Credit and Debit Cards: Federal Entities Are Taking Actions to Limit Their Interchange Fees, but Additional Revenue Collection Cost Savings May Exist
Published: 2008-05-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Federal entities--agencies, corporations, and others--are growing users of credit and debit cards, as both "merchants" (receiving payments) and purchasers. Merchants accepting cards incur fees--called merchant discount fees--paid to banks to process the transactions. For Visa and MasterCard transactions, a large portion of these fees-- referred to as interchange--goes to the card-issuing banks. Some countries have acted to limit these fees. GAO was asked to examine (1) the benefits and costs associated with federal entities' acceptance of cards, (2) the effects of other countries' actions to limit interchange fees, and (3) the impact on federal entities of using cards to make purchases. Among other things, GAO analyzed fee data and information on the impact of accepting and using cards from the Department of the Treasury (Treasury) and the General Services Administration, reviewed literature, and interviewed officials of major card companies and three foreign governments.
section_title: What GAO Found
paragraphs: By accepting cards, federal entities realize benefits, including more satisfied customers, fewer bad checks and cash thefts, and improved operational efficiency. In fiscal year 2007, federal entities accepted cards for over $27 billion in revenues and paid at least $433 million in associated merchant discount fees. For those able to separately identify interchange costs, these entities collected $18.6 billion in card revenues and paid $205 million in interchange fees. Federal entities are taking steps to control card acceptance costs, including reviewing transactions to ensure that the lowest interchange rates--which can vary by merchant category, type of card used, and other factors--are assessed. While the Visa and MasterCard card networks have established lower interchange rates for many government transactions, some federal entities have attempted to negotiate lower ones, with mixed success. To identify savings from cards and other collection mechanisms, Treasury's Financial Management Service (FMS)--which handles revenues and pays merchant discount fees for many federal entities--initiated a program in 2007 to review each entity's overall revenue collections. FMS has identified potential efficiency and cost saving improvements at the eight entities it has reviewed thus far, but has yet to develop a full implementation strategy-- including a timeline for completing all reviews, cost savings estimates, and resource assessment--that could help expeditiously achieve program goals. Several countries have taken steps to lower interchange rates, but information on their effects is limited. Among the three countries GAO examined, regulators in Australia and Israel intervened directly to establish limits on interchange rates, while Mexico's banking association voluntarily lowered some rates. Since Australia's regulators acted in 2003, total merchant discount fees paid by merchants have declined, but no conclusive evidence exists that lower interchange fees led merchants to reduce retail prices for goods; further, some costs for card users, such as annual and other fees, have increased. Few data exist on the impact of the actions taken in Mexico (beginning in 2004) and Israel (beginning in the late 1990s). Because of the limited data on effects, and because the structure and regulation of credit and debit card markets in these countries differ from those in the United States, estimating the impact of taking similar actions in the United States is difficult. Federal officials cited various benefits from card use--which totaled more than $27 billion in fiscal year 2007, a 51 percent increase since fiscal year 1999 after adjusting for inflation--including the ability to make purchases more quickly and with lower administrative costs than with previously used purchasing methods. The banks that issue cards to federal entities also rebate a small percentage of their card purchase amounts; these rebates totaled $175 million in fiscal year 2007. Preventing inappropriate card use poses challenges, and GAO and others have identified inadequate controls over various agencies' card programs. However, tools and data provided by the issuing banks now allow entities to review transactions more quickly, increasing their ability to detect suspicious transactions.

section_title: Letter
paragraphs: Consumers increasingly use credit and debit cards to make payments,  including those to federal, state, and local governments for such things as  park admission fees, driver licenses, and income taxes. According to a  federal banking regulator, 47 billion credit and debit card transactions  occurred in 2006, exceeding the approximately 31 billion check payments  made that year. As with other forms of payment, merchants and  government entities incur various costs to accept credit or debit cards.  The majority of the costs associated with accepting cards are the  “merchant discount fees” paid to the banks that merchants use to process  their transactions. Generally, for each Visa or MasterCard transaction, a  portion of the merchant discount fee is paid from the merchant’s bank— called the acquiring bank—to the bank that issued the card. This portion,  called the interchange fee, reimburses card issuers for a portion of the  costs they incur in providing card services. The balance of the merchant  discount fee is retained by the acquiring bank to cover its costs of  providing services. In addition to these fees, government entities that  accept cards also incur other, less significant costs to install and maintain  necessary equipment and to transmit card transaction data.
Interchange fee amounts are calculated using rates, typically between 1  and 2 percent of a purchase’s value. The two largest card networks (Visa  and MasterCard) establish default interchange rates for their respective  systems. According to officials from one card network, in establishing  default interchange rates, the networks take into consideration  competitive factors of both card issuers and merchants as well as certain  costs that are associated with issuing and accepting cards. Interchange  rates vary according to a number of factors, including the type of  merchant accepting the card, the method used to transmit the transaction  information, and the type of card used. For example, “reward” credit  cards, which provide their holders with cash rebates or points, typically  have a higher interchange rate than standard credit cards. That is, a  merchant accepting a reward credit card, depending on the merchant’s  agreement with its acquiring bank, may pay a higher merchant discount  fee for a purchase made with a reward credit card. Additionally, if a  cardholder uses a debit card and enters a personal identification number  (PIN), rather than signing a receipt to authorize the transaction, the  transaction generally poses less risk to the card issuer, partly because the  identity of the cardholder is more certain and therefore the interchange  rate is lower.
As the popularity of credit and debit cards for making purchases and  payments has grown, so has the amount of merchant discount fees paid by  the merchants—including federal government entities—that accept cards.  One source estimates more than $36 billion in interchange fees was paid in  2006. These fees have been the subject of litigation in the United States,  but they are not federally regulated. In some other countries, government  authorities have taken steps to limit the amounts of these fees.
In addition to accepting cards for payments, federal entities also use cards  to make purchases. The General Services Administration (GSA)  administers the SmartPay® program, which provides cards for federal  entities to purchase goods and services, including office supplies, fuel for  government vehicles, and airline tickets and hotel visits for employees on  official travel. GSA negotiates master contracts with card-issuing banks  on behalf of federal government entities, which then negotiate agreements  with the banks to specify services and requirements for their card  programs.
You asked us to review a number of issues concerning interchange fees,  including their effect on the federal government—as both an accepter and  a user of debit and credit cards—and actions other countries have taken  regarding these fees. This report examines (1) the benefits and costs,  including interchange fees, associated with federal entities’ acceptance of  cards as payment for the sale of goods, services, and revenue collection;  (2) actions taken in countries that have regulated or otherwise limited  interchange fees and their impact; and (3) the impact on federal entities of  using cards to make purchases.
To examine the benefits and costs associated with acceptance of cards, we  analyzed data representing a broad a range of entities associated with the  federal government, including executive, legislative, and judicial branch  agencies; government corporations; and other federal instrumentalities  that accept credit and debit cards for payment. Card transactions for the  majority of executive, judicial, and legislative branch agencies and federal  commissions, boards, and other entities are processed by the Department  of the Treasury’s (Treasury) Financial Management Service (FMS), which  pays the associated fees for these entities. We reviewed data on the  merchant discount fees FMS paid from fiscal years 2005 through 2007. We  also reviewed data from several federal entities for which FMS does not  settle transactions: Amtrak, the U.S. Postal Service, and a number of  Department of Defense and Department of Homeland Security  nonappropriated fund instrumentalities (NAFI), which operate retail  stores or recreational facilities for the military. Among the entities  included in our review, Amtrak, FMS, and the Postal Service provided data  specifically showing the amount of interchange fees paid. For the other  entities, we obtained the total amounts paid in merchant discount fees.  The data we collected from federal entities were the best data available;  however, because of limitations in and differences among the record  keeping of the entities, the data may not be complete for all years, may  treat some costs inconsistently, and in one case contain estimated, rather  than actual, values. We reviewed the data for completeness and accuracy  and determined that none of these limitations materially affect the findings  we report. (For further information on data sources, as well as a more  detailed discussion of our objectives, scope, and methodology, see app. I.)  In addition, we reviewed Visa and MasterCard interchange rate tables and  met with officials from Visa, MasterCard, American Express, and Discover  to obtain information on how these companies determine the rates  charged to federal entities. We met with federal entity officials responsible  for settling card transactions to identify factors that could affect the  interchange rates charged for the transactions. Further, we conducted  semistructured interviews with five federal entities for which FMS  processes card transactions, based on a selection of entities with the  highest and lowest volumes of card transactions. To report on actions  taken in countries where interchange rates have been limited by regulation  or other means and the effects of those actions, we reviewed available  literature, contacted our counterparts (other audit institutions) in several  countries, and interviewed officials of the Federal Reserve Bank of Kansas  City and industry officials to identify various countries that had addressed  interchange rates. To illustrate differing approaches to limiting  interchange rates, we judgmentally selected three countries—Australia,  Israel, and Mexico—that adopted diverse approaches and whose efforts  had been under way for sufficient time to allow for study. To obtain more  detailed information, we conducted literature reviews and interviewed  regulators and officials in the three countries. To determine the impact on  federal entities of using cards to make purchases, we reviewed policies  and procedures developed for the GSA SmartPay program, collected and  analyzed data on card use from GSA, and reviewed our prior reports.  Finally, we interviewed officials from five entities that were among those  with the highest volume of card use in fiscal year 2006 and officials from  the bank whose total government card spending was the highest.
We conducted this performance audit from June 2007 to May 2008 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: As consumers increasingly use credit and debit cards for purchases,  federal entities’ acceptance of cards to pay for goods and services has also  increased. The Treasury’s FMS performs the processing for card  transactions for executive, judicial, and legislative branch agencies, as  well as a number of governmental commissions, boards, and other entities  that choose to accept credit and debit cards as a method of payment.  Some other federal entities, such as the U.S. Postal Service and Amtrak,  operate their own credit and debit card-processing programs and pay the  associated fees for processing card transactions. FMS operates the Credit  and Debit Card Acquiring Service, a governmentwide service that allows  the federal entities for which it collects revenues to accept Visa,  MasterCard, American Express, and Discover credit cards, as well as some  types of debit cards. The volume of card transactions that FMS processed  increased by more than 30 percent from fiscal year 2005 to fiscal year  2007. In fiscal year 2007, FMS processed more than 65 million card  payments made to federal entities. FMS pays the fees associated with card  acceptance for the federal entities that participate in the Card Acquiring  Service.
