A new Harvard study estimates that credit card interchange fees transfer about $30 billion annually from cash and debit card users to credit card users.
Researchers found the payment system creates a regressive wealth transfer, with lower- and middle-income households effectively subsidizing rewards earned by higher-income consumers.
The study concludes that consumer sorting and lower fees negotiated by large merchants reduce the size of the transfer but do not eliminate it.
Paying with cash or a debit card will definitely prevent you from running up an unmanageable credit card bill. There’s nothing wrong with that.
However, a new study from researchers at Harvard University, Stanford University, Northwestern University, and Georgia State University concludes that America's payment system redistributes roughly $30 billion annually from cash and debit card users to consumers who use rewards credit cards.
The study, "Who Pays for Payments?", examined payment data from approximately one million U.S. merchants and found that interchange fees — the charges merchants pay when customers use credit cards — are largely passed through to consumers in the form of higher retail prices.
Because merchants generally do not charge different prices based on payment method, all shoppers help cover the cost of those fees. If you pay with cash or a credit card, you don’t get any kind of break. However, shopping with a cashback credit card gives that consumer a slightly lower price.
"All consumers pay higher retail prices, but the users of high-interchange-fee credit cards capture most of the rewards," the authors wrote.
The researchers estimate that the resulting cross-subsidy transfers about $9.2 billion annually from households earning less than $150,000 per year to higher-income households, who are more likely to use rewards credit cards and premium cards with richer benefits.
Loss of purchasing power
According to the study, cash users effectively lose about 96 basis points of purchasing power because of interchange fees, while users of regulated debit cards lose about 47 basis points. By contrast, users of basic and premium rewards credit cards gain approximately 54 basis points in purchasing power through rewards funded by merchant fees.
The researchers compared the impact to a hidden tax. They estimate that interchange fees have an effect similar to increasing sales taxes for cash users by about 16% and for regulated debit card users by about 8%, while effectively reducing sales taxes for credit card users.
However, the study challenges the conventional view that every cash or debit user is equally subsidizing every rewards cardholder. Researchers found that consumers often shop at different types of merchants depending on their preferred payment method. High-income consumers who use premium credit cards tend to shop at merchants frequented by similar customers, reducing the amount of cross-subsidization.
In addition, large merchants such as grocery chains and major retailers often negotiate lower interchange rates or receive sector-specific discounts. Because these merchants are also where shoppers using different payment methods are most likely to overlap, the lower fees reduce the amount of redistribution that occurs.
The study estimates that consumer sorting reduces the annual transfer by about $8.6 billion, while merchant fee discounts provide an additional $1.7 billion benefit to cash and debit users. Together, those factors cut the size of the transfer by roughly 25%, though they do not eliminate it.