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Popular Media The claim that rewards credit cards benefit the rich at the expense of the poor has been trotted out many times by those who want . . .
The claim that rewards credit cards benefit the rich at the expense of the poor has been trotted out many times by those who want to cap the fees charged to merchants by card issuers. Though the myth of this so-called “reverse Robin Hood” effect has been debunked repeatedly, it continues to resurface from the grave. This is troubling for various reasons—not least because capping interchange fees would actually harm the poor the most.
Read the full piece here.
ICLE Issue Brief This paper considers the evidence for and against the reverse Robin Hood hypothesis, finding that the reverse Robin Hood may be more mythical than the original Robin Hood.
News consumers have been treated to a litany of stories in recent years highlighting the purportedly regressive nature of credit-card rewards programs. The coverage centers on a hypothesis about rewards credit cards: that because merchants pay higher interchange fees for credit cards with rewards and then pass those costs on to consumers, it must be the case that users of cash, debit, and non-rewards credit cards effectively subsidize users of rewards credit cards. This hypothesis presumes that users of rewards credit cards tend to be more affluent than those who pay with cash, debit, or non-rewards cards. It is therefore asserted that this arrangement constitutes a transfer of wealth from poorer consumers to more affluent consumers. As newspaper and website headlines declare:
It isn’t just the consumer press that has explored this “reverse Robin Hood” hypothesis. Two working papers from authors at the Federal Reserve Bank of Boston, from 2010 and 2020, likewise argue that credit-card-rewards programs largely benefit higher-income consumers at the expense of lower-income consumers. In response, there have been calls for regulatory intervention in order to redress the harms felt by lower-income consumers due to these supposedly unfair practices.
It is a fundamental feature of retail consumer markets that not every consumer gains the same amount from every amenity or service offered by a merchant. For example, “free parking” at a grocery store or shopping mall benefits wealthier people who are more likely to own cars than lower-income people who do not. Higher-income people are more likely to earn free trips using frequent-flyer miles than lower-income people who travel less. Simply because higher-income people may benefit more than lower-income people from a retailer’s loyalty program or some other benefit does not automatically suggest the presence of a market failure or a need for regulatory intervention.
This paper considers the evidence for and against the reverse Robin Hood hypothesis. Much like the original Robin Hood narrative, it is a moralistic story in which one income group benefits at the expense of another. In the original story, the outlaw Robin Hood and his Merry Men rob from the rich and give to the poor. In the “reverse Robin Hood” story, credit-card companies rob from the poor users of cash and give to the rich users of credit cards. But there are real problems with this story. Indeed, the reverse Robin Hood may be more mythical than the original Robin Hood.
Part I describes a strong form of the reverse Robin Hood hypothesis in more detail, focusing on studies published by the Brookings Institution and the Boston Federal Reserve Bank. Despite the popularity of this hypothesis, and the seeming endorsement from scholars, there are many problems with the reverse Robin Hood narrative that should be understood before it used as the basis for public policy. Part I breaks down the hypothesis into a series of conjectures which are considered later in the paper.
Part II subjects this strong form of the reverse Robin Hood hypothesis to economic scrutiny. First, the economics of multisided markets is introduced to provide a basic framework to understand the operation of credit-card networks and the roles played by interchange fees and rewards programs. This framework helps explain that all participants in the credit-card ecosystem benefit from its establishment of complex relationships. Sometimes, this means participants on one side of the platform, such as merchants, pay charges that are used to provide benefits to another side of the platform, such as consumers. But doing so often ultimately benefits participants on the side that pays—for example, by increasing their sales sufficiently that net income increases despite the additional cost. Mandating changes to one part of the system—for example, by capping credit-card interchange fees—could affect other platform participants in unexpected ways, including by reducing benefits to consumers, who make fewer purchases, which results in lower net income for merchants.
Second, the logic of the reverse Robin Hood hypothesis is analyzed in light of those economic principles, as well as the system’s empirical realities. Implicit to the conjectures that make up the reverse Robin Hood hypothesis are a number of propositions that must be true for the hypothesis to be upheld. Two main observations falsify the hypothesis. First, merchants are not able to pass on all costs to consumers. Second, the availability of rewards cards is more tied to credit ratings than to income, which means that even those with lower incomes do benefit from the use of rewards cards.