A merchant—including a government entity—that accepts MasterCard or  Visa credit and/or debit cards for payment of goods and services enters  into a contract with an acquiring bank that has a relationship with Visa  and/or MasterCard to provide card payment-processing services. The  merchant contract specifies the level of services the merchant desires, as  well as the merchant discount fee and other fees that will apply to the  processing of the merchant’s card transactions. To provide card  acceptance services to federal entities that participate in the Card  Acquiring Service, FMS enters into an agreement with a financial  institution that has been designated as a financial agent of the U.S.  government to provide acquiring banking services. The agreement  specifies the services to be provided to FMS and the federal entities that  participate in the Card Acquiring Service. Visa and MasterCard establish  and enforce rules and standards that may apply to merchants who choose  to accept their cards. According to officials of the card networks,  however, the networks are not involved in the relationship between a  merchant and its acquiring bank.
subsections: section_title: Fees Allocate the Costs among Parties Associated with Card Transactions
paragraphs: Several parties are involved in a card transaction. For example, Visa and  MasterCard transactions involve (1) the bank that issued a cardholder’s  card, (2) the cardholder, (3) the merchant that accepts the cardholder’s  card, and (4) an acquiring bank. The acquiring bank charges the merchant  a merchant discount fee that is established through negotiations between  the merchant and the bank. A portion of the merchant discount fee is  generally paid from the acquiring bank to the issuing bank in the form of  an interchange fee to cover a portion of the card issuer’s costs to issue the  card. The balance of the merchant discount fee is retained by the acquiring  bank to cover its costs for processing the transaction. A merchant does  not pay the interchange fee directly; rather, the interchange fee portion of  the merchant discount fee is transferred from the acquiring bank to the  issuing bank. Because issuing banks incur costs to issue cards to  consumers, the interchange fee helps to allocate these costs among the  parties involved in card transactions. Figure 1 illustrates the roles of each  of the four parties in a typical credit card transaction and how fees are  transferred among the parties. The figure shows that when a cardholder  makes a $100 purchase, the merchant pays $2.20 in merchant discount fees  for the transaction. This amount is divided between the issuing bank,  which receives $1.70 in interchange fees, and the acquiring bank, which  receives $0.50 for processing the transaction.
For American Express and Discover card transactions, generally only  three parties are involved: the consumer, the merchant, and one company  that acts as both the issuing and acquiring entities. Merchants that choose  to accept these two types of cards typically negotiate directly with  American Express and Discover over the merchant discount fees that will  be assessed on their transactions. Because the issuing and acquiring  institution are the same, no interchange fee is involved in the transaction.  The merchant discount fees charged on American Express and Discover  transactions are, however, set to cover some of the same types of costs  that merchant discount fees (which include interchange fees) cover for  Visa and MasterCard transactions.
Officials of both the Visa and MasterCard networks told us that they aim to  set default interchange rates at a level that encourages banks to issue their  cards and merchants to accept those cards. According to the network  officials, the rates are set to recognize the value of card acceptance and to  reimburse issuing banks for some of the risks and costs incurred in  maintaining cardholder accounts, including lending costs, such as the cost  of funding the interest-free loan period, the cost associated with  cardholders that default on their loans, and losses stemming from fraud.  Officials with one of the card networks noted that interchange fees help to  reimburse issuers for bearing the costs that merchants would otherwise  have to bear for the ability to make sales to customers on credit.
Both Visa and MasterCard develop and publish interchange rate tables that  disclose the default rates that apply to various types of transactions.  According to Visa and MasterCard officials, four main factors determine  interchange rates applicable to a given transaction:    Type of card—Different interchange rates apply to different types of card  products. For example, both MasterCard and Visa have separate  interchange rates for general purpose consumer credit cards, reward  credit cards, commercial credit cards (issued to businesses), and debit  cards. The rates vary because the costs, risks, and revenues associated  with these different card products vary for issuers; they also reflect the  networks’ goal of providing incentives for both issuance and acceptance of  cards. For example, reward cards involve higher interchange fees for a  number of reasons: According to network officials, such cards tend to  provide greater benefits to merchants (in the form of average transaction  amounts that are typically higher than those on standard cards) and to  cardholders (in the form of cash rebates or points).
Merchant category—The card networks classify merchants according to  the line of business in which they are engaged. Interchange rates may  reflect unique characteristics of different merchant categories, such as  average profit margins and the way in which merchants authorize  transactions. For example, according to card network officials, because  the supermarket industry tends to have very low profit margins, the  networks set interchange rates to encourage supermarkets to accept  cards. Also, the method in which a merchant authorizes payments can  affect the extent to which a card network’s system is used. (For example,  hotels typically must authorize a payment at least twice—once at guest  check-in to ensure the customer is authorized for the minimum payment  amount, and again at checkout to authorize the final payment amount.)  Additionally, some merchant types may qualify for special incentive  interchange rates if a card network determines the merchant category has  growth potential for card acceptance. For example, government  organizations and utility providers receive lower interchange rates to  encourage them to accept cards.
Merchant size (transaction volume)—Both MasterCard and Visa set lower  interchange rates for merchants in some categories that conduct high  volumes of card transactions over their networks. For example, according  to Visa’s default interchange rates that were in effect as of October 2007,  supermarkets that conducted a minimum of about 7 million Visa card  transactions in calendar year 2006 qualified for lower rates than  supermarkets that conducted fewer Visa transactions.
Mode in which a transaction is processed—Interchange rates also differ  depending on how a card transaction is processed. For example,  transactions that occur without a card being physically present, such as in  Internet transactions, carry a greater risk of fraud; therefore, higher  interchange rates apply to these transactions. Similarly, swiping a card  through a card terminal, rather than key-entering the account number,  provides more information to the issuing bank to verify the validity of a  transaction; therefore, swipe transactions are assessed a lower  interchange rate.
section_title: Interchange Fees Are Not Directly Regulated, but Are the Subject of Legislative Initiatives and Litigation
paragraphs: Interchange fees are not regulated at the federal level in the United States.  The Federal Reserve, under the Truth in Lending Act (TILA), however, is  responsible for creating and enforcing requirements relating to the  disclosure of terms and conditions of consumer credit, including those  applicable to credit cards. In addition, the Federal Reserve and other  federal agencies, including the Office of the Comptroller of the Currency,  the Federal Deposit Insurance Corporation, the Office of Thrift  Supervision, and the National Credit Union Administration oversee credit  card issuers. As part of their oversight, these regulators review card  issuers’ compliance with TILA and ensure that an institution’s credit card  operations do not pose a threat to the institution’s safety and soundness.  The Federal Trade Commission (FTC) generally has responsibility for  enforcing TILA and other consumer protection laws for credit card issuers  that are not depository institutions.
As of early 2008, interchange fees were the subject of federal and state  legislative proposals. For example, the Credit Card Fair Fee Act of 2008,  introduced in March 2008, would, according to one of the bill’s sponsors,  establish a process by which merchants and issuing banks could agree to  set interchange fees and other terms of access to covered electronic  payments systems without violating federal antitrust laws. Additionally,  the bill would establish a three-judge panel, called the “Electronic  Payment System Judges,” to make determinations of access rates and  terms for electronic payments systems. The purpose of the panel would be  to conduct proceedings to ensure that the rates and terms established by  participants in the system are calculated to represent the rates and terms  that would be negotiated in a perfectly competitive marketplace, that is, a  marketplace of willing buyers and sellers in which neither has market  power.  Also, under legislative initiatives pending in some states,  merchants who are parties to payment card agreements would be given  access to information about the issuing bank’s interchange fees, including  a schedule of all interchange fees charged by the bank, as well as notice of  any change in the fees. State bills also would, among other things,    prohibit a financial institution that issues a credit card or debit card from  charging any fee, including interchange fees, based on the sales and use  tax portion of a retail sales transaction.    prohibit a financial institution from increasing the fee based on the size or  cost of a transaction.    call on Congress to assess the impact on merchants of interchange fees  and other discount fees and to require credit card issuers to be more open  with merchants about the costs of the payment systems in which they  participate.
As of March 2008, none of the initiatives had been enacted into law.
Interchange fees also have been a factor in lawsuits alleging violations of  the antitrust laws by credit card networks and related parties. The  plaintiffs in those cases alleged that interchange fees were an example of  the networks’ unlawful exercise of market power. As of October 2005,  merchants had instituted at least 14 class action lawsuits in four separate  districts against Visa and MasterCard and their member banks, alleging  specifically that the defendants fixed interchange fees at supracompetitive  levels in violation of Section One of the Sherman Antitrust Act. Currently,  in a consolidated action pending in the United States District Court for the  Eastern District of New York, merchants claim that interchange fees have  an anticompetitive effect in violation of the federal antitrust laws.  Appendix II provides additional information on cases that include, among  other things, allegations that interchange rates were a function of  anticompetitive conduct in violation of antitrust laws.
section_title: Government Entities Also Use Cards
paragraphs: Under GSA’s SmartPay program, GSA negotiates master contracts with  banks to issue cards to federal entities that participate in the program. The  first SmartPay master contracts were established in 1998 with five banks.
These contracts are set to expire in November 2008 and will be replaced  by new master contracts with four issuing banks under GSA’s SmartPay 2  program. Participating federal entities choose a bank from among those  under contract with GSA that offer services that meet their needs, and  develop individual task orders that specify the products and services that  the banks will provide them. In negotiating their individual task orders,  these federal entities also can specify to the issuing banks other services  they may need to operate their card programs. For example, banks can  provide tools that the federal entities use to monitor card usage and  expenses, or customer service support, such as 24-hour emergency card  service for federal employees.
section_title: Federal Entities Are Taking Steps to Control Costs while Realizing the Benefits Associated with Accepting Credit and Debit Cards
paragraphs: Federal entities realize benefits from accepting credit and debit cards,  including increased customer satisfaction, fewer bad checks and cash  thefts, and improved operational efficiency. Realizing these benefits  entails costs, principally the merchant discount fees associated with card  transactions but also the costs for related equipment needed to process  the transactions. In fiscal year 2007, federal entities from which we  collected data reported paying $433 million dollars in merchant discount  fees for the processing of over $27 billion in credit and debit card  revenues. As card acceptance has become more common, federal entities  have worked to control the associated fees, including reviewing the ways  in which transactions are processed to ensure they qualify for the lowest  possible interchange rates. Additionally, FMS began a pilot program in  which it is reviewing the revenue collection mechanisms of the federal  entities for which it provides services, with the aim of identifying cost  savings and efficiencies. FMS has reviewed collection cash flows for eight  federal entities thus far and has identified cost-savings opportunities.  While it plans to conduct over 100 more reviews, it has not yet developed a  full implementation strategy for the program. Such a strategy would help  ensure that FMS achieves the program’s goals as expeditiously as possible  and increase overall savings to the government.
subsections: section_title: Federal Entities Receive Numerous Benefits Associated with Card Acceptance
paragraphs: The ability to accept credit and debit cards provides a variety of benefits  to federal entities, including greater customer satisfaction and improved  internal operations. Officials at several federal entities noted that card  acceptance helped to ensure that the federal entities would remain  competitive with private sector organizations. Many of the officials we  spoke with told us that consumers expect to be able to use cards to make  payments, and some stated that they did not think they could stop  accepting cards. For example, Amtrak officials stated that customers  paying with cards account for about 85 percent of its sales and that if they  did not accept cards, the number of people who ride their trains would  decline significantly. Among the benefits mentioned by federal officials  with whom we spoke was that card acceptance improves customer  satisfaction with their organizations because consumers like to use their  cards for convenience, credit card reward programs, and security reasons.  Accepting cards also has enabled entities to conduct business via the  Internet, which can reduce labor costs associated with sales and also can  provide greater convenience to customers. For example, officials from the  U.S. Mint stated that about 50 percent of their sales occurred through the  Mint’s Web site. Some entities also stated that the ability to accept cards  has increased their sales volume.
