The credit card companies, you won't be surprised to learn, dismiss this analysis, claiming that rewards programs are a win for consumers, a win for merchants and a win for their shareholders. How can that be? Because, the argument goes, credit cards have brought so much efficiency to retail operations that they have actually lowered retail prices, not raised them. The credit card companies have figured out a way to spin straw into gold!
This argument is not as fanciful as it might sound. The widespread use of credit cards by consumers and retailers probably has made the payments process less costly and more efficient, particularly once those clunky mechanical systems were replaced with easy swipes of the card. But those efficiencies were pretty much realized a decade ago, when most retailers adopted the latest technology. It's hard to see how there could have been enough additional efficiencies since then to justify the big jump in typical merchant fees since 2005. The Government Accountability Office found that not only have fees for transactions with standard cards increased about 25 percent but also that there has been a significant jump in merchant revenue as a result of the extra half-percentage point that card companies impose for purchases made with premium rewards cards.
In an effort to deal with this perverse competitive dynamic, the Justice Department brought an antitrust suit against Visa, Mastercard and American Express in October. In settling the suit, Visa and Mastercard agreed to change their contracts so that merchants can inform customers of the transaction fees and use discounts or gentle persuasion to encourage them to use cash or cards that have lower fees. The intent is to bring some price competition back into the market for merchant participation. At most retailers, however, the new rules won't go into effect until a similar agreement is either negotiated with American Express or imposed by a federal court.
Certainly this is a good first step. It would have been better if Justice had also insisted that merchants be given the option of adding surcharges for credit card purchases or the right to refuse to accept higher-fee cards altogether. Both are prohibited under credit card contracts.
In the end, there is only so much under existing antitrust law that the Justice Department can do. Given the hammerlock that Visa, Mastercard and American Express have on the market, the only sure way to prevent them from charging excessive fees and earning monopoly-like profits is through direct regulation. Congress recently mandated just that for debit-card fees, which the Federal Reserve now proposes to cut by more than 80 percent. It was only political push back from the banks and credit card companies that prevented similar regulation of credit cards.
There are two other reasons for the public to be concerned about the arms race in premium awards card.
The first is that the current kickback arrangement is highly regressive. A study by the Federal Reserve Bank of Boston found that households with annual incomes of less than $20,000 pay an extra $21 a year in higher retail prices as a result of merchants' credit card fees, while households with incomes of $150,000 benefit by $750. The reason is simple: Poorer people tend to do more of their business in cash and don't qualify for many high-reward cards.
The other is debt. One common rationale that the industry gives for high-reward cards is that they help to "lift" merchant sales by getting customers to spend more than they otherwise would. While that might be true for an individual merchant, it can't be true for all merchants unless it increases overall household income (unlikely) or induces consumers to save less and take on more debt. And, indeed, that's exactly what appears to have happened during the recent credit bubble - a bubble, we should remember, that led to a financial crisis, a prolonged recession and, ironically, tens of billions of dollars in bad debt write-offs by credit card issuers.
That hardly seems like the kind of social and economic benefit that the credit card industry wants to brag about.