Part III considers a weaker form of the reverse Robin Hood hypothesis from a 2020 Boston Fed Study. This study attempts to establish regressivity by positing a larger “net pecuniary cost” as a percentage of transaction value for lower-income consumers compared to higher-income consumers. But to do so, it must assume a pass-through rate of merchant costs that is inconsistent with known estimates from the empirical literature. While it may be the case that wealthier rewards-card users benefit even more from rewards than those who use them less, this hardly means that there is a harm that demands regulation, any more than it would make sense to regulate access to parking lots because car owners may tend to be wealthier on average than those who commute by public transportation.
Finally, the brief considers the likely distributional effects of proposed legislative or regulatory action to target credit-card interchange fees. Specifically, Part IV considers the evidence related to merchant pass-through of interchange-fee caps in the form of lower prices for consumers, as well as the likely ways banks and other card issuers would adapt to any such fee caps. If the experience with caps on debit card fees under the Durbin Amendment is any indication, the benefits of interchange-fee caps will be much smaller than the costs to consumers, especially lower-income consumers.
Read the full issue brief here.
TL;DR Data is one of the pillars of the modern digital economy, but its value is contingent on its ability to flow around the globe in real time, permitting individuals and firms to develop new and novel insights and to operate at higher levels of efficiency and safety.
Data is one of the pillars of the modern digital economy, but its value is contingent on its ability to flow around the globe in real time, permitting individuals and firms to develop new and novel insights and to operate at higher levels of efficiency and safety.
Those data flows increasingly run into barriers when they seek to cross national borders. These often take the form of “data-localization” requirements to locate, store, and/or process data within national boundaries.
Data-localization policies are often framed as necessary to protect critical digital infrastructure and national-security interests, but they serve instead as trade barriers that hurt consumers more than they help. An examination of the impact on the financial services industry helps to illustrate the problem.
Read the full explainer here.
TOTM The U.S. economy survived the COVID-19 pandemic and associated government-imposed business shutdowns with a variety of innovations that facilitated online shopping, contactless payments, and reduced . . .
The U.S. economy survived the COVID-19 pandemic and associated government-imposed business shutdowns with a variety of innovations that facilitated online shopping, contactless payments, and reduced use and handling of cash, a known vector of disease transmission.
TL;DR The Dodd-Frank Act of 2010 set price controls for debit-card interchange fees charged by banks with more than $10 billion in assets.
The Dodd-Frank Act of 2010 set price controls for debit-card interchange fees charged by banks with more than $10 billion in assets. Known colloquially as the “Durbin Amendment” after Sen. Dick Durbin, who sponsored the original proposal, the provision was supposed to cut costs for customers and merchants by cutting the interchange fees charged by large banks roughly in half.
Covered banks and credit unions have recouped these losses by eliminating free checking accounts, raising minimum balance requirements, and charging higher maintenance fees. While retailers have seen cost reductions as a result of the Durbin Amendment, there is little evidence those savings have been passed on to consumers.
In recent years, some lawmakers have signaled interest in limiting interchange fees on credit-card transactions, as well. Some elements of the retail sector likewise sought a cap on credit card interchange fees as part of COVID-19 relief legislation in 2020. Sen. Durbin himself also recently suggested the Durbin Amendment’s cap on interchange fees should be extended to credit cards. The predictable result would be a reduction in credit and rewards programs made available to consumers.
Scholarship Many people hope that data interoperability can increase competition, by making it easier for customers to switch and multi-home across different products. The UK’s Open . . .
Many people hope that data interoperability can increase competition, by making it easier for customers to switch and multi-home across different products. The UK’s Open Banking is the most important example of such a remedy imposed by a competition authority, but the experience demonstrates that such remedies are unlikely to be straightforward. The experience of Open Banking suggests that such remedies should be applied with focus and patience, may require ongoing regulatory oversight to work, and may be best suited to particular kinds of market where, like retail banking, the products are relatively homogeneous. But even then, they may not deliver the outcomes that many hopes for.
Data portability and interoperability tools allow customers to easily move their data between competing services, either on a one-off or an ongoing basis. Some see these tools as offering the potential to strengthen competition in digital markets; customers who feel locked in to services that they have provided data to might be more likely to switch to competitors if they could move that data more easily. This would be particularly true, advocates hope, where network effects grant existing services value that new rivals cannot emulate or where one of the barriers to switching services is the cost of re-entering personal data.
The UK’s Open Banking system is one of the most mature and important examples of this kind of policy in practice. As such, the UK’s experience to date may offer useful clues as to the potential for similar policies in other markets, for which the UK’s Furman Report has cited Open Banking as a model. But fans of interoperability sometimes gloss over the difficulties and limitations that Open Banking has faced, which are just as important as the potential benefits.
