The Case Against Swipe Fees


This week, I have been exploring the issue of interchange fees, also known as swipe fees.

Swipe Fees

More On Swipe Fees

I have been very eager to make the case for swipe fees in their current form, as I have found much of the merchant propaganda against swipe fees to be so dramatically poor.    Take for example, this web site from the Merchants Payment Coalition.   In it, they repeatedly claim that the swipe fees cost consumers $42 Billion a year.   By consumers, they must mean merchants, who actually pay the swipe fees, otherwise why would they care?   For the record, a merchant is pretty much the opposite of a consumer, but why get technical?   At worst, some percentage of these fees are passed on to consumers, as any reasonable opponent of swipe fees must concede.

A Reasonable Case Against Swipe Fees

After reading so much worthless industry propaganda against interchange fees, imagine my surprise when I came across a well researched and presented economic argument against swipe fees.    Sure the web site didn’t initially strike me as a place I would find a reasoned argument against swipe fees, but here it is. Instead of merely adding up interchange fees and declaring them to be a tax directly passed on to consumers, the authors of this paper, Robert J. Shapiro and Jiwon Vellucci actually attempt to quantify how much of the swipe fees are being passed on to consumers.    They conclude that 56% of the interchange fees are passed on to consumers.    Since Robert J. Shapiro does have a PhD from Harvard (and I do not), I will take his word on this statistic which is a far cry from the 100% “tax on consumers argument” that the industry loves to claim.

With that number out of the way, let’s turn to the central components of their argument:

Regressive Cross-subsidies

Regressive cross-subsidies is a fancy economic term for the poor subsidizing the rich in a reverse Robin Hood sort of way.   Most people in the center and the left of American politics (and even some on the right) feel that regressive cross-subsidies are a bad thing.   I agree.   Here is how Shapiro and Vellucci argue that swipe fees are regressive cross-subsidies:

We estimate that about 56 percent of interchange fees are passed along by merchants in the form of higher prices for consumers. However, an estimated 54 percent of lower and moderate-income American families pay these prices without receiving the benefits of any credit card.  Moreover, some 59 percent of higher-income card holders receive rewards financed by these fees, compared to 25 percent of lower-income card holders and 39 percent of those with moderate incomes. As a result, these arrangements force those without cards or who carry cards with no rewards to subsidize the rewards which largely go to higher-income people.

Again, I am inclined to trust the source for these numbers, especially for the sake of this argument.

Higher Prices Cost Jobs

If you accept that approximately half of the interchange fees paid by merchants result in higher prices paid by consumers, one may then extrapolate that these higher prices reduce consumption and have a negative effect on the overall number of jobs in the economy.   The authors assert that:

“…interchange fees add approximately 1 to 3 percent to the price of virtually
everything Americans purchase, and an estimated 56 percent of these additional costs are passed along to consumers in higher prices. As a result, American households pay an average of $230 each, per-year, in higher prices, net of the system’s actual processing and transaction costs. These higher prices reduce real demand for goods and services, which reduces job creation in the industries that produce the goods and services. We estimate that if these additional costs were not present, lower interchange fees would lead to the creation of 242,000 new jobs.”

Here as well, I will not argue with data, but I will take exception to the conclusions in tomorrow’s post.

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5 Responses to “The Case Against Swipe Fees”

  1. Edwin | Finantage Says:

    Great information, I haven’t quite made a decision on whether I support or oppose swipe fees. Initially I have no problem with them as it’s a fee for a huge convenience provided by CC companies. People tend to spend more with their credit cards so even though merchants have to pay the fees, they still make more money.

    Sure, part of this is passed on to the consumer but as the research you’ve provided shows, it’s not near all of it.

    The part I would be less sure of is if CC companies attempted to increase the fees. At this point, credit cards are such a big part of society that it’s not longer optional for most companies to take or not take credit cards (as it was when they were first introduced).

    While there may be jobs lost, I’d be interested to see the jobs gained from interchange fees.

  2. Credit Card Mosaic Says:


    1. The interesting thing about the argument surrounding swipe fees and who subsidizes them is that it directly correlates with the credit card business in general. Revolvers (on average, those of lower FICO and means) support transactors (on average, higher FICO and means).

    2. If you asked any retailer today that you could boost their sales by 30% by taking 2% of the sale, most all would say yes. Why? Because when you work from a margin of gross margin of 40%, you only have to grow sales by 5% to cover the 2% in lost margin to break even.

