A couple of weeks ago, I read about a study in Wall Street Journal that talked about a “Reverse Robin Hood” theory. The actual study was done by the Boston Federal Reserve and can be found here. I am pro- credit cards. So am I taking money away from the poor? Are my frequent flier miles funded by food stamp users? Should I feel guilty for using credit cards?
Summary of the study (emphasis added by me)
Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. 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. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and 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. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.
I don’t agree with all their assumptions like where they say that cash handling cost is 0.5% vs 2% for credit card fees (I feel the cash handling for Walmart type places is much more expensive than for a small business, now that the credit card system is in place) or that credit card rewards are paid entirely from the merchant interchange fees (if interchange fees are the only determining factor why did the credit card companies chop a lot of rewards when the interest rates and the late fees were capped by the 2009 CARD act). But I get the gist of the study and consider that I might be paying less than the cash customers.
In case you are wondering what this Interchange fee is – it is the fees that the issuing bank charges the merchant when he chooses to accept credit cards using card networks (Example: Visa)
So what do we do about it?
Let us consider all the options to put an end to this :
- Increase prices for credit card users? This option is already there. Sort of. Retailers chose not to use this. Have you seen the cash discount in gas stations? Even some major stores give cash discounts. As far as I know, offering discounts to cash customers is perfectly legal. According to the Visa/MasterCard rules, retailers are not allowed to charge cardholders a checkout fee for using their cards. But they are free to offer a discount for cash or check users. Why aren’t they doing it?
- Cap the interchange fees? This can be done. Yes. But what makes it evident that this will reduce the price? The price is set by the market. The retailers are in this for making money not charity. They will set the maximum price the market will pay. In fact the 2009 CARD act directed the GAO (U.S. Government Accountability Office) to review (along with other objectives) the potential impact of various options intended to lower merchant costs. And they came up with this – “Federal Reserve economists noted that the extent to which merchants would pass on their interchange fee savings likely would depend on the competitiveness of the markets in which the merchants operate”.
- Everyone give up their credit cards and go cash? This is also possible. But what good will it do? I use my credit card for
- Protection against fraud.
- Prevent theft and loss.
- Convenience. I don’t like to carry a lot of cash.
- Easier record keeping.
- Build my credit history.
- Added benefits (extended warranty, price protection).
- Rewards.
Even if I don’t get any rewards, I would still use credit cards just for (1) & (2). I have paid a surcharge for using a credit card while booking hotels overseas. I still wouldn’t have it any other way, it gives me peace of mind. Lets say that all of us use cash only, even then the sales/coupons/discounts will be subsidized by people who the pay full price. A lot of studies claim, millionaires use coupons, so we to ban coupons & discounts too? Where does it stop?
And above all, credit card users could be subsidizing the cash users! Why does every single store accept credit cards? Well, because credit cards also increase volume sales, which in turn can drive the prices down for everyone. So isn’t it possible that credit card users are subsidizing cash users in this way?
Should I fee guilty for using a credit card?
As I said, I am a heavy credit card user, optimizing rewards. And I got a little more than $1000 back from my credit card last year. So am I at fault here? I personally don’t think so. Economics works on balance. Poor people with a bad credit history get much high interest rate on loans for mortgage, car, etc. They are subsidizing loans for people with good credit, so do we skip getting home loans? Rebates exist because a lot of people don’t bother to fill in the rebate form, so essentially they are subsidizing my price after rebate. Even supermarkets spend money to maintain shopping carts which are built into the prices, so people who don’t use carts are subsidizing people using carts? It can go on and on….
Credit cards are a tool. If we use them responsibly they can be a great asset. I ask a few questions before buying anything other than groceries/gas.
- Can I really afford this?
- Do I need this?
- What does this add to my life?
- If I would love to have this, is the current price a good price?
- How long can I wait and what is the best price?
Its not about the payment method, its about taking personal responsibility and changing our spending habits. Personally I spend less when I use my credit card and it gives me peace of mind in addition. I could ask for a discount for using cash or I could use the credit card and get rewards. I don’t think one thing is taking money away from another. Being an informed customer and having personal responsibility goes farther than any regulations/bans that the government can enforce.
