Proposed Rules For Credit Cards Will Worsen Inequality By Making It More Difficult For Low Income Households To Obtain Them

These days the majority of transactions in the United States are done via credit card, and 85 percent of all American households have at least one card. Their use is common all across the income distribution—even a majority of households with an income below $25,000 have access to a credit card. What’s more, the pandemic greatly increased the use of electronic payments by greatly increasing online purchases while also accelerating the adoption of touchless transactions in stores as well as the use of smartphones to conduct credit card transactions.

Despite their ubiquity and their widespread adoption across the income distribution, there are those who insist that their use—especially those that offer consumer rewards—serves to exacerbate income inequality. For instance, an essay by Chenzi Xu and Jeffrey Reppucci in the New York Times

NYT
earlier this month described credit card rewards as mainly benefiting the rich and recommended that we impose a significant reduction in what retailers pay to have credit card transactions processed—the so-called interchange fee. Such a step, they aver, would result in lower overall prices—especially for people without credit card rewards or those who must use cash—without any untoward consequences otherwise.

However, a decade ago we did precisely such a thing with debit cards and—unsurprisingly to financial regulatory economists—the price caps served to reduce the ability of low-income households to obtain a debit card, with no discernible benefit for consumers or debit card users who kept theirs. Repeating such a step and expecting a different outcome makes no sense at all, and the authors of the Times op-ed should know better.

The assertion in their article that credit card rewards go primarily to “educated, usually urban professionals” implies that a minority of credit card users avail themselves of such programs when fully 80 percent of all credit cards in the U.S. are rewards cards. What’s more, it is not the case that the rewards are disproportionately distributed by income: The Federal Reserve study they cite to buttress their argument about inequality actually states that “the relevant transfer is from naive to sophisticated consumers rather than across income cohorts,” which is distinct from their point.

In fact, the Fed study clearly rebuts the premise of Xu and Reppuci’s op-ed: “[Our] findings are not driven by income and therefore inconsistent with a ‘reverse Robin Hood’ mechanism.”

Also, the contention that credit card reward fees raise prices via higher interchange fees is up for debate: A study I wrote with Chris Richardson found no evidence that the cap on interchange fees on debit cards affected consumer prices, but we did find that the cap resulted in fewer consumers being able to obtain debit cards, since many marginal consumers were no longer profitable for banks to retain as debit card customers.

Painting credit card rewards as solely going towards “flights to Costa Rica” and “Saks Fifth Avenue,” for the wealthy, as the authors take pains to do, is simply inaccurate, as is much of the rest of the analysis—which is why they doubtless felt compelled to use such inflammatory rhetoric in their piece. More people who collect rewards apply them to groceries and gasoline purchases, but such a quotidian reality doesn’t comport with the intent of the authors.

Credit cards help facilitate safe and secure transactions, and the providers spend a lot of money to provide such a service—one which protects us from liability from fraud or theft, among other things. A reduction in the interchange fee will ultimately result in credit card issuers eschewing those who use them the least but cost them the most—namely, the lower-income households who are more likely to declare bankruptcy or make relatively few transactions. Far from mitigating income inequality, a reduction in interchange fees may cut off more low-income people from credit cards altogether, which is precisely what happened when we cut the interchange fees for debit cards.

The federal government has pushed mightily to help increase access to credit and banking services to low-income Americans in the 21s century. It’s a mystery as to why Congress is now considering steps that would undo those advances.