    3. You are correct in that our society has moved to one being cashless, but the swipe fees also pay for a great deal of risk taken on by the issuing bank. You could make a case that the network and acquiring bank have less to do with the transaction and therefore may be increasing fees more then necessary, but if its not profitable for the issuer then nobody gets a card. Acquirers and Networks only care about volume, Issuers care about profitable volume.

    4. With the recent bent of consumer-related legislation, the regulatory bodies have forced the issuers to think more like the acquiring banks and networks. The mantra, think more like a transaction-based business models rather then a lending one. In doing so, the only place left to get the money is the retailer. In waiting until after CARD act the retailers may have doomed themselves.

    5. This experiment of regulating interchange has already tried and failed. Multiple studies have been done on the Australian experiment with this regulation. The conclusion, prices did not fall. In other words, rewards that had been passed along to consumers went back into business bottom lines, NOT into lower overall pricing.

  3. Edwin | Finantage Says:

    Credit Card Mosaic, do you possibly have a link to these Australian studies? Even a title and author name would do as I could look it up, they sound very interesting.

    One thing to note regarding the CARD act is that yes someone gets hurt in the process, but that’s the way of change. When the electricity is discovered, the candle makers take a big hit. Whenever something changes the status quo, there is almost guaranteed to be a party that is hurt in the process.

  4. Credit Card Mosaic Says:

    Edwin there has been multiple studies done in this area but the one I find pre-eminent is the one conducted by Charles River Associates (CRA International). The 83 page report takes piece by piece what was expected by Aussie regulators and what actually happened. While it was conducted on behalf of the payments industry it is so detailed, methodical, and sourced it is conclusions are in my mind beyond reproach. You can read a copy of it here.

    I post the conclusion below:

    Interchange fees and no-surcharge rules are issues that are being actively considered by regulators in various countries around the world. The effects of the RBA’s decisions to order a 50% reduction in credit card interchange fees as of November 2003 and to prohibit no-surcharge rules as of January 2003 are therefore of great interest internationally, as well as in Australia.

    The evidence on the actual effects of the RBA’s interventions since 2003 should cause the RBA to reconsider and should give pause to regulators in other countries considering similar regulations. One of the main effects of the RBA’s interventions has been a redistribution of wealth in favour of merchants. Merchant service charges have declined as a result of the RBA’s regulations. The fact that merchants in Australia are lobbying aggressively for further reductions in interchange fees (indeed, the elimination of interchange fees) is clear evidence that they have benefited from the RBA’s regulations and strongly suggests that they have not simply passed through reductions in merchant service charges in the form of lower prices and/or improved quality of service. In addition, there is evidence of merchants applying above-cost surcharges as part of an effort to capture some of the value that would otherwise be derived by consumers from the use of payment cards.

    The RBA’s regulations in contrast have harmed consumers by causing cardholder fees to increase and the value of card benefits such as reward programmes to decline. Consumers have also been harmed to the extent that the reduction in the profitability of issuers has reduced their incentive to invest in new types of cards and payment system innovations. Against these undeniable sources of consumer harm, merchants have not presented any empirical evidence documenting the extent to which reductions in merchant service charges have been passed through to consumers, and neither has the RBA or anyone else. Thus, while the RBA’s regulations have clearly harmed consumers by causing higher cardholder fees and less valuable reward programmes and possibly reducing payment system innovation, there is no evidence that these undeniable losses to consumers have been offset by reductions in retail prices or improvement in the quality of service.

    The RBA’s case for intervening in the payment card industry was based on its belief that credit card transactions were more costly in resource terms than debit card transactions and its belief that interchange fees exacerbate this alleged inefficiency by promoting the use of credit cards relative to debit cards. In addition to analysing the impact of the RBA’s regulations on final consumers, we have examined the cost studies on which the RBA has relied in reaching its conclusion that credit cards are more costly than debit cards. We have shown that the cost calculations on which the RBA relies (including the updated cost calculations) are deeply flawed and that, in fact, there is no basis for concluding that there is a significant waste of resources in Australia associated with transactions conducted using a credit card that could have been made using a debit card.

    As we noted in the introduction, regulation should be employed only if there is clear evidence of a market failure and only if there is reason to believe that regulation is likely to benefit consumers. The evidence in this paper suggests that the RBA’s intervention in the payment card industry in Australia failed both legs of this test. The market failures alleged (but not substantiated) by the RBA do not justify continuation of regulatory intervention. Moreover, the actual effects of the RBA’s intervention provide no evidence that the payment system in Australia is now operating more efficiently or that consumers have derived any net benefits from the intervention.

  5. Edwin | Finantage Says:

    Thanks for linking that. I have it printing now and hope to get into the details soon, this is some very interesting information.

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