In this article, I argue that Open Banking provides lessons that should both give hope to optimists about data portability and interoperability, as well as temper some of the enthusiasm for applying it too broadly and readily.
I draw on my experiences as part of the team that produced the industry review “Open Banking: Preparing For Lift Off” in 2019. That report concluded that Open Banking, though promising, needed several additional reforms to succeed, a few of which I discuss in this piece. I was also the co-author of a white paper that argued for an Open Banking-like remedy in the UK’s retail electricity market, which I discuss briefly below. All views expressed here are my own.
I argue that there are three main lessons to draw from Open Banking for considerations of similar remedies in other markets:
I conclude that Open Banking has not yet led to noticeably stronger competition in the UK banking sector. Implementation challenges suggest that taking an equivalent approach to other markets would require more time, investment and effort than many advocates of interoperability requirements usually concede and may not deliver the anticipated benefits. To the extent that Open Banking is to be a model, it would be best applied as a focused approach in markets that bear particular characteristics and where the costs are outweighed by the benefits, rather than a blanket measure that can be applied to every market where customer data matters.
Read the full white paper here.
TOTM Excess is unflattering, no less when claiming that every evolution in legal doctrine is a slippery slope leading to damnation. In Friday’s New York Times, . . .
Excess is unflattering, no less when claiming that every evolution in legal doctrine is a slippery slope leading to damnation. In Friday’s New York Times, Lina Khan trots down this alarmist path while considering the implications for the pending Supreme Court case of Ohio v. American Express. One of the core issues in the case is the proper mode of antitrust analysis for credit card networks as two-sided markets. The Second Circuit Court of Appeals agreed with arguments, such as those that we have made, that it is important to consider the costs and benefits to both sides of a two-sided market when conducting an antitrust analysis. The Second Circuit’s opinion is under review in the American Express case.
Scholarship Over the past 20 years, credit cards have become an increasingly popular means of paying for goods and services in Canada. Today nearly 90 percent of Canadian adults own a credit card and approximately 65 percent of all point of sale payments are made using credit cards.
Over the past 20 years, credit cards have become an increasingly popular means of paying for goods and services in Canada. Today nearly 90 percent of Canadian adults own a credit card and approximately 65 percent of all point of sale payments are made using credit cards.
The rise of credit cards has been driven by the benefits that accompany their use, including convenience, security, insurance, and warranties on purchases. But arguably the biggest driver has been the rewards that cards offer, such as cash back, Air Miles or Aeroplan rewards, or merchant-specific rewards. About 80 percent of Canadians with credit cards have at least one card that offers rewards for use, and owners of credit cards with rewards say that the rewards are the primary reason they use their rewards card for purchases.
The benefits provided by credit cards are paid for by the issuing bank through a combination of annual fees charged to cardholders and transaction fees charged to merchants. In closed-loop three-party card systems (primarily American Express, as well as international cards issued by Discover), the payment card provider charges both merchants and consumers directly. In four-party card systems (Visa and Mastercard), card issuers charge cardholders directly but the fees from merchants come via the acquirer (such as a merchant’s bank), which charges merchants a service charge. The largest portion of the merchant service charge is the interchange fee, which is passed on to issuing banks.
In spite of the higher annual fees on cards with more benefits, the vast majority of consumers report that they receive more benefits from their cards than the cost of the fees they carry. Middle class consumers are the major beneficiaries of credit card rewards. A consumer or household earning $40k might expect annual rewards valued at $450, while paying fees of $75, providing a net bene t of $375. Meanwhile, a consumer or household earning $90k might expect benefits of about $1350 while paying $225 in fees, providing a net bene t of around $1125.
Merchants, however, are less happy with the higher interchange fees. Apparently assuming that all of the bene t of rewards cards accrues to users, while merchants bear the added interchange cost, these merchants say that the increase has negatively affected their profitability. Of note, however, the number of merchants who accept credit cards, after falling in the early 2000s, has increased in the past decade – and appears to have risen more rapidly following the introduction of more generous rewards cards, in spite of a rise in accompanying interchange fees.
Some merchant groups have, in fact, called for the government to impose caps on interchange fees; in February 2016, a private member’s bill was introduced in Parliament seeking to do just that.
Interchange fee caps, like other price controls, tend to have predictable effects: as a rule, they result in other prices increasing, leading to a redistribution, but not a reduction, in overall costs. Several other countries have introduced caps on interchange fees, including, of particular relevance, the caps introduced in Australia in 2003. These caps resulted in a significant increase in the annual fees charged to cardholders and a substantial reduction in the rate at which card use earned rewards.
