Credit Cards and the Tragedy of The Commons
I’ve noticed here in the personal finance corner of the blogosphere that many of my fellow financial bloggers are promoting various credit cards. While many bloggers promote the fact that many cards have very generous cash back or enrollment bonuses (up to $500), the blogs are also making money on this promotion. Many financial blogs receive affiliate advertising money from links to credit card enrollment sites, and I understand that some of the affiliate fees going to bloggers can be nearly $90 per accepted card enrollment.
To be clear, using credit cards with high cash back benefits can get you back a significant amount of money. For example, the card that I use provides 6% cash back on grocery store purchases. This is probably worth about $300 per year, which is a significant amount of money. Many financial bloggers encourage readers to funnel all retail purchases through these cards to get the cash back benefits, and that is not bad advice. Further, using credit cards does afford a consumer certain protections from financial fraud – credit card providers take the hit if your card or card number is stolen and used to make fradulent purchases. Some cards also provide benefits like insurance on rental cars. I personally use my card for all of the above benefits.
However, all of these benefits do not come free, and this is where the tragedy of the commons comes into play. I am referring to merchant fees, which are the payment processing fees that credit card companies and banks (for debit cards) charge to retailers for processing the card transactions. This is also why tech companies are desperate to get into the payment processing business – there is a lot of money to be made in a 70% consumer economy.
First, we must understand that there are two types of card payment fees: credit and debit. Credit card fees are charged by traditional credit card companies or when you use your debit card as the “credit” option. Fees charged to merchants when you use your credit card can range from 2% to 5%. It is no wonder that my card can provide 6% cash back on groceries when they are charging 5% to the merchant! Of course, the merchants just pass these fees on to consumers as higher retail prices. This is the tragedy of the commons – we use our credit cards to get the personal cash back benefits, but we are all paying higher retail prices for this supposed benefit.
Debit cards have much lower merchant fees. In fact, these fees were actually regulated by the Federal Reserve as a result of the Durbin Amendment to the Dodd Frank Wallstreet Reform Act. As a result, banks can only charge merchants .05% of the transaction value plus a fixed fee of $.21 for each transaction. As Nobel-winning economist Joseph Stiglitz explains in this interview at Democracy Now!, the Federal Reserve actually fought against even lower rates under the Durbin Amendedment, and won in a court battle against retailers.
The results of these merchant fees for credit card and debit card transactions, and particularly the high credit card fees, is that a type of “sales tax” funnels billions of dollars each year out of the pockets of ordinary consumers, as well as retailers, and into the coffers of banks and credit card companies. This is just one way that the financial services industry makes money at the expense of ordinary people. Even if you pay your credit card balance each month, we are all collectively paying the costs of using credit cards.
What can we do about this injustice? While the retailer court challenge to the Fed’s inflated debit transaction fee rates failed, these fees are still a tiny percentage of the fees that credit card companies charge. To encourage financial justice, we must all use our debit cards when making retail purchases rather than credit. The result is that we collectively lower retail transaction fees from as much as 5% down to a regulated rate of .05%. This is a significant savings that retailers will eventually pass on to consumers if enough consumers start selecting “debit” and punching in their pin numbers. Do you want to be very radical? You could even use cash to pay for retail purchases, but what do you do then with all of the pocket change!?
I should note that there are times that I will use my credit card, and I always keep my credit card with me for emergencies. I always use my credit card where security or fear of swiping/card theft is a concern (e.g., restaurants), and I always use my credit card for car rentals to take advantage of the built-in car insurance in my card. However, I no longer use my credit card to take advantage of the “cash back” benefit, because I realize that I’m just harming all consumers by accepting this sort of “bribe” from the credit card companies. I hope you will do the same. Together we can start to take back some of our financial freedom from the finance industry!