Opinion | Credit Card Points Are Being Paid For by the Poor

There’s an undeniable feeling of excitement when you turn your daily credit card swipes at Starbucks into first-class airfare or a weekend jaunt to Costa Rica. Thanks to mobile banking and the ease of autopay, you can scrupulously avoid any additional costs by paying your monthly bill in full. Free flights and exclusive discounts abound.

Something for nothing, right?

Not exactly nothing. Credit card perks for educated, usually urban professionals are being subsidized by people who have less. In other words, when you book a hotel room or enjoy entry to an airport lounge at no cost, poor consumers are ultimately footing the bill.

Demand for rewards is only going up. In 2016, Chase launched its Sapphire Reserve card. The card comes with perks, bonuses and points multipliers that for big-spending travelers and diners are worth far more than its steep $550 annual fee. There was so much initial demand that Chase ran out of the metal slabs it prints the cards on. Sapphire’s enormous success set off a credit card perks war, with numerous banks flooding the market with sign-on bonuses worth thousands of dollars.

In 2022, the Federal Reserve published data showing that the cost of rewards, as a share of total transaction volume on credit cards, increased 25 percent from 2015 through 2021. This bonanza has helped affluent professionals flood Instagram with envy-inducing shots of white sand beaches, hotel suites and plush airport lounges.

But these high-income travelers are also less likely to carry balances that incur interest charges and late fees, which traditionally increase profits for card issuers. So, to offset the cost of paying lavish rewards to these consumers, banks have sought to maximize other usage-based revenues.

Enter interchange fees, or the money it costs merchants to accept noncash payments. A recent study at Stanford found that when credit card rewards increase, so do these fees.

The United States now has some of the highest credit card processing costs in the world, typically at 2 percent to 2.25 percent of every purchase. This is eight to nine times as much as the prevailing swipe fee in the European Union. The vast majority of merchants pass these costs on to consumers by charging more for their products — regardless of how one pays.

The result? Lower-income consumers are forced to pay higher prices on the goods they buy, but they rarely receive any benefit from rewards programs, according to the Federal Reserve, which has been tracking the distributional effects of card rewards. Its December 2022 report estimates an annual redistribution of $15 billion in rewards value from poorer people to richer people, from low-education people to highly educated people and from diverse communities to less diverse communities.

Put another way, credit card rewards are essentially a tax on less affluent consumers, who are much more likely to pay for their goods with cash, debit cards or standard credit products that accrue no such rewards.

According to the San Francisco Fed, Americans with annual incomes at the national median (a bit less than $70,000) use credit cards for 23 percent of purchases. The numbers drop off precipitously as income decreases. Roughly half of all households use cash or debit cards for most purchases. Households with annual incomes over $150,000 use a credit card the most frequently, or 44 percent of the time.

The poor are much less likely to have access to rewards credit cards, even if they want them. Why? Cards with the highest value rewards are often available only to the rich. First, you’ll need a credit score of at least 700 to qualify for a premium card. That eliminates half the country. And only 21 percent of Black households have FICO scores above 700. Second, issuers consider your income and debt-to-income ratio, which can be used to disqualify card applicants with high credit scores. Banks just don’t want to issue rewards-heavy cards and pay lucrative sign-on bonuses to consumers who have low credit limits and spend much less overall.

Now consider the design of these rewards programs: five times as many points on hotels, three times as many points on dining, a $300 credit to SoulCycle, a $100 credit to Saks Fifth Avenue. This generation of prestige points cards often rewards discretionary, even luxury purchases, further transferring dollars to the highest income card holders. Cash-back cards available to households with lower credit scores and incomes offer more modest rewards than their prestige alternatives do.

Visa and Mastercard operate the two largest card networks, accounting for 77 percent of about 650 million general purpose credit cards in the United States. They act as agents for thousands of banks and dictate the terms and fees that merchants must pay.

And business is booming. In 2021 these two companies generated $77 billion in credit card interchange fees, which they share with issuing banks.

The aggregate costs of credit card points, driven by Visa and Mastercard’s longstanding interchange duopoly, spurred Senators Richard Durbin, Democrat of Illinois, and Roger Marshall, Republican of Kansas, to introduce the Credit Card Competition Act last July. The House soon followed with its own bipartisan bill. Yet multiple attempts to attach the legislation to military and omnibus funding bills by year’s end failed.

The act would have forced Visa and Mastercard to compete head-to-head with other processors, reducing their overwhelming market power to set rates. Lower interchange fees can mean lower prices for consumers. (Despite expected opposition from the now-Republican-controlled House, Mr. Durbin plans to reintroduce the bill this year, his office said.)

The American Bankers Association argues that such legislation would result in net harm. It points to reductions in credit card rewards programs and hints at the creation of new fees by banks to make up the lost revenues.

The first part is certainly true; however, it’s hard to muster a defense for preserving rewards at Saks Fifth Avenue in the name of consumer welfare. The latter may also be true — and sounds like something the Consumer Financial Protection Bureau should look into.

Opponents of the bill also correctly point out that network security could suffer in the short run: Introducing smaller players and novel technologies would create vulnerabilities that hackers might exploit. Visa and Mastercard do use their systemwide scale in the name of effective fraud protection. However, the economics of competition suggest that all companies, especially Visa and Mastercard, would be heavily incentivized to innovate on network security to preserve market share against new entrants.

A problem for any reform that helps working-class families will be that consumers who enjoy great privileges from premium credit cards would end up worse off. But they would be returning economic value to working Americans, whose production and consumption sustains the economy in the first place.

And prestige card holders surely will manage. They may have hoped to use points toward an overwater villa in the Maldives. If Congress acts, they can settle for a free hotel room in Hawaii.

Chenzi Xu is a finance professor at the Stanford Graduate School of Business. Jeffrey Reppucci is a candidate for a Master of Business Administration and Master of Public Policy at Stanford.

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