Whom Do Credit-Card-Rewards Programs Really Reward?

The credit-card industry wants its customers to know about a threat to “our favorite cash back and travel rewards programs.” They could disappear forever, the industry says, if Congress approves a piece of legislation called the Credit Card Competition Act. It remains to be seen if that prospect will inspire masses of cardholders to reach out to their senators and representatives with the message—“Hands off my rewards!”—that industry lobbyists have crafted for the occasion. Even if the response falls short of their hopes, though, the lobbyists will have performed a public service: by raising the spectre of a rewardless credit-card future, they have called attention to a very peculiar feature of the credit-card present.

Credit-card issuers began offering rewards in the mid-nineteen-eighties. They started out with a few élite brands—Diners Club and American Express were among the first—seeking to identify themselves as cards of choice for the affluent. But other companies quickly embraced the idea, and it developed into an engine of growth for the business as a whole. The rewards game did double duty, diverting attention from costs that would outweigh the benefits for a majority of cardholders, but also turning credit-card use into a genuinely lucrative activity for those who could afford to spend heavily and pay off their monthly balances in full and on time. In both cases, the game worked out to the industry’s advantage as well, thanks to an under-scrutinized fact about how it makes most of its money—not from interest or late charges, as painful as they can be, but from a set of fees that automatically apply to every transaction. Of these, by far the biggest is an interchange fee, also known as a swipe fee. The United States, moreover, has the industrial world’s highest swipe fees. The industry has made sure of that, through a pricing arrangement that, although it doesn’t require the executives of multiple companies to sit down together and act in concert, produces the same general result.

Swipe-fee revenue goes to the card issuers, which are, in most cases, big national banks. Instead of setting the fees themselves, however, they assign that task to a duopoly of payment-processing networks, Visa and Mastercard, acting on their collective behalf. Together, Visa, Mastercard, and their partner banks control about seventy-five per cent of the country’s credit-card market. (American Express and Discover account for most of the balance. They operate a bit differently—as card issuers and payment processors rolled into one—but have a history of following the lead of Visa and Mastercard when it comes to pricing.) This country’s swipe fees average about 2.25 per cent of the purchase amount, or eight times the prevailing rate in the nations of the European Union.

To confuse matters further, the industry collects these fees from merchants, who swallow part of the expense and pass the rest along to their customers—all their customers, including the ones who don’t use credit cards. Though the courts have upheld the right of retailers to charge credit-card users extra (a practice once banned by Visa and Mastercard contracts), a tangle of network rules, customer expectations, and, in a few states, anti-surcharge laws continues to stand in the way, leading the great majority of retailers to stick with a policy of uniform pricing, which means higher prices across the board. When you buy something with a credit card, in other words, some of the expense of your transaction falls on people who pay in cash or with a debit card or a phone app; and, because card use rises with income, this cross-subsidy works out to the advantage of the relatively rich at the expense of the relatively poor. Last year, according to a report commissioned by the Hispanic Leadership Fund, and written by the economists Efraim Berkovich and Zheli He, of the Wharton School, credit-card fees caused Americans with family incomes of less than seventy-five thousand dollars to send a cumulative 3.5 billion dollars to families with incomes above that level. More than a billion dollars of this total came from families making less than twenty thousand dollars, and 1.9 billion dollars went to families with incomes of a hundred and fifty thousand or more.

Credit cards have been an agent of rising inequality in the business world as well as in the human world. Through the aggressive promotion of rewards programs, which give people a reason to use their cards for routine purchases, the industry has succeeded in taking a bigger and bigger bite out of the earnings of retailers. Meanwhile, inflated credit-card revenues have helped lift the country’s top banks to breathtaking levels of profitability. Last year, according to New York University’s Stern School of Business, a group of seven nationwide banks enjoyed net-profit margins of thirty-two per cent. The profit margins of the two card networks were higher still: fifty-one per cent for Visa, and forty-five per cent for Mastercard.

In the credit-card market as in other realms of banking activity, the financial industry has taken advantage of an era of lax regulation in general and scant antitrust enforcement in particular. Retailers have been complaining about swipe fees for decades, winning the occasional victory (including a 5.5-billion-dollar settlement brokered by a federal judge in 2019), but failing to find a court of law willing to put an end to the credit-card industry’s entire pricing system. Just in the past few years, though, monopoly power has reëmerged as a hot issue in Washington, and, with the introduction of the Credit Card Competition Act, retailers see a chance of gaining from Congress the breakthrough that has long eluded them in the courts.

Their optimism stems partly from the identity of the bill’s principal sponsor in the Senate, Dick Durbin, Democrat of Illinois. Durbin, who holds the post of Majority Whip, engineered the enactment of a measure that slashed debit-card fees a decade ago. Working this time with a Republican co-sponsor, Senator Roger Marshall, of Kansas, Durbin tried to get his proposal attached to a defense-funding bill in October. Although the big banks were able to block that effort, they fear that he may try to attach it to another piece of must-pass legislation sometime soon.

That concern may help explain why the banks, which have traditionally waged most of their political battles in backroom settings, are making their case against the Durbin-Marshall bill in the court of public opinion. The bill aims to bring price competition to the market by breaking the exclusive relationship between the major banks and the two dominant networks; under its terms, every card would have to have at least one authorized payment processor other than Visa or Mastercard, giving retailers a chance to shop for a better deal. The banks have rested their opposition mainly on the assertion that, by making the market more competitive and bringing fees down, it would, in the words of a trade group called the Electronic Payments Coalition, “effectively eliminate credit card rewards as we know it.”

It’s a debatable claim, but an intriguing thought. Suppose the measure passes, and credit-card fees fall to a level that causes the major banks to bail out of the rewards business. Where would that lead? To lower prices and diminished inflation, to begin with. (Credit-card fees add about 1.4 per cent to the over-all price of consumer goods, according to a report put out by the Federal Reserve Bank of Kansas City in 2020.) Cash and debit-card customers would benefit the most, though a majority of credit-card users would also realize a net gain. Credit cards would cease to be instruments of upward income redistribution. Their costs, no longer hidden from view, would be easier for customers to understand and compare.

The demise of rewards would be a boon to retailers, and, above all, to the small operators, since, unlike the giant chains, they lack the clout to issue branded credit cards of their own or to negotiate concessions from the banks. They could expect to benefit twice over—in the first place, through the reduced cost of a credit-card transaction, and, in the second, through an increased migration of consumers from credit cards to simpler and faster forms of electronic payment.

Swipe-fee reform might not in practice have such sweeping effects, however. In recent decades, Australia, the United Kingdom, and the European Union have enacted regulations that brought fees down to levels lower than anyone expects to see as a result of Durbin-Marshall, and rewards programs still exist in those countries. The Credit Card Competition Act would probably not bring an end to them, either. But it would be a good first step in that direction. ♦