One huge plus arising out of this horrible recession has been Americans' drop in credit card use. In July, the Federal Reserve Board reported that borrowing via plastic fell 6.3 percent from the previous year. In fact, some analysts expect only 45 percent of consumers to use their cards this year -- that's down from 87 percent only three years ago. Less charging equals less debt, and less debt means that fewer people are paying 19% in interest annually -- and they're winding up with more real money to spend.
But those who have saved money by steering clear of credit cards should refrain from wallowing in that old wealth effect just yet. According to a paper published this summer by the Federal Reserve Bank of Boston, they are still paying plenty, mostly to subsidize those who do use credit cards: "On average, each cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash users every year," declared the study. That's a total annual transfer of $1,282 from the presumably frugal to the more extravagant spender.
How could this be? Although the three authors of the report, Scott Schuh, Director of the Consumer Payments Research Center at the Boston FRB and his economist colleagues Oz Shy and Joanna Stavins, deploy gobs of data and equations with exponents and Greek letters to make their case, the explanation is fairly simple. When accepting credit cards, merchants pay interchange fees to the banks that issue them. To cover those costs, merchants raise prices -- not just on peoople who actually use cards but on everybody -- all cash payers -- among them those who write checks, use debit cards or even exchange wampum. The fees go partly to finance the rewards credit-card holders garner, for example, air miles, free meals, discounts and so on. Ergo, the all-cash crowd subsidizes them too.
This transfer has an even more invidious aspect, however. Higher-income people use cards more often than folks of more modest means -- and collect more rewards. (The more you charge, remember, the more goodies you harvest.) The authors calculate that each cash-paying household with an income below $20,000 underwrites every credit-card using household with an income over $150,000 some $8 a year, and each of the latter collect $430 annually from maybe 54 of the poorer households. According to the report, "about 79 percent of banks' revenue from credit card merchant fees is obtained from cash payers and disproportionately from low-income cash payers." Pretty outrageous.
Solutions aren't easy to come by. The authors suggest, among other fixes, cost-based pricing, which would allow merchants to charge people who use GreedyCard, for example, 2 percent more to defray the cost of fees to its bank, but only 1.5 percent more for those using LessGreedyCard which charges lower fees. (Currently, credit card companies prohibit such surcharges.) Scott Schuh advocates more disclosure of fees, costs and price markups. "Consumers need to be aware that merchants pay fees that are passed on," he says. Conceivably, if you were informed, you would use a credit card with lower interchange fees. But to make sure fees were lower, you might find yourself shopping more often than not at giant stores like Target or Walmart that have the power to negotiate lower fees with credit card companies. Mom and pop stores would lose your business. The most efficient solution would probably have the Federal Reserve or another government agency setting limits --hopefully lower limits -- on interchange fees. That would lower costs for consumers and merchants alike.
Meanwhile, what should you do? Right now, there's no way out. If you use cash, checks or a debit card to pay for stuff, you avoid taking on debt, but you have to feel like a bit of a chump for subsidizing that hedge fund manager who flies to Gstaad. If you are that hedge fund manager, you should feel a little guilty that you are taking a vacation on the backs of the poor and the thrifty. Maybe the only solution for now is to charge with abandon, collect all the rewards you can, but pay off your bill every month -- and, if you must ease your conscience, regularly put something extra in the collection box.