Payment card interchange fees, which were paid without contention for almost seven decades, are now the source of controversy. An interchange fee is paid by the merchant's bank to the cardholder's bank (that issued the card) after the cardholder purchases goods or services with a payment (credit or debit) card. The Durbin Amendment to S. 3217 as amended and incorporated into the Senate-passed version of H.R. 4173 proposes to ensure that small businesses and other entities that accept debit cards pay a reasonable and proportional price for using the payment card networks and prohibit the payment card network from imposing anti-competitive restrictions on small businesses and other entities that accept payment cards, such as providing discount to customers who pay with cash. Earlier in the 111 th Congress, the House Judiciary Committee had introduced interchange fee legislation. On June 4, 2009, House Judiciary Chairman John Conyers Jr. introduced the Credit Card Fair Fee Act of 2009 ( H.R. 2695 ), which would require voluntary interchange fee negotiations among merchants, the Visa and MasterCard associations, and card-issuing banks. It would also require that the negotiating parties file the negotiation schedule with the U.S. Attorney General within one month of the enactment of the bill. If the negotiating parties do not file such a schedule within one month, the Attorney General would issue the schedule. The act would grant the negotiating parties limited antitrust immunity for negotiation of access fees and terms for using the electronic payment system to make electronic transactions. Some opponents of H.R. 2695 argue that the bill would force interchange negotiations whether or not the stake holders are interested in such negotiations. The Credit Card Accountability, Responsibility and Disclosure Act of 2009 ( P.L. 111-24 ) was enacted on May 22, 2009, two weeks before H.R. 2695 was introduced. P.L. 111-24 did not mandate any change in interchange fees. However, it directed the Government Accountability Office (GAO) to complete a study of the interchange issues within six months of its enactment. In the 110 th Congress, Chairman Conyers established a congressional task force to look into interchange fees because some merchant and consumer groups had complained that these fees are cutting into merchants' profits and are costing the cardholders and non-cardholders, who ultimately pay the fee in the price of the goods or services. According to Chairman Conyers, "in 2005, U.S. families paid an average of more than $300 for hidden interchange fees including households that do not even use credit cards." Another source estimated that, "in 2007, retail merchants in the United States will pay banks issuing Visa and MasterCard payment cards more than $30 billion in collectively set per transaction interchange fees." At issue are increases in interchange fees set by the credit card associations like Visa and MasterCard and card-issuing banks or companies like Discover Card and American Express to enable merchants to gain access to the associations' and issuers' electronic payment network. Interchange fees have been rising since the 1990s, despite diminishing fraud losses and technological advances in communications that lowered the costs of accessing the electronic payment system. Merchants argue that the card associations have not negotiated these fees with them but instead present them as take it or leave it offers. Economists who have studied the payment card market attribute the higher interchange fees to the nature and structure of the market, which is not the traditional market but a two-sided market. Within this structure, they have identified two conditions that, combined, could lead to high interchange fees. The conditions are where the payment card issuers have market power and merchants have an inelastic demand for accepting payment cards. Some commentators note that if it is determined that interchange fees are excessive as a result of issuing banks' marketing power, those circumstances could lead to the government imposing legal or regulatory caps on interchange fees, as was the case in Australia and the United Kingdom. Related questions have been raised concerning the mechanism the government might use to induce merchants to lower their prices and pass the excess revenues back to the cardholders. In these two countries, the pass back of the fees through price reduction has been voluntary, and there is no formal evidence that merchants lowered their prices. This report focuses on the Visa and MasterCard card associations that account for more than three-fourths of the payment card market, with Visa accounting for 44% and MasterCard accounting for 31% of the market in the United States in 2008. The report does not discuss unitary payment card systems, such as American Express and Discover cards, that issue virtually all their own cards and sign up their own merchants. This report does not analyze the application of antitrust statutes to interchange fees. The report begins with a discussion of the nontraditional structure of the payment card market. The second section is an analysis of the problem