US Study concludes the poor subsidize rich credit card users

Boston - A study published by the Federal Reserve Bank of Boston is recommending that American businesses reduce merchant fees and card rewards to rectify an imbalance that has the poor subsidizing the credit card use of the rich.

A discussion paper released Monday by the Federal Reserve Bank of Boston reveals that people with low income subsidize the credit card use of the more affluent. Report authors Scott Schuh, Oz Shy, and Joanna Stavins wrote

"... On average, each cash-using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year."

Titled Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, the 57 page discussion paper examines how money is transferred from the poor to the rich through credit card payments that results in, after accounting for rewards paid to households by banks,

"... the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year."

In essence, the authors explain, the situation was created by system fees that merchants have to pay in order to be able to be paid through credit cards. Most stores pass those charges on to all customers via markups in pricing of goods and services, resulting in a situation where those who pay with cash are actually paying more for the goods and services they are buying than does the guy in the line right behind paying for the identical products with his credit card. The authors said because some low-income households use credit cards and some wealthy households pay with cash, the transfers from poor to rich are lower than they might otherwise be. The authors said

"... This regressive transfer is amplified by the disproportionate distribution of rewards, which are proportional to credit card sales, to high-income credit card users."

Schuh, Shy and Stavins emphasized the unintentional nature of the consequences of merchant fees and reward programs, saying

"We want to be clear that we do not allege or imply that banks or credit card companies have designed or operated the credit card market intentionally to produce a regressive transfer from low-income to high-income households."

Credit card usage is strongly correlated to household income level, a relationship that was first discovered in 1998. Poorer people who hold credit cards are less likely to use their credit cards, while wealthier people use their credit cards more. The situation is exacerbated by a "no surcharge" rule that does not allow merchants to recoup merchant fees for credit card use just from credit card users. Because merchants pass on the costs in higher mark-ups on the goods and services sold, and because discounts are usually not offered for cash payments, the poor subsidize the credit card shopping of the rich. The system also means the poor are subsidizing the credit card rewards offered to credit card users. The authors say that getting rid of merchant fees and the rewards programs would increase consumer welfare. The finding has been described as the "reverse Robin Hood." Robin Hood stole from the rich to give to the poor, so the story goes. But with American credit cards, the rich gain at the expense of the poor. When a 2009 study on credit card use was published by the Hispanic Institute, author Efraim Berkovich said

“This study found that there is a massive wealth transfer caused by credit and debit card industry pricing policies in which the poor pay higher prices to subsidize the most affluent Americans."

Hispanic Institute Chairman, Gus West summarized the study saying

“Hidden credit card interchange fees, also known as swipe fees, have created a ‘Reverse Robin Hood’ situation in which Visa, MasterCard and major banks win while everyday Americans lose.”

Berkovich's study, Cross-Subsidization of Consumers in the Payment Card Market, examined the purchases of gasoline and groceries, finding

"... through imposing swipe fees on every transaction paid by plastic and requiring those fees to be buried in prices to consumers, the credit card industry ensures that the top 10% of Americans get at least $354 million in frills while the bottom tier pays at least $669 million more than they should."

The phenomenon has also been called "trickle up." Other observers have not hesitated to call the transfer of wealth from poor to rich as a scam. The Federal Reserve Bank of Boston is part of the US Central Bank.