Federal entity officials also noted that accepting cards reduces the amount  spent on processing other forms of payment. By accepting cards, federal  entities incurred less expense in transporting cash, lower losses from theft  of cash, and had fewer bad check expenses. For example, officials at the  Department of the Interior noted that cash transport costs can be high for  some remote parks and wildlife refuges. Several federal officials also  stated that accepting cards has reduced the costs associated with  processing checks, and that funds are deposited in accounts faster when  customers use credit or debit cards than when they use checks.  Additionally, Amtrak officials told us that accepting cards onboard trains  for ticket and food and beverage sales resulted in fewer instances of  employee theft of cash.
Finally, many officials cited that card acceptance improved internal  operations at their entities. For example, officials at the Department of the  Interior stated that payments made by credit cards result in a more  streamlined bookkeeping approach because card sales involve less  paperwork (for reconciliation) than other payment forms. Defense  Commissary Agency (DeCA) officials also stated that they believed that  labor associated with reconciling sales at the end of the day declined as a  result of the reduced volume of cash. Additional operational efficiencies  mentioned by officials included a reduction in costs and exposure to fraud  and errors from misplacing or miscounting cash and checks. Some  officials stated that the efficiencies gained in their internal operations as a  result of card acceptance allowed them to reallocate staff to different and  more productive uses. For example, officials at the Department of the  Interior explained that card acceptance at automated kiosks allowed them  to reallocate some staff that used to collect entrance fees to more  productive tasks. Amtrak officials also stated that customers’ ability to  purchase tickets using cards, especially through the Amtrak Web site, has  reduced their labor costs.
Because the federal entities that utilize FMS’s collection services are not  responsible for the associated card-processing costs, we could not  determine how officials at these agencies would regard card acceptance if  they had to pay these costs. However, an official at one federal entity that  accepts cards and pays the associated costs noted that it is difficult to  assess if the savings from receiving less revenue in the form of cash or  checks (and more from cards) sufficiently offsets the entity’s card-related  processing costs, including the interchange fees. He also stated that it is  uncertain whether the entity receives higher revenues from accepting  cards, as some customers would likely spend the same amount with them  regardless of the type of payment used. However, customers demand  convenient payment alternatives, and for some of their products, private  sector entities provide similar services, and thus he believed the ability to  accept cards allows the entity to stay competitive with these entities.
The federal entities we contacted were not able to provide comprehensive  data on any cost savings from accepting cards. We identified various  government, academic, and industry studies that compared the cost of  processing for different forms of payment; however, many of these studies  found that precise estimates were difficult to calculate. Additionally, while  most of the studies we reviewed found cash to be the least expensive  payment form to process, the methodologies used in the studies were not  consistent and the data contained in many of them were outdated.
section_title: As Card Revenues Have Increased, So Have Associated Costs
paragraphs: The volume of revenues accepted through credit and debit card payments  was growing for the group of federal entities we reviewed. Data on  revenues collected by FMS, which processes the card transactions for a  large number of federal executive, legislative, and judicial branch agencies  and other federal entities, show that while credit and debit card  transactions accounted for only 0.23 percent of the total federal  government revenues FMS collected in fiscal year 2007, its card  collections have grown by almost 28 percent in just 2 years—from  approximately $5.5 billion in fiscal year 2005 to almost $7.1 billion in fiscal  year 2007 (in current dollars). As shown in table 1, the other federal  entities from which we collected data also experienced an increase in card  payments over the 3-year period, with the total reaching approximately  $27 billion in credit and debit transactions for fiscal year 2007. (App. I  contains a detailed discussion of our data sources and analysis of the data  reported to us from the federal entities.)
As revenues from card payments have increased, so has the total amount  of merchant discount fees paid by the federal entities from which we  collected data. These federal entities reported paying a total of almost  $433 million in merchant discount fees in fiscal year 2007 (see table 1).  This figure represents an almost 12 percent increase over the amount paid  in fiscal year 2006 and an almost 27 percent increase over the amount paid  in fiscal year 2005. The average merchant discount rate increased about 4  percent from fiscal year 2005 to fiscal year 2007.
Among the entities included in our review, Amtrak, FMS, and the Postal  Service provided data specifically showing the amount of interchange fees  associated with their Visa and MasterCard transactions (their acquiring  banks provide them with these data). These three entities paid a total of  approximately $205 million in interchange fees during fiscal year 2007, out  of a total $218 million in merchant discount fees specifically for  MasterCard and Visa transactions. These interchange fees accounted for  the majority of total merchant discount fees these entities paid for  accepting all card types. As card revenues and merchant discount fees  increased for these three entities, so did the interchange fees they paid.  Interchange fees increased by almost 36 percent, from almost $151 million  in fiscal year 2005 to $205 million in fiscal year 2007 (in fiscal year 2006,  they were $179 million).
For a variety of reasons, some of the Department of Defense and  Department of Homeland Security NAFIs were not able to separate  interchange fees from the total merchant discount fees they paid. (For  example, according to an official from one entity, its contract with its  acquiring bank specified that all credit card transactions would be charged  a fixed percentage fee, regardless of the interchange fees associated with a  particular transaction; therefore, the entity did not have specific  information on interchange fees.) The data provided by these entities  showed that both card revenues and the associated merchant discount  fees increased over the 2005 to 2007 period. Revenues from sales made on  cards were about $7.5 billion in fiscal year 2005 and over $8.5 billion in  fiscal year 2007, an approximately 14 percent increase. The merchant  discount fees for card payments at these entities also increased from  approximately $128 million in fiscal year 2005 to almost $150 million in  fiscal year 2007, an increase of almost 17 percent.
For some payments made using cards, the government does not bear  merchant discount costs. For example, consumers can pay their income  and business taxes to the Internal Revenue Service (IRS) using cards. To  accept these payments, IRS has agreements with two private third-party  entities that process payments for individuals or businesses that choose to  use a credit or debit card to make a tax payment. The two private entities  charge a convenience fee of 2.49 percent of the total tax payment for  taxpayers who use their services, a portion of which covers the merchant  discount fees paid by the third-party entity to its acquiring bank. In fiscal  year 2007, these merchant discount fees totaled about $47.5 million for  approximately $2.4 billion in tax payments, an 85 percent increase in tax  payments made with credit and debit cards from fiscal year 2005.
In addition to the interchange and processing fees that make up the  merchant discount fee, federal entities face other costs associated with the  acceptance of credit and debit cards. For example, entities must pay for  equipment and software for card transactions, such as point-of-sale  terminals, keypads for PIN debit card transactions, computers, modems,  and printers, and pay for their installation and maintenance. While FMS  pays the merchant discount fees associated with card transactions for  entities for which it settles transactions, it does not pay for the costs  associated with equipment and software; these costs are the responsibility  of the entities. Other costs of accepting cards include complying with  industry security standards, known as the Payment Card Industry Data  Security Standard, training employees to process and reconcile card  transactions, and experiencing losses associated with fraudulent use of  cards. However, information provided by some entities indicated that  these additional costs were not significant compared to merchant discount  fees.
section_title: Federal Entities Are Making Efforts to Reduce Card Acceptance Costs
paragraphs: As card acceptance has grown, federal entities have used several methods  to manage their costs and reduce the fees associated with card  transactions. One method is to ensure that their Visa and MasterCard  transactions are processed so as to qualify for the lowest applicable  interchange rate. Both Visa and MasterCard have a merchant category for  federal entities, and the interchange rates for the transactions of  merchants in these categories are lower than those for many other  merchant categories. As long as federal entities’ transactions meet all  applicable processing requirements—for example, they must be submitted  for final settlement in a timely manner—the entities are charged the  interchange rate applicable to those merchant categories. For example, as  of April 2008, if transactions met all applicable processing requirements,  government entities accepting a MasterCard consumer credit card as  payment would pay an interchange fee of 1.55 percent of the transaction  amount plus $0.10, and if accepting a Visa consumer credit card, an  interchange fee of 1.43 percent of the transaction amount plus $0.05. (In  comparison, the interchange rate applicable to a MasterCard general  purpose consumer credit card transaction at some fast food stores is 1.90  percent.) In some cases, card transactions at federal entities can be  assessed a lower rate. For example, FMS officials told us that the DeCA’s  transactions qualify to be processed using the interchange rate applicable  to the supermarket merchant category, which can range from 1.27 percent  to 1.48 percent plus $0.05 for MasterCard general purpose consumer credit  card transactions, depending on the volume of card transactions  processed.
Given that the method in which the card is accepted, transaction volume,  and other factors can affect interchange rates, many federal entities have  taken steps to ensure that the acceptance and processing procedures they  follow result in the most advantageous interchange rates applying to their  transactions. For example, Amtrak officials explained that by replacing  card machines (that embossed paper receipts) with wireless card  terminals on trains, they were able to significantly reduce the interchange  rates that applied to transactions made aboard their trains, because the  electronic transaction qualified for a lower interchange rate than the paper  transactions.
Moreover, FMS officials explained that before the agency signed the  current agreement with their acquiring bank in August 2006, they carefully  reviewed the bank’s interchange management capabilities and  incorporated provisions to ensure that the bank employs them. For  example, the bank is responsible for monitoring how card transactions are  being processed and the interchange rates they are being assessed. In  addition, the bank provides FMS with daily and monthly reports that  provide various levels of detail on the interchange fees paid. Both the bank  and FMS officials review these reports to identify instances in which  transactions may have been charged a higher interchange rate—known as  a downgrade—because they were not processed under the requirements  necessary to qualify for a lower rate. An FMS official stated that FMS then  works with the acquiring bank and individual federal entity that processed  the transaction to identify the reasons and to resolve the problem in order  to avoid future downgrades. For example, an FMS official explained that  in one instance a DeCA store had a broken card terminal in a checkout  aisle that prevented employees from swiping cards. Instead, employees  keyed in card information, which resulted in a number of transactions  being downgraded and assessed a higher interchange rate. With the  assistance of FMS’s acquiring bank, the problem was identified and DeCA  employees were told that should the problem reoccur, they are to use  other terminals to process card transactions, which would ensure they  would not be assessed a higher rate. An FMS official stated that under the  current agreement with its acquiring bank, very few transactions have  been downgraded; however, FMS still works to resolve these instances  when they occur so that the total cost associated with government  transactions can be reduced. Officials of two other federal government  entities told us that they similarly review data provided by their acquiring  banks to identify opportunities to reduce fees.
