can single handedly dictate what goods and services can exist.
I have some major dental work upcoming, about $10k worth. I was surprised when they told me I would get a 5% discount if I paid by check or cash. I had no idea the fees were that high. That much for a single transaction seems quite excessive to me.
@a country lawyer:
I’ve seen similar, and also discounts for paying cash.
@Stormy Dragon: I am correct, this is the world I work in. Attributing the sprawling Visa Inc policy to the Chairman (in ignorance of Visa corporate structure, the management team and its governance, the layers of policy that the entities go through, international concerns, etc) is nothing more than Lefty on-line Just So tales – very typical of your mode of understanding, but Just So Tales repeatedly to fellow true believers nodding sagely.
As a further analytical note: the ad-hoc Left urban intello assertion that one would be better off relative to Adult Content with smaller processors shows a poor grasp of financial risk – as like with the challenge of the marijuana sector – a small processor operating within the regulated financial sector is less able to assume potential civil liability risks or for banking or similar partners to vicariously assume it given the nasty American civil litigation habit of reaching through to the deeper pockets.
Welcome to the unintended side-effects of Left backed civil litigation development from the 197os onwards in the USA.
There are certainly good arguments for regulatory action to break up or otherwise mitigate the effective duopoly of Visa and Mastercard for either a national processing platform as a regulated single offer or mandate for smaller operator access, but “Porn Risk” is not one that is the least bit coherent for the 2nd option with legal and financial risk coming out of the dual risk areas of Left-prudes/antiporn exploitation/antiblahlbah and Right-religious prudes and civil litigation risks under American law. (the first option of a US federal processor it is sheer fantasy to expect such would have a more liberal to libertine Lefty attitude).
Offshore processing existing outside of the US regulatory framework of course is quite possible but is a market barrier – and generally platforms that are aimed at achieving scale rationally would rather sacrifice some fringe content that is higher risk of generating legal liabilities in whatever jurisdictions they operate in than die on a trivial side-hill. That is simply the reality of their own real goals and interest to scale.
Of course one can try to achieve carve-out protection in law, although good luck with porn, rather better chance for marijuana if eventually the US Federal restrictions are lifted or suspended in some fashion.
(for avoidance of any ambiguity, my personal view is quite libertine but personal view and understanding of how potential vicarioius liability risks are not the same conclusions).
@Lounsbury: “I am correct, this is the world I work in”
And apparently completely unable to see anything outside the lens of “what is good for the corporation is good for the world.”
Not saying there is anything wrong with your perception, only that it would be nice if you would occasionally notice that you are just as blinded by your ideology — which you characterize as absolute truth — as any of the “ad hoc Left intellos” or whatever silly label you’re choosing today.
Sorry, but “my subjective point of view is actually objective truth while everyone else’s is mere ideological delusion” only works as an argument if everyone you’re talking to shares your views.
@wr:
Well it seems as if the thin-skinned wr continues to be reading comprehension impoverished
The factual description of the risk analysis and motivations of a public stock exchanges listed multi-national payments provider are factual. They are not statements of Good or Bad or morality or not – indeed as I noted my own personal views do not so align.
The corporate bureaucracy of a payments provider where vicarious liability or direct regulatory attack – depending on the jurisdiciton will dictate certain actions like risk mitigation by eliminating marginal areas that are from an operating PoV “not worth the risk” – that is an observation not attaching any moral value nor approval (nor disapproval). It is simply the more accurate reprsentation that “This individual person in management is a member of Cathoic Grop X and in our over-heated jumping to conclusions in Left online jibber-jabbering without any knowledge of the actual corporate governance or risk areas…”‘ – there is literally nothing subjective about observing actual factual bases on which financial service providers structure risk mitigation (correctly or not, morally or not).
You rather are so blinded by your ideology and petty partisan sniping that you mistake observation as statement of moral value.
Given my other comment, which perhaps is far too suble for you as not couched in over-heated Left discourse, approving of higher levels of regulation as to the effective duopoly, those with joined up reading skills can conclude that my view is not at all US Libertarian….
@Lounsbury: It is exactly the same kind of “objective” analysis that leads Ford to conclude it would be more cost effective to sell the Pinto and pay off the lawsuits over the inevitable deaths than it would to fix the problem. And all those executives would have said at the time that the decision had nothing to do with morality, it was simply the business math.
That, too, is a level of ideological blindness, and one that you are so desperately afraid to acknowledge that you fly into Trump-level hysterics and name-calling anytime someone suggests to you that you are not perfectly and objectively wise.
“The system must do whatever it has to in order to keep the system functioning in exactly the same way” is not a morality-free statement, no matter how much you long for it to be so.