of the optimum level of payment cards to achieve the highest social welfare benefit for cardholders and merchants. The third section discusses the Durbin Amendment to the Restoring American Financial Stability Act of 2010 ( S. 3217 ) and provisions of the Credit Card Fair Fee Act of 2009 ( H.R. 2695 ) and 2008 ( H.R. 5546 ), respectively. The last section discusses the implications of the analysis. There are several components of cost in a payment card transaction. When a consumer makes a purchase with a payment card, the merchant's account at the merchant's bank, the acquirer bank, is credited with the purchase amount, less an amount called the merchant discount fee . The merchant discount fee consists of a flat rate in the amount ranging from a few cents to a dollar or a percentage amount of the purchase. The total fees usually range from 1% to 3% but could be as high as 15% for merchants who are of high risk because of low transaction volume, limited credit history, or the nature of their business. The acquirer bank retains part of the merchant discount fee, and the remainder is remitted to the network association. The interchange fee is this remittance to the network association. The remittance to the card issuer is also called the interchange fee . The network association that receives the remittance from the acquiring bank keeps a small portion of it for the costs of authorization, clearing, and settling the transaction. The association remits the rest to the issuer bank to cover the costs of funding the purchase, chargebacks (returns), and fraud risks. The network association sets the interchange rates annually. The level of the fees charged by the network is partially based on the interchange rate, which is set by the issuing and acquirer banks. Thus, the merchant discount fee is the interchange rate plus an additional percentage taken by the acquirer bank. However, the interchange rate does not vary much on the basis of the cost of the transaction. It varies mainly on the merchant's type and the level of bundled reward points attached to a particular payment card. As mentioned above, the merchant's discount fee varies by the merchant's risk profile and the acquirer bank profit component of the fee. Overall, the interchange rates are lower in stable, low-margin industries like groceries and higher in small volume, high-risk businesses like adult Internet websites. Explicit costs in the Visa or MasterCard association network reflect the associations' rules. These rules include merchant restraints that are designed to increase card usage at the expense of all other types of payments and to maintain higher interchange rates: (1) Merchants are forbidden to impose a surcharge for the use of payment (credit or debit) cards [no surcharge rule], even though card transactions cost merchants more than some other payment methods. The effect is to prevent merchants from passing on the cost of the payment card directly to their customers, who use the card, which would give their customers a disincentive to use the card. Thus, the merchants absorb the payment card transaction costs. (2) Merchants are required to take all credit cards bearing the card association brand [honor-all-cards rule], and they are required to accept these cards at all outlets [all-outlets rule]. In addition, (3) merchants are prohibited from offering discounts to particular types of cards [non-differentiation rule]. These rules prevent merchants from operating at overall minimum cost because the rules force them to accept all [all or none rule] the association's cards, even though different cards have different costs attached to them. To summarize the description of the mechanism, Figure 1 shows an example in which the merchant discount fee is 2.6% as set by the banks and the card association. For this discount, the merchant may attract cardholder customers and potentially higher sale volume, guaranteed payments, and reduced administration and accounting costs, as well as increased checkout efficiency. On the cardholder side, the card issuer bank issues payment cards to cardholders at its own costs, including card production and advertisements. In the beginning of card issuance, cardholders paid an annual fee for most cards. Today, issuer banks are profitable enough from the lines of credit attached to their cards as well as related fees (such as late and overdraft fees) that they generally no longer demand annual fees. More important, issuer banks are in highly competitive markets where the elasticity of demand for payment cards is high enough to force the fees to practically zero. In a card association network, the association serves as an active umbrella organization for four parties: (1) the acquiring bank and (2) the merchant, on one side, and (3) the issuing bank and (4) the cardholder, on the other. Starting at the bottom of Figure 1 , the cardholder purchases goods or services for $100.00 with a payment card. The accounting information goes to the merchant's acquirer bank as an account receivable. The acquirer bank credits the merchant's account $97.40, which is the merchant discount that was agreed to by accepting the card.