Another way that several federal entities have attempted to control fees  associated with card acceptance is by expanding their ability to accept  PIN debit card payments. For example, PIN debit transactions generally  are assessed lower interchange rates than “signature” debits, and therefore  some federal entities are beginning to implement the technology necessary  to accept these transactions. While federal entities must make an  investment in the equipment needed to process PIN debit transactions (for  example, PIN pads), one entity told us that the much lower interchange  rates associated with PIN debit transactions justified the investment. An  FMS official stated that the only entity for which it processes card  transactions that currently has the ability to accept PIN debit cards is  DeCA; however, as entities undergo equipment upgrades, FMS works with  them to identify equipment that may lower overall collection costs. For  example, one federal entity is in the process of developing a new terminal  system for card collections, and as part of this process, FMS is  encouraging the entity to implement a system that has the capability to  process PIN debit transactions. Additionally, some of the military NAFIs  with which we spoke adopted technologies necessary to accept PIN debit  cards, stating that they too recognized the cost savings associated with  these transactions.
Federal entities also can reduce card acceptance fees by changing the way  in which they or their acquiring banks connect to various card networks.  For example, Postal Service officials explained that they were in the  process of converting to a new method of processing transactions called a  payment switch, which will funnel all of the information from the Postal  Service’s 70,000 terminals into one settlement file at the end of the day.  The file then is sent to a third-party card processor. The officials explained  that the payment switch will reduce substantially the processing fee  component of card payment costs, because the technology in the payment  switch allows for routing each transaction to the lowest cost processor.  Additionally, the payment switch will enable the Postal Service to send  some card transactions directly to a card company rather than through the  third-party processor, reducing the cost of accepting those transactions.  FMS’s current acquiring bank has also implemented changes in the  method by which it processes PIN debit card transactions. FMS officials  explained that the bank identified a method for routing PIN debit card  transactions to different networks so that the costs for processing the  transaction are minimized, resulting in annual savings of almost $300,000  for FMS.
section_title: Federal Entities Have Attempted to Negotiate Lower Fees
paragraphs: Another way in which federal entities have acted to reduce card  acceptance costs is by negotiating with their acquiring banks for lower  merchant discount rates or with card networks for lower interchange  rates. Some of the federal entities we reviewed have realized card  acceptance savings by negotiating new acquiring bank services contracts.  These entities were able to negotiate lower rates for the processing  component of the merchant discount rate applied to their transactions.  For example, by signing a new acquiring bank agreement, one federal  entity received a substantial reduction in the processing fee component of  its merchant discount rate. Also, to obtain a more favorable merchant  discount rate for their transactions, officials from some of the military  service NAFIs have been working together to try to negotiate a lower  merchant discount rate with American Express on the basis of the volume  of transactions they provide to that company.
Officials at some of the entities with whom we spoke stated that they did  not believe they could negotiate effectively with the card networks— MasterCard and Visa—for lower interchange rates for their transactions.  However, some federal entities stated that they have attempted to  negotiate and have had varying levels of success:    FMS officials told us that they tried to negotiate lower interchange rates  with both Visa and MasterCard by stating that some factors that are  included in determining interchange rates do not necessarily apply to  federal government transactions. For example, FMS officials argued that  the federal entities that participate in the Card Acquiring Service pose less  risk than other merchant types and that there is no risk of delinquency on  the part of the Treasury. FMS officials stated that their negotiations were  not successful and that they were not able to negotiate lower interchange  rates.
Officials from the Postal Service also explained their attempts to negotiate  with the card networks. They stated that they believe lower interchange  rates should be applied to their transactions for a variety of reasons. First,  the Postal Service estimates that it is one of the top U.S. merchants in  terms of card transaction volume. Second, there is less risk of fraud than  some other merchants because most transactions are conducted face to  face. Third, the Postal Service operates a large retail network with 35,000  offices, self-service terminals, mail and phone orders, plus a Web site that  receives approximately 30 million hits per month and provides a great  amount of visibility for the networks. Fourth, the Postal Service has its  own law enforcement agency that investigates instances of fraud,  including fraudulent use of cards where merchandise travels through the  mail. These investigations result in the recovery of merchandise as well as  stolen card data and in some cases the arrest of international criminals to  the benefit of the credit card industry. They noted that the benefit of such  a service to the card networks was not reflected in the interchange rates  applicable to Postal Service transactions. The officials did state that they  have had some limited success in negotiations with the card networks  resulting in some small cost savings.
Officials from another federal entity told us that they have had some  success in receiving funds from one of the networks as a result of a joint  marketing program. The funds could be used to reduce interchange costs  and/or for additional marketing efforts; however, the details of the  negotiations are bound by confidentiality agreements and are considered  proprietary information. The officials explained that negotiations of this  type are not typical of federal entities because of the limited marketing  opportunities available to most government entities.
Although some federal entities have had some success in negotiating lower  interchange rates for their transactions, whether additional opportunities  exist for further reductions in interchange rates is unclear. According to  officials of MasterCard and Visa, among the factors that are considered  when setting interchange rates is whether the industry or sector  represents a new market for credit and debit cards. According to these  officials, they see government payments as a market in which they hope to  increase card acceptance and transaction volumes; thus, the interchange  rates that Visa and MasterCard set for government transactions are lower  than those of many other merchant categories. Additionally, officials at  both MasterCard and Visa told us that opportunities exist for merchants,  including federal entities, to negotiate for lower interchange rates assessed  on their transactions. For example, the MasterCard officials explained an  instance in which, in response to rapidly rising gasoline prices, they  worked with gasoline merchants to develop a cap on the interchange fees  that can be charged on petroleum purchases. Officials from both networks  explained that they have individuals dedicated to developing customized  arrangements with merchants and that these negotiations involve  identifying mutually beneficial arrangements for both the merchant and  the network. Also, we found it difficult to assess whether federal entities  could negotiate rate reductions based on their relative transaction volume  or aggregate card revenues, because we could not identify any publicly  available data we could use to determine how the federal government’s  total transaction volume or aggregate card revenues compare with those  of other large merchants.
section_title: FMS Has Begun a Program to Identify Cost Savings Opportunities, but Has Yet to Develop a Full Implementation Strategy
paragraphs: In addition to looking for opportunities to reduce card acceptance costs,  FMS has initiated a program to review the overall cash management  practices of federal entities. In its role as the federal government’s central  collection services provider, FMS provides federal entities with a number  of alternative revenue collection mechanisms to meet their needs. It is also  responsible for ensuring that the federal government’s collection activities  are efficient and that costs are minimized. Additionally, according to FMS,  the Deficit Reduction Act of 1984 authorizes FMS to conduct periodic cash  management reviews of federal entities’ financial operations. In the past,  FMS allowed federal entities for which it collected revenues to pick from  the variety of collection mechanisms that FMS offered without examining  the most cost-efficient mechanisms of collecting the revenue. However,  the Office of Management and Budget’s (OMB) 2004 assessment of FMS’s  collections program identified the need for FMS to develop additional  techniques to convince the federal entities to reduce paper-based  collections.
In 2007, FMS piloted a program to review the revenue collection  mechanisms used by the federal entities for which it collects revenues, and  how and from whom payments to these entities typically are made. The  reviews are designed to identify inefficiencies in current collection  mechanisms and to help FMS attain one of its strategic goals of providing  timely collection of federal government revenues, at the lowest cost,  through electronic means. According to FMS officials, the program is not  focused on card transactions, but rather on overall payment management  improvements. The reviews will allow FMS to work with federal entities to  take advantage of advances in lower-cost technology that may have  occurred since the entities began using their existing mechanisms. Among  other things, FMS is examining whether entities are using paper collection  mechanisms when they could instead be using electronic mechanisms,  or—if electronic mechanisms are already being used—opportunities to  reduce any associated fees by substituting cheaper electronic  mechanisms. For example, if an entity accepts credit cards, FMS may also  suggest cheaper collection alternatives, such as PIN debit cards or  automated clearinghouse transactions. Once it has reviewed an entity’s  collections and processes and identified improvements, FMS develops an  agreement that details the changes to be made and the timeline for  implementing them. FMS officials explained that while entities are not  mandated to implement changes in their collection mechanisms, the  agreements will provide for an “inefficiency charge” that will assess  penalties to the entity if the agreed-upon recommendations are not  implemented by the dates stipulated in the agreement. Such charges will  be calculated on a per transaction basis and require that the entity transfer  funds to the Treasury to cover the amount.
In determining which entities to review for the pilot phase, FMS officials  said that their focus for the program was first on the 24 Chief Financial  Officer (CFO) agencies identified in the Chief Financial Officers Act of  1990. FMS officials said that they also focused on entities that showed the  most potential for savings that could be realized by revising their  collection mechanisms. Criteria used for selecting agencies to participate  in the pilot program included (1) the dollar volume of the entity’s  collections, (2) the amount of revenue not collected in electronic form  (that is, cash and checks), and (3) entities with whom FMS previously  experienced good cooperation in converting paper processes to electronic  mechanisms.
As of March 2008, FMS had reviewed collection cash flows at eight federal  entities and had drafted agreements to implement revised collection  procedures with each. The results confirm that opportunities for  improvement exist, although only two of the eight agreements have been  signed (the agency’s goal for the program for fiscal year 2008 is to have at  least six of the eight agreements signed). Through the eight agreements  that have been developed, FMS has identified various potential process  improvements and changes that would result in recurring cost savings. For  example, FMS staff determined that replacing the check-processing  method DeCA used with a more advanced method that converts paper  checks to electronic images at the point of sale would produce savings  each time a check is presented at a DeCA location. FMS officials told us  that they previously had developed a general estimate for cost savings that  could be achieved by converting from paper collection mechanisms to  electronic collection mechanisms before beginning the program; however,  they have not developed cost savings estimates that would be achieved by  implementing the specific actions that they have recommended at each of  the entities they have reviewed thus far. At our request, FMS officials  developed an estimate of the cost savings associated with a  recommendation contained in one of the draft agreements they have  prepared. FMS estimated that if IRS converted 67 million payments  currently being received in paper to transactions processed by an  electronic system, savings of approximately $40 million annually would  result.
FMS officials stated that they have begun to prioritize the order in which  they will conduct reviews for the remainder of the federal entities. They  estimate that they will conduct reviews, and draft agreements, with as  many as 85 entities within the 24 CFO agencies. An FMS official estimated  that the average length of the reviews they plan to complete should take  approximately 6 to 9 months; however, each of the reviews that have been  conducted as part of the pilot have taken longer. FMS officials attributed  the extra length of time to conduct reviews during the pilot phase to the  fact that the program is new, and they have spent time developing a  standard review process and templates for the agreements. Additionally,  the officials explained that much of the success and length of time a  review takes is dependent on the willingness of the entities to work with  FMS and to incorporate the recommended changes into their existing  mission and goals. After reviews of the CFO agencies are completed, FMS  officials anticipate that an additional 29 reviews will be conducted for the  non-CFO agencies for which FMS provides collection services. The FMS  staff responsible for conducting these reviews consists of five full-time  staff members that constitute a new customer relationship management  group formed in the last few years, and performing the reviews currently  consumes the majority of these staff members’ time. In addition to these  five staff members, FMS has a director who oversees the program, as well  as staff in various program areas within FMS that assist in different stages  of the reviews.
