Consumers who pay with cash and debit cards are effectively subsidizing those who pay with credit, according to a research white paper released by the Bank of Canada.
The paper Distributional Effects of Payment Card Pricing and Merchant Cost Pass-Through in Canada and the United States is a joint product of the Bank of Canada and the U.S. Federal Reserve. It studied whether payment card choices and how merchants deal with payment card costs have “regressive” distributional effects, sometimes known as “Reverse Robin Hood”. It found such an effect exists, essentially a small wealth transfer from lower income consumers to higher income consumers at the point of sale.
The study confirms the results of a Consumers Council of Canada research project into consumer views on the relationship between loyalty programs and merchant costs.
The crux of the issue is that merchants pay a fee for every credit card transaction, a fee that is notably higher than for debit card payments. Credit cards that are associated with higher spend loyalty programs have even higher merchant fees. A significant portion of those merchant fees are used to fund the rewards given to cardholders. Merchants lack the ability to change prices based on the payment choice of the consumer, so the costs are passed along to all consumers in the form of higher retail prices.
“Credit card transactions are cross-subsidized by cheaper debit and cash payments, The Bank of Canada report noted. “Because, compared with low-income consumers, high-income consumers are more likely to hold rewards cards, tend to hold cards with higher rewards levels, and tend to spend more on those cards, these cross-subsidies across payment methods likely become transfers from low-income to high-income consumers.”
The report uses some sophisticated econometric methods to evaluate many different elements of the subsidies and the complete relationship between consumers and their banks, including bank account fees, ATM fees, debit card fees, transaction limits and other factors. A complex set of interrelationships was identified, and the report evaluates fees paid to financial institutions and rewards received from credit or debit card issuers.
The Bank of Canada researchers also evaluated some ways to mitigate the regressive effects. These methods include reducing credit card rewards, changing the fee structures of bank accounts, and providing consumers with clear and transparent information about the relative costs to merchants of different payment methods.
A Consumers Council of Canada report in 2015, focused on loyalty and rewards programs, tested consumer attitudes about the relationship between loyalty programs and merchant transaction fees. It found that consumers had virtually no understanding of how payment systems work, how rewards were funded and the higher merchant costs of accepting premium credit cards. When presented with the information in considerable detail, focus group participants expressed little desire to change their payment choice. Even if rewards were dramatically reduced, they said their payments choices would not likely change because they felt any rewards were like getting “something for nothing”. Consumers also expressed deep cynicism that merchants would pass lower transaction costs along to consumers with lower retail prices.