Using data on and analysis of the effect of Australia’s interchange fee caps, combined with publicly available and proprietary data on Canadian credit card use, household income and expenditure, and other economic variables, the authors of this report modelled the likely effects of introducing a cap on interchange fees in Canada. They estimate that, were an interchange fee cap imposed here, it would have significant negative consequences for Canadian consumers and the Canadian economy as a whole. Specifically, they estimate that if interchange fees were forcibly reduced by 40 percent:
The authors estimate that a tighter cap on interchange fees would have a more dramatic negative effect on middle class households and the economy as a whole.
They also provide specific case studies for three typical middle class households, showing how a cap on interchange fees, along the lines of those imposed in Australia, would affect their household income and expenditure.
Continue reading at Macdonald-Laurier Institute
ICLE White Paper During the past decade, academics—predominantly scholars of behavioral law and economics—have increasingly turned to the claimed insights of behavioral economics in order to craft novel policy proposals in many fields, most significantly consumer credit regulation.
During the past decade, academics—predominantly scholars of behavioral law and economics—have increasingly turned to the claimed insights of behavioral economics in order to craft novel policy proposals in many fields, most significantly consumer credit regulation. Over the same period, these ideas have also gained traction with policymakers, resulting in a variety of legislative efforts, such as the creation of the Consumer Financial Protection Bureau.
In 2016 the issue reached the Supreme Court, which granted certiorari in Expressions Hair Design v. New York for the October 2016 term. The case, which centers on a decades-old New York state law that prohibits merchants from imposing surcharge fees for credit card purchases, represents the first major effort to ground constitutional law (here, First Amendment law) in the claims of behavioral economics.
In this article we examine the merits of that effort. Claims about the real-world application of behavioral economic theories should not be uncritically accepted— especially when advanced to challenge a state’s commercial regulation on constitutional grounds. And courts should be especially careful before relying on such claims where the available evidence fails to support them, where the underlying theories are so poorly developed that they have actually been employed elsewhere to support precisely opposite arguments, and where alternative theories grounded in more traditional economic reasoning are consistent with both the history of the challenged laws and the evidence of actual consumer behavior. The Petitioners in the case (five New York businesses) and their amici (scholars of both behavioral law and economics and First Amendment law) argue that New York’s ban on surcharge fees but not discounts for cash payments violates the free speech clause of the First Amendment. The argument relies on a claim derived from behavioral economics: namely, that a surcharge and a discount are mathematically equivalent, but that, because of behavioral biases, a price adjustment framed as a surcharge is more effective than one framed as a discount in inducing customers to pay with cash in lieu of credit. Because, Petitioners and amici claim, the only difference between the two is how they are labeled, the prohibition on surcharging is an impermissible restriction on commercial speech (and not a permissible regulation of conduct). Assessing the merits of the underlying economic arguments (but not the ultimate First Amendment claim), we conclude that, in this case, neither the behavioral economic
The Petitioners in the case (five New York businesses) and their amici (scholars of both behavioral law and economics and First Amendment law) argue that New York’s ban on surcharge fees but not discounts for cash payments violates the free speech clause of the First Amendment. The argument relies on a claim derived from behavioral economics: namely, that a surcharge and a discount are mathematically equivalent, but that, because of behavioral biases, a price adjustment framed as a surcharge is more effective than one framed as a discount in inducing customers to pay with cash in lieu of credit. Because, Petitioners and amici claim, the only difference between the two is how they are labeled, the prohibition on surcharging is an impermissible restriction on commercial speech (and not a permissible regulation of conduct). Assessing the merits of the underlying economic arguments (but not the ultimate First Amendment claim), we conclude that, in this case, neither the behavioral economic
Assessing the merits of the underlying economic arguments (but not the ultimate First Amendment claim), we conclude that, in this case, neither the behavioral economic theory, nor the evidence adduced to support it, justifies the Petitioners’ claims. The indeterminacy of the behavioral economics underlying the claims makes for a behavioral law and economics “just-so story”—an unsupported hypothesis about the relative effect of surcharges and discounts on consumer behavior adduced to achieve a desired legal result, but that happens to lack any empirical support. And not only does the evidence not support the contention that consumer welfare is increased by permitting card surcharge fees, it strongly suggests that, in fact, consumer welfare would be harmed by such fees, as they expose consumers to potential opportunistic holdup and rent extraction.
As far as we know, this is the first time the Supreme Court has been expressly asked to consider arguments rooted in behavioral law and economics in reaching its decision. It should decline the offer.