Because FMS began this program as a pilot, it has not developed a full  implementation strategy that could help ensure an appropriate resource  commitment and timely attainment of its goals. For example, FMS officials  told us they have not developed a timeline for completion of the reviews  for all agencies because they are focused on the 24 CFO agencies.  However, because this program will help FMS achieve its strategic goal of  increasing the percentage of federal government revenues collected  electronically—a percentage that has remained constant for the last 3  fiscal years—establishing a targeted timeline for completing the remaining  reviews could help FMS ensure that it makes progress toward this goal. In  addition, in its 2004 review, OMB noted that FMS lacked policies and  techniques for convincing federal entities to eliminate paper-based  collections. Including in its reviews estimates of the cost savings to be  achieved by implementing the recommended changes could help FMS  emphasize to the entities the importance of acting on the  recommendations that it identifies. Finally, FMS has already found that  reviews are taking more time to complete than it initially anticipated. The  cost savings associated with implementing the efficiencies identified in the  reviews are both immediate and recurring. Accordingly, as the pilot  program is fully implemented, ensuring that it has adequate resources for  completing the reviews expeditiously would help achieve the program’s  goals.
section_title: Other Countries Have Acted to Influence Interchange Rates, but Limited Information Is Available on the Effects of These Actions on Consumers
paragraphs: Authorities in as many as 26 countries have taken or considered actions  intended to either limit interchange fees or improve card payment  systems. In the 3 countries we examined in more detail—Australia, Israel,  and Mexico—reforms designed to effect reductions in interchange rates  were undertaken as part of broader efforts to change payment systems or  card markets; thus, isolating the effects of the interchange interventions is  difficult. Further, differences regarding the regulatory and market  structures between these countries and those of the United States make it  difficult to estimate the effects of any similar actions in the United States.
subsections: section_title: Foreign Jurisdictions Have Taken Actions Regarding Cards
paragraphs: According to information from regulators, card networks, and others,  actions regarding card fees, issuer practices, or payment system  functioning in general have been taken or considered in as many as 26  countries as well as the European Union in the last 18 years. These  actions were described as, among other things, agreements between card  networks or issuing banks and governmental authorities, as well as  decisions by antitrust tribunals and commissions. For example, in  December 2007 the European Commission issued a decision finding that  MasterCard’s interchange fees for cross-border transactions in the  European Economic Area violate European Community Treaty rules on  restrictive business practices. In addition, the commission recently  announced that it would conduct an inquiry into whether Visa’s  interchange fees similarly violate the treaty rules. In some cases, the  actions taken are under appeal in these jurisdictions.
In reviewing information available from U.S. and foreign regulators, card  networks, and other sources, we determined that Australia, Israel, and  Mexico had taken actions affecting various parts of their card and  payment system markets in recent years, including actions specifically  addressing merchant discount or interchange fees. However, data on the  impact of the actions taken in these three countries are limited. The  following sections summarize the actions in the three countries.
subsections: section_title: Australia
paragraphs: A 1998 amendment to Australia’s Reserve Bank Act created the Payment  Systems Board within Australia’s central bank, the Reserve Bank of  Australia (RBA), and tasks the board with ensuring the efficiency,  competition, and stability of that country’s payment system. In 2000, RBA  published the results of a study that it conducted with the Australian  Competition and Consumer Commission, which concluded that prices to  cardholders for various forms of card payments did not generally reflect  the relative costs of those forms of payments. The authors of the 2000  study noted that merchant discount rates for credit card transactions  averaged 1.78 percent, which included average interchange rates of 0.95  percent. RBA officials explained to us that because card users do not  directly pay some of the costs of using cards, including interchange fees,  consumers’ use of credit cards at the expense of other lower-cost payment  methods, such as debit cards was inefficient for their economy as a whole.
To help remedy this perceived inefficiency, RBA first attempted to  encourage voluntary action on the part of the credit card industry. When  these attempts were unsuccessful, RBA set a ceiling applicable to average  credit card interchange rates, which took effect in 2003. RBA officials  explained that to determine how to assess appropriate interchange rate  levels, they worked with card networks to identify the range of costs  incorporated in the calculation of interchange rates. After considering  these costs, RBA officials decided that costs associated with transaction  processing, fraud and fraud prevention, authorizing transactions, and  financing the period between the time the merchant is paid and the time  that the issuer receives payment should be covered by the interchange  fees, while costs associated with credit losses should not be. To lower  interchange rates from their then current levels, the central bank set a  benchmark rate that excluded the disallowed costs, and required that the  weighted average of the rates set by each four-party credit card system— which at that time included Visa, MasterCard, and a domestic card brand  called Bankcard—not exceed that benchmark. RBA officials stated that  they chose to use a cost-based method because it appeared to be a  transparent and objective way to lower interchange rates. As a result of  the reforms, the average interchange rate in the Visa and MasterCard  networks declined from 0.95 percent to around 0.50 percent. In addition to  the actions taken to limit credit card interchange fees, the central bank  also took several other actions designed to promote efficiency and  competition in the payment systems during the same period.
section_title: Israel
paragraphs: In the late 1990s, officials at the Israel Antitrust Authority (IAA)  considered actions to address a lack of competition in their country’s  credit card market. The market was dominated by two companies, each of  which issued and acquired its own major card brand. The rates of  merchant discount fees charged by these companies differed according to  merchant type, and estimates of the average merchant discount rate at that  time varied. Some estimated averages reported in 1997 and 1998 ranged  from 1.9 percent to 2.46 percent. In 1998, a second company began issuing  Visa cards and acquiring Visa transactions in Israel. According to IAA  officials, the two Visa issuers executed an agreement between them that  included provisions setting the interchange rates applicable to  transactions involving their cards. IAA declared the agreement between  the companies to be a restraint of trade under Israeli antitrust law, but  granted the agreement several exemptions in return for a gradual  reduction in the interchange fees, under the condition that Visa conduct an  issuer cost study that would provide the IAA with data to establish a  suitable and acceptable interchange fee. After these exemptions expired  and the IAA found the data provided by the Visa companies to be  incomplete, the law required that banks obtain approval of their  agreement from the Israeli Antitrust Tribunal—a court with exclusive  jurisdiction over noncriminal governmental antitrust proceedings. After  years of discussions on the appropriate costs to be covered and different  methodologies for setting interchange rates, the Israeli Antitrust Tribunal  issued a decision in 2006 that the costs that could be considered in  calculating interchange rates included those relating to  financing the period between when the merchant is paid and when the  issuer receives payment, and   payment guarantee (including both costs involving losses due to  cardholder fraud and costs related to prevention of such fraud).
At the same time that this decision was reached, the two Visa issuers,  along with Israel’s single MasterCard issuer, agreed with IAA to contract  with merchants to accept both Visa and MasterCard transactions and to  gradually reduce interchange rates. Under this agreement, interchange  rates are to gradually drop from their October 2006 level of 1.25 percent to  0.875 percent by 2012. As of January 2007, interchange rates fell to 1.2  percent in keeping with the agreement. In addition, in accordance with the  tribunal’s decision many of the categories based on merchant type will be  eliminated. However, the transactions of government entities that accept  cards in Israel will continue to be eligible for a lower interchange rate, also  in accordance with the tribunal’s decision, under the theory that  government entities do not benefit from the payment guarantee, because  they have other ways of guaranteeing payment (for example, confiscating  assets), and so the interchange fee charged on its acceptance transactions  should not include that cost. Although the Antitrust Tribunal has  temporarily approved this agreement, it has stated that final approval  cannot occur until an independent expert appointed by IAA determines  that the agreement is consistent with the tribunal’s approved methodology  for setting fees.
section_title: Mexico
paragraphs: Given responsibility for ensuring the proper functioning of payment  systems, the Banco de Mexico (the Mexican central bank) has been  encouraging the use of more efficient means of payment. In 2004, the  Banco de Mexico was granted specific authority to regulate interchange  fees in response to concerns by legislators in that country regarding the  amount that banks were charging for services as well as the lack of  sufficient information for cardholders and merchants. Shortly after the  2004 law was passed, the Association of Mexican Banks, which establishes  interchange rates in Mexico, undertook a review of interchange rates and  under the supervision of the Mexican central bank, began to develop a  method to set them. In addition, the association and the central bank  reviewed the way in which interchange rates applied to merchants. For  example, five different interchange rates could be applied to transactions,  depending on the merchant’s expected annual sales volume, with  merchants with higher sales volumes receiving lower rates. Mexican  central bank officials explained to us that they believed this led to  discrimination against small merchants, and as part of the reforms, the  bank association introduced new categories that were based on merchant  type rather than size.
To address interchange rates, the bank association under the supervision  of Banco de Mexico established a method to set a “reference” interchange  rate. In contrast to the cost-based approaches used by Australia and Israel,  the bank association used a model that balances issuing and acquiring  banks’ profits (net of interchange) through the interchange fee. Prior to  these developments, the interchange rates for credit cards averaged about  2.73 percent. Since that time rates have declined. In February 2005, the  association reduced the credit card interchange rate by an average of 43  basis points and also eliminated the highest bracket of rates for credit  cards. Because some of the disadvantages of the previous system  persisted despite this intervention, in October 2005 the association  proposed a new mechanism for setting a reference interchange rate, which  accounts for issuer and acquirer revenues and expected network growth  in addition to issuer and acquirer costs. The association then adjusted the  single reference rate to account for differences in merchant type, resulting  in 22 different merchant categories, most of them with different applicable  interchange rates. The association and the central bank continue to work  together to refine this method. As of January 2008, the effective reference  interchange rate for credit cards was lowered to 1.61 percent.
section_title: Limited Information on the Effects of Interchange Rate Intervention Suggests Some Benefit to Merchants and a Mixed Picture for Consumers
paragraphs: In the three countries we examined, incomplete information is available  on the impact of actions to reduce interchange rates, but available data  indicate that merchants appear to have benefited, while the impact on  consumers has been mixed. Because the actions relating to interchange  rates in these countries generally coincided with various other changes in  credit and debit card markets, researchers’ ability to isolate and measure  the specific effects of interchange rate intervention has been limited.  However, merchants in these countries generally appear to have received  benefits in the form of lower merchant discount rates. Data on merchant  discount rates for credit cards in Australia show a significant decline in  these rates since the reforms were instituted and suggest that changes in  interchange rates have been reflected in merchant discount rates. The  Australian central bank reported that the average merchant discount rate  for Bankcard, MasterCard, and Visa had fallen by around 62 basis points to  0.79 percent between the September quarter of 2003, just prior to the  reforms, and the December quarter of 2007, which was greater than the  decline in interchange rates over that period. Merchant discount rates for  American Express and Diners Club cards, although not regulated by the  central bank, also fell by 0.29 and 0.18 percentage points, respectively,  between September 2003 and December 2007. In September 2007, the  central bank estimated that, in the aggregate, merchants’ costs for card  acceptance over the previous financial year were about $920 million lower  than they would have been absent the reforms. Similar reductions also  have occurred in Mexico as the credit card merchant discount rates across  all businesses declined an average of 8 percent, from 2005 through 2006.  According to information provided by IAA, average merchant discount  rates have declined in Israel since 1998, especially for Visa cards; however,  other factors may have contributed to the overall decline in merchant  discount rates in Israel. For example, other regulatory actions relating to  limiting merchant discount rates also were being taken during this period.  In addition, officials from the antitrust authority expressed the belief that  the increased competition in the Visa issuing market since 1998 has  contributed to the lower merchant discount rates.
