Assessing the Costs and Benefits of Credit Card Rewards: A Response to 'Who Gains and Who Loses From Credit Card Payments? Theory and Calibrations'

This paper presents evidence and arguments that undermine the methodology and conclusions drawn by Federal Reserve Bank of Boston (FRBB) economists in their recent policy paper “Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations.” Many of the core assumptions made by the FRBB authors are suspect based on common sense understandings of the functioning of rewards cards, and those assumptions are particularly susceptible to criticism when subjected to deeper analysis. Moreover, even if the arguments put forth were sound, the recommendations for regulation are neither reasonable nor capable of rectifying the harms alleged. The FRBB authors’ core conclusion is that existing credit card programs reduce consumer welfare. To reach that conclusion, however, they tacitly and inexplicably deem benefits flowing from card use (other than rewards) irrelevant. As a result, their welfare calculations are at best overstated and potentially entirely inaccurate.Their analysis runs as follows: because the affluent use reward cards at a higher rate than the poor, card rewards transfer wealth from low-income households to high-income households. This predicted wealth transfer rests on the authors’ erroneous assumptions that: Merchants gain no benefit from card acceptance and thus accepting cards simply increases retail prices; and credit card rewards are the only benefit flowing to consumers from card use.A common sense review of these assumptions reveals that reward card use produces the following benefits to merchants, banks, and consumers choosing other means of payment: Merchants increase sales and save on collection and default costs that could effectively lower retail prices; Non-credit card customers benefit from spillover effects of card use (such as faster checkout) and from the choice offered by different means of payment to suit their needs; and banks earn profits from more efficient card networks, enabling them to invest in new banking products that benefit all consumers.Even if one unreasonably ignored these non-reward benefits of payment system choices, the FRBB authors’ welfare calculations would remain suspect upon close economic scrutiny. They adopt critical assumptions about the strength of the preference consumers have for reward cards and the negative consumer welfare effect of transferring money from low- to high-income households that are unsupported by hard data. Many reasonable alternative assumptions would wholly undermine the FRBB authors’ analysis. Assuming that the use of rewards credit cards did transfer some money from those who use the cards to those who do not, a serious question would remain about the propriety of regulatory intervention. The predicted wealth transfers from credit card programs would be indistinguishable from a myriad of other reward programs and retailing strategies that have been implemented by retailers across the economy with the same apparent effect. That these practices are so widespread indicates that they are generally accepted as legitimate competitive options supporting economic vitality. Finally, even if one concluded that a wealth transfer did occur and regulatory intervention was justified, encouraging surcharging and regulating fees – as the FRBB authors do – would be dangerous responses. The ubiquitous nature of rewards programs and other retailing strategies that disproportionately benefit wealthy households suggests that these programs have economic benefits. And the economic theory of two-sided markets, such as payment system markets, confirms that regulation and surcharging are highly unlikely to produce more efficient price levels. Rather than undermining card rewards, any regulatory activity in credit card markets should focus on expanding the availability of consumer-welfare enhancing reward programs to those consumers who currently choose not to use them. The FRBB authors’ proposals designed to reduce reward card availability thus point in the wrong direction.