There are a lot of excellent bloggers who have given their opinion on this study. Here are some that I really liked:
- Screw Robin Hood By Adam Baker @ ManVsDebt
- Do Credit cards take from the poor and give to the rich? By J.D. @ Get Rich Slowly
- Credit cards transfer wealth from poor to rich? Umm, No. By Darwinsmoney
- The poor transfer wealth to the rich via credit cards By Investor Junkie
There are a few related studies that caught my eye:
- Reverse Robin Hood Cross Subsidy Hypothesis – Do credit card system tax the poor and reward the rich? – Steven Semeraro, Professor of Law, Thomas Jefferson School of Law
- Rising Interchange Fees Have Increased Costs for Merchants, but Options for Reducing Fees Pose Challenges – United States Government Accountability Office. Here is the highlight (single page) if you want the summary of the study.
What do you think about this study? Will you consider cutting up your credit cards for the reasons mentioned in this study?
{ 10 comments… read them below or add one }
Maybe it’s just another tactic for the government to take over yet another variable in the banking industry. I’m beginning to think that our government is growing too large for its own britches. People who choose to use cash or don’t have any other option than to use cash aren’t necessarily funding credit card users directly. There was about a 6-year period in my life when I couldn’t use a credit card (I had ruined my credit). During that period, I made a point to only purchase things I could afford with cash and rebuild my credit. I don’t think I ever felt like I was funding credit card users. I had ruined my credit on my own and had to become responsible. That, I think, is the point: people need to take RESPONSIBILITY for their own actions!
I don’t have one ounce of remorse for accumulating cash rewards from my credit card. I have been financially responsible my whole life, and the benefit of that is a fee-free credit card that gives rewards. If anyone feels guilty about their rewards, then donate the proceeds to a worthy charity!
There are some places that charge less for items bought with cash, but admittedly they are not too common. As you said, there are also many benefits to purchasing with a credit card. Sometimes, if it ain’t broke, don’t fix it (or let consumers choose!)
Thanks for the mention!
Very interesting take. I think that capping the interchange rates would have some effect. If a giant low cost provider like a Walmart did it then others would be forced to follow as well.
I agree 100% with “Little House”!
I’m firmly in the take advantage of the credit card rewards as much as possible camp! Even after graduating from college, when I was very poor, I still took advantage of my GM rewards card (it helped me buy my car at a huge discount!)
I personally think using credit cards is a very frugal and smart move, as long as you make it a habit of paying it off each month.
It’s amazing how the government takes statistics and twist them to fool people into believing what they want the people to believe. Sad huh…
@Little House Yes personal responsibility and transparency on the companies part will fix almost everything Government is “enforcing”
@EverydayTips we donate a lot of charity and even do that with credit card! So I don’t know if I am double evil!
@Mark Yes capping the interchange rate would help, but it will also be the end of rewards.
@Money Reasons Personally I spend a lot less using credit card than using cash. Cash just disappears for me! And if people think of it as “credit” instead of free cash they will be motivated to pay it off. And if you read that study, the lower income households contributed (cash users) $113 and the rich contributed $348. Lower income folks collected (card users) $809 and higher income household got $2812. And out of the 17% that used credit cards, 7% were lower income and 10% was higher income. It doesn’t look impressive enough to come to the conclusion that rich is taking from the poor. But what do I know? Government knows better!!!
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I do not own a credit card, but I have no issue with the so-called subsidizing of those who take advantage of rewards by using their credit cards. Why? Because I am not a victim…I could use credit cards if I choose to, so why should I whine when others do to their betterment?
Credit cards probably do transfer money from the poor to the rich, but finance is regressive by its nature.
Risk is very momentum-sensitive, so its either careening up or down with not much space inbetween. Banks will probably just accelerate whatever direction you’re going in.
That said, I don’t it’s a good idea to just stop using credit cards. What this article said has always been true. Unless charging different prices for payments becomes a widespread practice, there’s no point to it.
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