Evidence relating to impacts on consumers since the interchange rate  intervention in these countries is limited. In Australia, where the reforms  have been in effect long enough to allow for some study, cardholders have  experienced a decline in the value of credit card reward points for most  cards and an increase in annual and other consumer credit card fees. For  example, RBA estimated that average annual fee revenue from fees, such  as cash advances and late payments on bank-issued personal credit cards  has doubled from around $40 per account in 2002 to around $80 in 2006,  although it did not estimate the total amount paid by all cardholders. RBA  officials attributed these changes to their reforms of the credit card  system. Although card users may receive fewer rewards and experience  higher fees when using their cards, consumers in Australia that want to  use cards to finance purchases may benefit from the lower-interest cards  that issuers began increasingly offering after the reforms were  implemented. Regulators indicated that banks altered their business  models when interchange fees were reduced to focus more on attracting  cardholders who carry a balance. This may have been due, in part, to  decreased revenue from interchange fees. In addition, Australia’s central  bank has not been able to discern whether merchants have passed along  their reduction in the costs of accepting cards—resulting from the  reforms—in the prices charged for retail goods and services. An RBA  official told us, however, that while such an effect would not likely be  measurable, he believed competition among merchants would lead  merchants to pass some portion of a reduction in their costs along to  consumers. RBA’s assessment of the reforms’ effects on overall welfare is  positive and it estimates that welfare gains are likely substantial.
In addition to the impact on merchants and consumers in the three  countries we examined, other developments in these countries’ payment  system markets have occurred since interchange rates were lowered. For  example, in Australia, the central bank found that over the past few years,  the number and value of debit card payments grew more quickly than  those of credit card payments. The central bank stated that this difference  reflects slowing growth in the number of credit card transactions—in part  resulting from cutbacks in credit card rewards and the introduction of  surcharges—as well as increasing growth in the number of debit card  transactions due in part to new types of deposit accounts offered by banks  that make debit card transactions more attractive. Additionally, the  combined market share of MasterCard, Visa, and Bankcard decreased, and  the combined market share of American Express and Diners Club  correspondingly increased by about 1 percent to around 16 percent of the  value of credit card transactions. The Mexican central bank reports that  the number of credit and debit card payments increased significantly in  the last few years. In addition, several new banks have entered the issuing  and acquiring markets and concentration in these markets has decreased,  although both markets still continue to be relatively concentrated  compared to that of the United States. In Israel, IAA officials told us that  too little time has passed to evaluate the effects of their reforms; however,  they expect that the creation of a single interchange system will yield  efficiency gains and promote competition for the benefit of consumers.
section_title: Potential Effects of Taking Similar Actions on Interchange Fees in the United States Are Uncertain
paragraphs: The extent to which similar actions to lower interchange rates in the  United States might reduce costs to merchants and consumers is unclear.  While actions in the three countries examined appear to have reduced the  costs to merchants for accepting cards, less information was available on  the impact on consumers. In Australia, for example, costs for card users  appear to have increased, but having these individuals experience higher  costs could be considered more efficient and appropriate than merchants  passing their card acceptance costs along to all consumers through higher  prices for goods and services, as RBA concluded was occurring before the  reforms. However, whether consumers choosing to make purchases with  other forms of payment have experienced any benefits was not clear.
In addition, variations in payment systems across the countries we studied  suggest that interchange levels may not be the only relevant factor to  consider when examining card costs in the United States compared with  those of other countries. For example, although average interchange rates  for credit cards in the United States are higher than the rates that have  been set in the countries we reviewed, one industry group found in 2005  that the amount of the processing fee component included in the total  merchant discount rate applied to credit card acceptance transactions in  many other developed countries around the world is actually greater than  in the United States. Therefore, comparing only interchange rates may not  give an accurate picture of the relative costs of card acceptance to  merchants. Further, because interchange rates are reportedly intended to  balance costs across consumers, merchants, and issuing and acquiring  banks, differences in interchange levels between the United States and  other countries could be the result of different cost structures for the  banks in these markets. For example, Israel has fewer than 10 card  issuers, and officials at the Federal Reserve Bank of Kansas City estimated  in 2006 that the four largest banks in Australia issued 55 percent of cards.  In contrast, we reported in 2006 that the United States has more than 6,000  depository institutions that issue credit cards, and therefore the costs of  issuing credit cards in this country could be different than in countries  with many fewer issuing banks.
Finally, the regulatory and legal structure in the United States differs from  those of other countries. For example, unlike in Australia and other  countries we reviewed, in the United States there is no entity specifically  tasked with regulating or overseeing the competitive aspects of the  interchange fee structure or the fees’ effects on consumers. To the extent  that the imposition of interchange fees would constitute an  anticompetitive or unfair business practice prohibited by the antitrust laws  or the Federal Trade Commission Act, the Department of Justice (DOJ)  and FTC, respectively, could take measures to ensure compliance with  those laws. In 1998, DOJ sued Visa and MasterCard for alleged antitrust  violations relating to the networks’ “exclusivity rules,” which prohibited  member banks from issuing Discover or American Express cards. The  court found that the exclusivity rules were a substantial restraint on  competition in violation of the Sherman Act. Although the imposition of  interchange fees was not found to violate the law, the trial court noted that  the defendants’ ability to impose and change the fees was evidence of  market power, which was an element in proving the anticompetitive  nature of the exclusivity rules. Further, DOJ officials told us that under  its authority to enforce the antitrust laws, DOJ is again looking into issues  concerning the payment systems industry. (Also, as previously noted,  interchange fees have been a factor in lawsuits alleging violations of the  federal antitrust laws by credit card networks and related parties. In  addition, private parties are pursuing civil actions that address interchange  fees under these same laws.) FTC officials expressed to us the view that  the FTC does not have authority to regulate interchange fees. Also,  officials of the Board of Governors of the Federal Reserve noted that the  Federal Reserve does not have a specific mandate to regulate interchange  fees in the United States.
section_title: Card Usage by Federal Entities Provides Numerous Benefits, but Creates Control Challenges
paragraphs: Many federal entities use cards to make purchases of goods and services  needed for their operations, spending more than $27 billion on purchase,  travel, and fleet cards in fiscal year 2007. Officials we interviewed from  five federal entities that were high-volume users of cards for goods, travel,  and automotive expenses told us that using cards reduces their  administrative expenses, provides income from the rebates they receive  from the issuing banks, and provides other benefits. Although generally  citing few drawbacks to the use of charge cards, federal entity officials  acknowledged challenges in controlling use of cards, but also noted that  the data available on card use and tools provided by the issuing banks help  them address these challenges.
subsections: section_title: Entities’ Use of Cards Has Grown Significantly and Is Expected to Increase Further
paragraphs: More than 350 federal entities participate in GSA’s SmartPay program— which provides purchase, travel, and fleet cards for these entities to use.  Federal entities pay no direct costs for the general use of cards.  According to card network officials, the banks that issue cards to federal  entities are compensated in part by the interchange fees they receive when  a government entity or employee uses a card to make a purchase.
In fiscal year 2007, federal entities used cards to purchase more than $27  billion of goods and services. This represents an inflation-adjusted  increase of 51 percent over fiscal year 1999 spending levels (see fig. 2).  Most of this spending occurred using purchase cards, which account for  nearly 70 percent of total federal entity card spending, while about one- quarter of card spending was done using travel cards and about 5 percent  using fleet cards. The number of transactions has also increased by 50  percent since 1999, from about 60 million transactions to over 90 million in  2007. However, the rate of growth of both spending and transactions has  slowed in recent years.
According to the Director of GSA’s Office of Charge Card Management, the  increases in spending and the number of transactions in the early years of  the SmartPay program were due to entities adjusting their purchasing  behaviors from previously used systems, such as purchase orders, and  learning how to use their cards to make additional purchases. Although  the number of transactions remained roughly constant between fiscal  years 2002 and 2007, the average transaction value rose from about $240 to  about $300, accounting for the growth in total spending during this time.  According to the Director, the number of transactions has remained  relatively stable in current years because, for the most part, entities have  transitioned from most of their previously used purchasing systems and  are now making only small changes to their programs to improve  efficiencies.
The Director of GSA’s Office of Charge Card Management also told us that  card use by federal entities is expected to continue growing as the entities  identify additional ways of using cards and implement new payment  technologies. For example, officials from the Department of Veterans  Affairs (VA) told us that they are working with the bank that issues the  department’s purchase cards to find new ways to increase card usage.  They explained that in 2003 they developed a process for making  payments through the card system to non-VA medical providers for  services provided to veterans who are unable to visit a VA center for  medical care, reducing the number of checks they must issue and  increasing both the number of electronic payments made and their card  use rebates. Additionally, officials stated that VA is reviewing its purchase  records to attempt to shift more purchasing to vendors that accept cards.  Similarly, the U.S. Army has developed an automated payment system that  uses purchase cards for most of the $400 million per year it pays schools  and other institutions for soldiers’ tuition assistance. GSA officials also  expect the new products and services that will be available under the  SmartPay 2 program will lead to increases in overall card spending. Some  of these products include prepaid cards, contactless cards, and cards in  foreign currencies.
section_title: Officials Cite Various Benefits Associated with Using Cards, Including Administrative Cost Savings and Rebates
paragraphs: According to federal entity officials we spoke with, one of the primary  benefits associated with card usage is the administrative cost savings  compared with procurement methods that card usage has partially  replaced, such as purchase orders, imprest funds, and blanket purchase  agreements. For example, obtaining goods or services under a purchase  order system requires that a purchase request be filled out and approved,  then sent to a procurement office, which issues it to a vendor. When  government entities use a card, however, goods or services can be directly  purchased by cardholders, who then review their statements at the end of  the billing cycle and forward the statement to an approving official.  Officials from the Department of Agriculture said that if cards were not  used, staff would need to complete purchase orders for each of the 1.5  million transactions per year that currently are made using purchase  cards. Officials from the Department of Homeland Security estimated that  the department would require four to five times the current number of  staff who operate its travel card program if it paid for travel expenses  without cards. In addition, officials at the Department of Agriculture stated  that new tools, such as an automated process to reset charge card  passwords, may further reduce the costs of administering their program.
