Distributional Effects of Payment Card Pricing and Merchant Cost Pass-through in the United States and Canada 
In the United States and Canada, merchants generally do not differentiate prices based on payment methods. Instead, they pass through their costs of accepting payment methods to all consumers, even though credit cards are more expensive for them to accept than either debit cards or cash. As a result, credit card transactions are cross-subsidized by lower-cost debit and cash payments. Card rewards and consumer fees paid to financial institutions may be other sources of cross-subsidies. Credit card rewards are proportional to the amount charged on a card. This disproportionately benefits higher-income consumers, who are more likely to hold rewards cards, tend to hold cards with higher reward levels, and tend to spend more on those cards.
Using data from the United States and Canada, the authors quantify the net pecuniary cost of using cash, credit cards, and debit cards to consumers in a range of income cohorts. The net cost includes the merchants’ cost of accepting payments that is passed on to consumers, fees paid to financial institutions, and rewards received from credit or debit card issuers. The authors examine whether payment card pricing and merchant cost pass-through have regressive distributional effects, that is, whether low-income consumers incur a disproportionally greater net pecuniary cost relative to their transaction amount.
Key Findings
- In both the United States and Canada, consumers in the highest-income cohort pay the least as a percentage of their transaction amount, while consumers in the lowest-income cohort pay the most, suggesting payment card pricing and merchant cost pass-through have regressive distributional effects on consumers in both countries.
- Although the quantitative results vary with the specific assumptions, such as merchants’ pass-through rate or whether a merchant serves all income cohorts or just a subset, the basic finding that low-income consumers bear a disproportionally high net pecuniary cost remains robust.
- The net pecuniary cost is lower for low-income consumers than for high-income consumers in absolute terms, as the formers’ transactions are smaller in both number and value.
- The net pecuniary cost is higher for Canadian consumers than for U.S. consumers, because Canadian consumers pay higher fees to their financial institutions and receive lower rewards.
Implications
The authors present ways to mitigate the regressive distributional effects of payment card pricing and merchant cost pass-through. They show that a small reduction in credit card rewards and an associated reduction in interchange fees could reduce the net pecuniary cost for more than 50 percent of U.S. consumers and more than 40 percent of Canadian consumers, including lower-income consumers. They also note that consumers could make informed decisions about their payment method if they were provided with clear and transparent information regarding the relative costs of using various payment methods; however, the authors acknowledge, such a practice would have a more subtle effect than if merchants were to differentiate retail prices based on payment methods. The authors also suggest that offering low-cost bank accounts to low-income U.S. consumers and raising transaction limits associated with bank accounts in Canada could reduce the regressive effects associated with bank account fees.
Abstract
Using data from the United States and Canada, we quantify consumers’ net pecuniary cost of using cash, credit cards, and debit cards for purchases across income cohorts. The net cost includes fees paid to financial institutions, rewards received from credit or debit card issuers, and the merchant cost of accepting payments that is passed on to consumers as higher retail prices. Even though credit cards are more expensive for merchants to accept compared with other payment methods, merchants typically do not differentiate prices at checkout, but instead pass through their costs to all consumers. As a result, credit card transactions are cross-subsidized by cheaper debit and cash payments. Card rewards and consumer fees paid to financial institutions are additional sources of cross-subsidies. We find that consumers in the lowest-income cohort pay the highest net pecuniary cost as a percentage of transaction value, while consumers in the highest-income cohort pay the lowest. This result is robust under various scenarios and assumptions, suggesting payment card pricing and merchant cost pass-through have regressive distributional effects in the United States and Canada.