Today, I am continuing my discussion of the swipe fee/interchange fee.

So far this week, I have introduced Swipe Fees and spoke More On Swipe Fees.

Yesterday I presented The Case Against Swipe Fees, and today I would like to present my rebuttal.

The Case Against The Case Against Swipe Fees

Yesterday, I discussed a report by Robert J. Shapiro and Jiwon Vellucci that attempted to add up the costs of interchange fees to the American economy.   Unlike previous articles I had read by people opposing swipe fees, this paper was written by actual economists who refrained from merely adding up swipe fees and concluding that they really just like a tax on consumers.

Shapiro and Velluci conclude that approximately half (56%) of the cost of interchange is passed on to consumers, and I am willing to accept that number for the sake of argument.    In response, I contend that they do not sufficiently quantify the value to the economy of the rewards given to consumers that swipe fees enable.   The authors are clearly aware of this issue as they write:

We note that this estimate does not take account of jobs created by the rewards provided by some cards. However, this factor should be offset entire or in substantial part by our assumption that the transaction and processing costs which are not passed along in higher prices account for 19.5 percent of interchange fees, a 50 percent increase of the rough estimate of 13 percent by previous researchers.

What does this mean?    They are not really taking rewards into account, they are just going to round up their figures for their actual cost of of the transaction processing 13% by a random number, 50% and then dismiss the rewards altogether.

What’s worse is that the 13% number itself is just a guess:

One study estimates that 13 percent of interchange fees represent the actual cost of transaction processing. The remainder of these fees goes to cover the rewards, which account for an estimated 44 percent of the total fees, as well as credit card network branding and servicing, and other transaction costs and profit margins for the card issuing banks.50 The authors caution, however, that their findings represent only rough estimates, since banks do not issue the data required to refine such an analysis.

Here, I lose them completely, because they claim that the rewards cover “44 percent of the total fees”.    It is only later that they shrink that number down to 50% of 13% or 6.5%.

They are relying on one study to get the 13% of the interchange fee going to the cost of transaction processing, but then discarding the same study’s estimate of 44% of the interchange fee going to rewards.   They then mark 44% down to 6.5% for reasons they don’t explain.   Remember, all the numbers, by their own admission, are based on guesswork to begin with anyways.

Beyond The Numbers

Statistics issues aside, I still have a problem with concluding that any expense a consumer pays is a cost to society.    The idea is that there is a zero sum gain to the economy as a whole between costs borne by consumers and profits made by corporations.    The same could be said about jobs.   As Mike Duff over at BNet points out in reference to the same study;

As for lower credit card fees adding a quarter million jobs–really? Besides the inherently dubious nature of the assertion that X amount of money translates into Y number of jobs, the retailers ignore the other side of the transaction. To wit: If banks are deprived of profiting from credit-card transactions, which is what the study bases its numbers on, how many bank jobs will be lost?

What About Reverse Robin Hood?

The authors of the study cite the negative cross subsidy effect, since lower income consumers tend not to use reward cards, while higher income consumers do.     The idea is that the poor are subsidizing the rich.   As one of my readers pointed out in a comment to yesterday’s post, that is an argument against credit cards in general, not just swipe fees.    The poor generally pay more interest and fees than rich.    This is true for almost all financial products from car loans to mortgages.    The reasons are obvious wealthier people are both more financially literate and are less likely to default.

Where Do I Come In?

I admit that I come out ahead between rewards received and whatever interchange fees are passed on to me in higher prices.   Deadbeats, rich or otherwise, like myself who don’t pay interest or fees can do a great job of gaining more in rewards from their credit card than the supposed price increase that can be attributed to interchange fees. With some skill, I regularly get about 4% back in travel related rewards from my Starwood Amex card.    There are several cards that return 2% in cash back with no skill at all.   The study can only attribute possibly 1% of the cost of an item at most to interchange fess beyond actual transaction costs.

Despite the fact that I am winning the interchange fee/reward return arbitrage, I still have to object to the idea that interchange fees are hurting the economy as a whole.   Nevertheless, I am in favor of some common sense regulation on interchange fees to ensure that retailers have the competitive market that cardholders currently enjoy.   This can be done without draconian price controls or the destruction of status quo where people pay one price for goods and services without regard to their method of payment.

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 CreditCardCon.com 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.