Estimates of per transaction administrative costs savings from card usage  vary, making it difficult to estimate total administrative cost savings. GSA  estimated total administrative cost savings from card use in fiscal year  2006 to be $1.7 billion. An official from GSA told us that this estimate was  based on per transaction saving estimates by the Purchase Card Council.  In 1994, the council, an interagency group, asked 17 civilian government  organizations to perform a detailed cost-benefit analysis comparing the  use of purchase orders versus purchase cards for transactions of $2,500  and below. The per transaction savings estimates for the 17 organizations  ranged from $1.42 to more than $142, with an average of about $54. More  recently, in a 2006 research study, the Association of Government  Accountants surveyed four civilian agencies with an approach similar to  that of the Purchase Card Council and reported savings estimates of $60 to  $166 per transaction, with a weighted average of about $87. In  comparison, a 2005 survey of almost 1,300 purchase card program  administrators from corporations, nonprofits, and government entities  found, for state and federal government entities, a $53 administrative cost  savings per transaction compared to purchase orders. Finally, a 1997  analysis by the U.S. Army Audit Agency showed that the average cost to  the U.S. Army of processing a purchase order was about $155 compared to  about $62 for a card, a savings of about $93 per transaction.
Another benefit of card use for federal entities is the receipt of rebates  from the banks that issue their cards. Rebate amounts, which, after  adjusting for inflation, have almost doubled since fiscal year 2002 to $175  million in fiscal year 2007 (see fig. 3), are based on a number of factors,  mainly the volume of net spending on cards and how quickly balances on  the cards are paid. GSA establishes a minimum rebate rate that federal  entities should receive, but entities can choose to negotiate with their  issuing banks for additional amounts. Between 1998 and 2007, the  minimum rate was 6 basis points of the net volume of spending on the  cards, while under the SmartPay 2 program, the minimum rebate rate will  increase to 8 basis points. A GSA official stated that typically in federal  entities’ negotiations with issuing banks, the rebate rate is increased as an  incentive for an entity to choose a particular bank to issue its cards.  According to the GSA official, however, some entities negotiate for  specialized services rather than increased rebate amounts, and GSA  encourages agencies to examine their programs holistically when  negotiating terms.
Federal entities differ in how they use their rebates. Two of the federal  entities we spoke with return the rebates directly to the location that  originated the relevant transaction, one adds the rebates into general  income for the entity, and one other allocates rebates to a working capital  fund for initiatives of general benefit to the entity.
Officials from federal entities also cited several other benefits associated  with using cards to make purchases. For example, officials from several  entities told us that the increased data on purchases that is available to  them by using charge cards allows for better management and/or tracking  of spending. According to officials at the Department of Agriculture,  purchase card data allowed them to examine their purchasing patterns  and identify opportunities for savings. They explained that by using  purchase cards to buy office supplies, they received data on the  transactions, which they used to negotiate a contract with a vendor to buy  supplies in bulk that resulted in millions of dollars in savings per year.  Officials from several entities also told us that cards allow them to make  purchases more quickly and/or more conveniently than previously used  methods of purchasing. For example, officials from one entity told us that  once the approval process is completed for a particular purchase, it can be  made immediately, whereas previously used methods take a longer time to  complete. According to officials from another entity, the ability to obtain  cash advances on cards benefits them because it eliminates the need for  imprest funds, which, according to officials from a different entity, are  harder to monitor for fraud. Other benefits cited by officials from one  entity included compensating vendors doing business with the government  more quickly and greater ability to resolve disputes with vendors because  charges can be reversed until the dispute is resolved.
section_title: While Minimizing Card Abuse Poses Control Challenges, Banks Provide Tools to Help Entities Address Them
paragraphs: Officials at the federal entities with whom we met cited only a few  drawbacks associated with the use of cards, though officials from some  entities mentioned the risk of fraud and misuse. However, these officials  told us that the risk of these occurrences is less than or equal to that under  previously used procurement systems. Although the instances of fraud and  misuse on cards may be infrequent, we and several inspectors general  have reported internal control weaknesses in charge card programs at  federal entities and instances of fraud and abuse. For example, in 2001 and  2002 we issued reports on control weaknesses in purchase card programs  at the Air Force, Army, and Navy. The reports contained over 100  recommendations targeted at improving the design and implementation of  controls over card use and establishing guidelines for disciplining those  who misuse their government purchase cards. In 2003, we reported that  the military services had begun or implemented nearly all of those  recommendations, some of which were included in legislative  requirements for the Department of Defense. In addition, earlier this year  we reported on breakdowns in internal controls in various federal entity  purchase card programs, which in some instances resulted in fraudulent,  improper, and abusive use of purchase cards.
For the most part, fraud and misuse can be limited through strong internal  controls in card programs of federal entities. GSA and OMB have issued  guidance on internal controls intended to reduce the risk of misuse of  cards. For example, GSA develops guidance through training courses for  federal entities and publishes guidelines for oversight and information on  detecting misuse and fraud. Additionally, OMB has issued several  memorandums related to oversight of card programs. For example, a 2002  OMB memorandum provided that each federal entity review the adequacy  of its internal controls for purchase and travel card expenditures, and  required entities to submit action plans detailing any risks associated with  these programs and identifying the internal controls that will be used to  manage these risks. In 2005, OMB also issued an appendix to its 1995  circular on management accountability and control, which consolidated  and updated governmentwide card program requirements and included  minimum requirements and best practices on several aspects of card  programs. Some of the best practices to limit fraud and misuse identified  in these guidance documents included implementing appropriate training  for cardholders, approving officials, and other staff; deactivating cards that  are not used; requiring charge card transaction or statement reconciliation  on the part of the cardholder in a timely manner; ensuring managerial  review of charge card purchases; and implementing policies outlining  appropriate administrative and/or disciplinary actions for charge card  misuse.
Finally, officials from some of the federal entities we interviewed told us  that the tools and data provided by their card-issuing banks helped them  to limit the risk of misuse of cards by enabling them to track and limit the  types of purchases made on the cards. For example, some entities block  the use of cards at certain merchant types, to help ensure that the cards  are used only for approved goods and services, or limit transaction  amounts, cash withdrawals, and other activities. Officials from several  entities noted that the data on card transactions they receive from their  issuing bank allow them to monitor for potentially fraudulent or  inappropriate transactions. For example, an official from one entity told us  that the data allowed it to identify suspicious transactions based on  specified dollar amounts, charges to certain vendors, and other types of  transactions that could involve misuse. Officials from another entity noted  that security features on cards help identify suspect charges by generating  alerts for questionable transactions and by sending an e-mail to the  cardholder every time a transaction occurs on his or her account in order  to verify whether the transaction was approved by the cardholder.
section_title: Conclusions
paragraphs: Federal entities’ acceptance of credit and debit cards provides a number of  benefits, including client and customer convenience, but also entails costs.  In collecting over $27 billion in revenue via cards in 2007, the transactions  of federal entities included within the scope of this report resulted in more  than $430 million in merchant discount fees, including at least $205 million  in interchange fees (paid by entities that provided us with data specifically  on interchange fees). Federal entities have undertaken a number of  worthwhile actions to ensure that card acceptance costs are minimized.  Further, FMS’s program to comprehensively examine the revenue sources  and collection mechanisms used by the many entities for which it  performs collections shows great promise for achieving savings and  identifying improvements for revenue collection, whether through cards or  other mechanisms. Since its initiation on a pilot basis in 2007, this program  has already identified potential cost savings or efficiency improvements at  the eight entities FMS has examined to date. Because such savings would  be recurring—in that they are applicable to future transactions—this  program appears to be a valuable effort for FMS to complete in a timely  manner. Ensuring that FMS’s program implementation strategy has  additional elements, such as a timeline for completing the reviews, cost  savings estimates, and an assessment of the adequacy of the resources  committed will increase the likelihood of FMS achieving its goals as  expeditiously as possible. Establishing a timeline for completion would  allow FMS management to determine whether the program is being  implemented expeditiously, including taking action if interim milestones  are not being met. Generating cost savings estimates would appear to  provide FMS with an additional tool for prompting entities to implement  the improvements that are identified. Further, establishing a timeline for  monitoring progress and estimating the cost savings to be realized could  also allow FMS to better assess whether the level of resources committed  to the program is appropriate. Perhaps most important, developing a full  implementation strategy would allow FMS to identify potential cost  savings for its collection activities—and federal entities to begin realizing  them—more quickly, resulting in larger overall financial benefits to the  government.
Other countries have examined the significance of interchange fees as part  of credit and debit card payments, and several have taken or are  considering actions to improve efficiencies and reduce costs involving  their card payment systems. In one of the three countries we examined  that has acted to limit interchange fees, available evidence suggests that  the costs for merchants from accepting cards has declined but the direct  costs for consumers using cards may have increased. However, a number  of factors may be influencing costs, and additional data and study would  be needed to more definitively assess the effects of these actions. Further  adding to the difficulty of estimating the potential effects of such actions  in the United States, are differences in the structure and regulation of the  U.S. card payment market from those of the other countries we examined.
Federal entities have realized benefits from using cards to make purchases  of needed goods and services, including supplies, travel expenses, and  vehicle operating costs, and have taken actions to address the challenge of  ensuring that cards are used only for intended purposes. In addition to  increased efficiency in administrative processes and cost savings, in fiscal  year 2007 card use also produced about $175 million in additional  operating funds through the rebates provided by the banks that issue  government cards. Agencies have acknowledged the continuing need to  ensure adequate monitoring and to have controls in place to minimize  fraudulent and abusive use of their cards. The ability to analyze data on  card activities—a capability that the issuing banks are providing to  agencies—appears to be a valuable tool, in that it helps federal entities  manage their card activities and potentially reduces costs for the  government.
section_title: Recommendation for Executive Action
paragraphs: In order to help expeditiously achieve savings to the government,  including those associated with accepting cards, we recommend that the  Secretary of the Treasury take steps to establish a full implementation  strategy for FMS’s revenue collection review program. Such a strategy  should include a timeline for completing the reviews, cost savings  estimates associated with individual reviews, and an assessment of the  adequacy of the resources committed to the program.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from the Treasury and  GSA. In an e-mail providing the Treasury’s comments, the manager of  FMS’s Internal Control Branch noted that our report acknowledges that  the acceptance of credit and debit cards has provided significant benefits  to the agencies and the public, and that as agencies implement more e- commerce initiatives and interact more with the public through the  Internet, credit and debit card acceptance is likely to continue to increase.  While FMS did not directly address our recommendation, the manager  agreed that FMS’s revenue collection review program, in which the  acceptance of credit and debit cards is only one of many processes that  will be evaluated, will help improve overall financial management at  federal agencies. FMS also provided technical comments, which we have  incorporated where appropriate. In addition, GSA reviewed a draft of this  report and, in an e-mail from the Director, Internal Control and Audit  Division, Office of the Controller, indicated agreement with the report’s  contents regarding the SmartPay program.
