Priceless? The Costs of Credit Cards

Abstract:     
Merchants pay banks a fee on every credit card transaction. These credit card transactions cost American merchants an average of six times the total cost of cash transactions. The variation among credit cards is also large, with some cards, such as rewards cards, costing merchants twice as much as others.

The largest component of the fee merchants pay goes to finance rewards programs, which in turn generate more credit card transactions. Although merchants finance the rewards programs, they derive no benefit from them. Rather than generating additional sales, rewards programs merely induce consumers to shift transactions from less expensive payment systems to more expensive rewards credit cards. Why, then, do all consumers pay the same price for purchases, regardless of the means of payment?

The answer lies in a set of credit card network rules known as merchant restraints. Merchant restraints prohibit merchants from accepting certain credit cards selectively and from pricing according to cost of payment. Merchant restraints thus prevent merchants from signaling to consumers the costs of different payment methods. Accordingly, consumers never internalize the costs of their choice of payment system. Merchant restraints thus encourage more credit card transactions at higher price than would occur in a perfectly efficient market. The restraints also permit card issuers to externalize the costs of rewards programs to merchants and, ultimately, to consumers who do not use reward cards.

Merchant restraints distort competition within the credit card industry and among payment systems in general. Merchant restraints' economic justifications are unfounded, and they should be banned as antitrust violations.

Keywords: credit cards, surcharges, discounts, no-surcharge rule, honor all cards, merchant restraints, debit cards, ATMs, interchange, merchant discount, cognitive bias, framing effect, price-fixing, MFN, MCC, monopolization, antitrust, tying, most favored nation, network effect, network externality

JEL Classifications: D24, D40, G21, G33, G28, K21, K23, L42, L4, L16

Working Paper Series