We are sending copies of this report to various other interested  congressional committees and members and to the Secretary of the  Treasury; the Administrator, General Services Administration; and other  interested parties. We will also provide copies to others on request. This  report will also be available at no charge on GAO’s Web site  http://www.gao.gov.
Please contact me at (202) 512-8678 or hillmanr@gao.gov if you or your  staff have any questions about this report. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. Key contributors to this report are listed in appendix  III.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to examine (1) the benefits and costs, including  interchange fees, associated with federal entities’ acceptance of cards as  payment for the sale of goods, services, and revenue collection; (2) actions  taken in countries that have regulated or otherwise limited interchange  fees and their impact; and (3) the impact on federal entities of using cards  to make purchases.
To determine the benefits received by federal entities from the acceptance  of credit and debit cards, we conducted semistructured interviews with  five judgmentally selected federal entities that participate in Financial  Management Service’s (FMS) Credit and Debit Card Acquiring Service,  which is a governmentwide service that allows federal entities to accept  payment by Visa, MasterCard, American Express, and Discover cards, as  well as some types of debit cards. FMS provides this service to any  executive, judicial, and legislative branch agency; government corporation;  commission; board; or other federal entity that determines that the  acceptance of cards is needed for revenue collection. Three of the five  entities we contacted were among those that conducted the highest  volume of card transactions, and two entities were among those that  conducted the lowest volume of card transactions. We also reviewed and  summarized studies and reports on the costs associated with processing  different forms of payment to identify how these costs compared with the  costs associated with card acceptance.
To estimate the costs associated with federal entities’ acceptance of cards  as payment, we collected data from as broad a range of entities associated  with the federal government as possible. To determine the federal entities  from which to collect data, we met with FMS who provided us with data  on all federal entities that participate in its Credit and Debit Card  Acquiring Service. FMS provided us data on revenues collected through  card transactions and the merchant discount, interchange, and processing  fees it paid for these entities’ acceptance of cards for fiscal years 2005  through 2007. Additionally, FMS officials provided us with a list of  Department of Defense and Department of Homeland Security  nonappropriated fund instrumentalities that have independent authority to  collect revenue and thus handle their own card collections. We reviewed  data for these entities as well. These entities included    Air Force Services Agency,    U.S. Army and MWR Command,    Army and Air Force Exchange Service,    Marine Corps Community Services,    Navy Exchange Service Command,    Navy Morale, Welfare and Recreation,    Coast Guard Exchange System, and    Coast Guard Morale, Well-being, and Recreation.
The U.S. Postal Service, Amtrak, and Smithsonian Institution operate their  own card collection programs as well and do not utilize FMS’s services,  thus we collected data directly from those entities for fiscal years 2005  through 2007. Smithsonian Institution and the Coast Guard Morale, Well- being, and Recreation were unable to provide us data on their card  collection programs for this period of time because they do not maintain  centralized program data on card revenues and fees. Instead, their card  operations are decentralized among the various locations in which they  operate. We also collected data from two private entities that accept tax  payments made by credit and debit cards on behalf of the Internal  Revenue Service (IRS). These two entities—Official Payments Corporation  and LINK2GOV—provide this service at no cost to IRS and instead charge  taxpayers who choose to use their services a convenience fee for doing so.  While we report the card acceptance fees associated with federal tax  payments for these two entities, we do not include them in the total  amount of card acceptance fees paid by federal entities. We did not  attempt to determine additional federal entities beyond those listed here  that may operate their own card collection programs and therefore pay  fees related to card acceptance.
From each of the entities that we collected data, we requested three pieces  of information for fiscal years 2005 through 2007:  total amount of revenue collected in credit and debit cards, total amount of interchange fees assessed on card transactions, and  total amount of merchant discount fees (for processing fees as well as  interchange fees) assessed on card transactions.
Only three entities—Amtrak, FMS, and the Postal Service—were able to  separately identify the amounts they paid in interchange fees. For the  other entities, we obtained the total amounts paid in merchant discount  fees. The data we collected on the costs associated with card acceptance  from the federal entities were the best data available; however, because of  limitations in and differences among the record keeping of the entities, the  data may not be complete for all years, may treat some costs  inconsistently, and in one case contain estimated, rather than actual,  values. For example, not all entities could provide us with complete data  for all 3 fiscal years, and some entities treated certain costs inconsistently,  such as including cost information for chargeback fees in their merchant  discount fee data. In another case, a federal entity used data from other  time periods to estimate some of the pieces of information we requested.  We reviewed these data for completeness and accuracy and determined  that none of the limitations materially affect the findings we report.  However, due to these limitations, the actual figures presented are best  viewed as approximations, or estimates in some cases, rather than precise  figures. The dollar values for this objective are reported as current dollars.
In addition to analyzing data from federal entities on the revenues and  costs associated with card acceptance, we also reviewed some federal  entities’ contracts or agreements with acquiring banks. To determine the  interchange fees applicable to the federal entities’ card transactions, as  well as the factors that cause interchange fees to vary, we reviewed  MasterCard and Visa interchange rate schedules effective beginning  October 2007 and April 2008. We also reviewed historical interchange rate  schedules for rates that were effective August 2003 through April 2007 that  were provided by an acquiring bank. Additionally, we interviewed  government officials responsible for settling card transactions, and  officials from American Express Company, Discover Financial Services,  MasterCard Incorporated, Visa Inc., and Fifth Third Bancorp—FMS’s  current acquiring bank—to gather information on how government  entities’ card acceptance fees are assessed and steps being taken to  manage the fees.
To examine actions taken in countries that have limited interchange fees,  we reviewed available literature, contacted our counterparts (other audit  institutions) in several countries, and interviewed Federal Reserve and  industry officials to identify various countries where regulators or others  had taken such actions. We judgmentally selected countries for further  examination from among those identified based on three criteria: (1)  actions had been taken that required actually determining interchange  rates, (2) information available on the methods they used to determine the  rates had been made available (3) efforts had been under way for  sufficient time to allow for study. To allow for illustration of diverse  approaches to limiting interchange fees, we sought to include countries  that had taken different types of actions. In addition, in order to study the  impacts of these actions, we sought to include countries where the effects  of the intervention had been the subject of empirical study. On the basis of  these criteria, we selected three countries—Australia, Israel, and  Mexico—for more detailed study. We conducted further literature reviews  on these countries and conducted interviews with officials involved in the  efforts to limit rates in each of these countries to learn about the measures  taken, other measures that were considered, and any empirical data on the  effects of the interchange limitation. Additionally, we met with officials  from the Board of Governors of the Federal Reserve System, Department  of Justice, and the Federal Trade Commission to learn how the regulatory  and legal structure in the United States addresses interchange fees.
To determine the impact on federal entities of using cards to make  purchases, we obtained and analyzed fiscal years 1999 through 2007  General Services Administration (GSA) SmartPay program data on  spending, transactions, and rebates received. On the basis of our review  and testing of GSA’s data for a separate engagement, we determined that  these data were sufficiently reliable for the purposes of this engagement.  Dollar values have been adjusted for this objective to fiscal year 2007  constant dollars using the gross domestic product (GDP) price index.  Additionally, we reviewed policies and procedures related to card usage  from GSA and other government entities, as well as our prior reports, and  academic and government reports. To obtain their views on the benefits  and drawbacks of card usage, we interviewed officials from GSA, 5 federal  entities that were among the 10 entities with the highest spending and  most transactions on cards in fiscal year 2006, the bank that issued cards  which accounted for the highest government card spending in fiscal year  2006, and one academic researcher with extensive work on government  use of cards.
We conducted this performance audit from June 2007 to May 2008 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Summary of Major Federal Antitrust Actions Surrounding Interchange Rates
paragraphs: The following identifies key cases concerning interchange fees.
In this 1980s case, NaBanco claimed that the setting of credit card  interchange fees by Visa member banks constituted unlawful price fixing.  NaBanco was a third-party enterprise that processed credit card  transactions for its client acquiring banks, who were members of the Visa  network. NaBanco alleged that the imposition of an interchange fee  affected the amount it could collect for its service, and that under Visa’s  rules the fee had an anticompetitive effect. The court ruled that NaBanco  did not satisfy its burden of proof under a “rule of reason” analysis to  show that interchange fees were a restraint of trade.
In 1998, Department of Justice (DOJ) sued Visa and MasterCard for alleged  antitrust violations. In that proceeding, the government focused on two  points. First, the department claimed that because the boards of Visa and  MasterCard were dominated by many of the same banks, intersystem  competition was reduced. Second, DOJ challenged the networks’  “exclusivity rules,” which prohibited member banks from issuing Discover  or American Express cards. The court ruled against the government on the  first claim (DOJ did not appeal) but found that the exclusivity rules were a  substantial restraint on competition in violation of the Sherman Act. The  district court invalidated the exclusivity rules, enjoined the defendants  from restricting banks from issuing other cards, and permitted Visa and  MasterCard issuers to terminate any contractual obligations to abide by  the exclusivity rules. Although the imposition of interchange fees was not  found to violate the law, the court noted that the defendants’ ability to  impose and change the fees was evidence of market power, which was an  element in proving the anticompetitive nature of the exclusivity rules.
Pending Class Action—U. S. District Court (E.D.N.Y.)
In a class action pending in the United States District Court for the Eastern  District of New York, merchants claim that interchange fees have an  anticompetitive effect in violation of the federal antitrust laws. This case  is a consolidation of numerous separate actions. As of October 2005,  merchants had instituted 14 class action lawsuits in four separate districts  against Visa and MasterCard and their member banks. According to the  Magistrate Judge assigned to the consolidated case, as of February 2006  “some forty class action lawsuits” had been brought “on behalf of a class  of merchants against the defendant credit card networks and certain of  their member banks.”
In March 2008, the Federal Court of Appeals for the Ninth Circuit upheld  the District Court’s dismissal of a claim in which merchants alleged that  the merchant discount fees set by Visa, MasterCard, Bank of America,  Wells Fargo Bank, and U.S. Bank violated Section 1 of the Sherman Act,15  U.S.C. § 1, and Section 16 of the Clayton Act, 15 U.S.C. § 26. The court  ruled that the plaintiffs failed to plead evidentiary facts necessary to  support such a claim. Specifically, the court found that the merchants  failed to allege facts necessary to support their theory that the banks  conspired or agreed with each other or with Visa and MasterCard to  restrain trade. With respect to the allegations against the banks, the court  observed that “merely charging, adopting or following the fees set by a  Consortium is insufficient as a matter of law to constitute a violation of  Section 1 of the Sherman Act.” Further, the court concluded that the  interchange fee set by Visa and MasterCard was not imposed directly upon  the merchants as an anticompetitive measure but instead constituted a  cost imposed on the banks which the banks passed on to the merchants as  a rational business decision.
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Dave Wood, Director; Cody  Goebel, Assistant Director; Rudy Chatlos; Isidro Gomez; Christine Houle;  Christopher Krzeminski; Marc Molino; Paul Thompson; Ann Marie Udale;  and Ethan Wozniak made key contributions to this report.