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The dirty secret to credit card rewards


An automatic upgrade to first class on a flight, cash back for your date night dinner, elite status hotel bookings - do those free credit card perks actually come at a price? And if so, who pays it? Well, our next guest argues that people with less financial security are subsidizing those bonuses for wealthier urban professionals. Chenzi Xu is a finance professor at the Stanford Graduate School of Business. Welcome to ALL THINGS CONSIDERED.


SHAPIRO: Explain this argument that credit card rewards amount to a tax on less affluent people. How does that work?

XU: So credit card companies charge fees for when merchants use cards, and this is because they provide a service. So interchange fees cover things like fraud protection, for instance. This is very useful, but actually, credit card companies want to compete for users. And they compete by creating really nice perks, and then they fund those perks on the back end by charging merchants more for every swipe. And so when merchants see, actually, I have a pretty big bill coming from interchange, what they do is they raise prices. And everybody pays those prices regardless of whether they're using a credit card or not.

SHAPIRO: And since less wealthy people use credit cards less frequently, they end up paying for the fancy perks that rich people are getting.

XU: Essentially, yes. So the prices that the merchants are using to recoup their losses on interchange are paid by everybody, and then the fees that the merchants are paying are being rebated back to wealthy credit card users.

SHAPIRO: There are lawmakers who see this as a problem. Tell us what people in Congress are talking about doing.

XU: So there was a Durbin amendment that was passed a while ago that regulates interchange fees and debit cards, and when that happened, we saw that debit rewards went down. Senator Durbin has essentially introduced a bill that would do the same for credit cards. And I believe the idea is to model it somewhat like the way interchange is regulated in Europe, for instance, where once you cap the amount of fees that can be charged to merchants, what you'll see is that there's actually not going to be enough to fund these rewards. And so the rewards go away, but now that the fees are lower, the merchants aren't passing on those fees to prices as much as they would have done before.

SHAPIRO: So what advice do you have for consumers?

XU: Well...

SHAPIRO: I mean, like, is this the credit card companies' and the lawmakers' problem? Or if I'm using a card and worried that the perks are unethical or if I'm not using a card and worried that I'm carrying the water of rich people, like, what - should this be a concern to the individual?

XU: Well, this is one of those cases where the structure of the way cards compete for customers and the way merchants try to compete for customers makes it so that, you know, if you're carrying a card, you're strictly better off, and you want to keep doing that. And it's hard to get out of that system without something that looks like system-wide interchange regulation.

SHAPIRO: Sounds like you're saying there's not much the individual can do.

XU: Yeah. I mean, if you are a business owner who sets prices, you can potentially price discriminate. If we...

SHAPIRO: You mean, like, charge a fee for credit card users.

XU: Exactly. If we live in a world where everybody just paid the fees that their payment method actually charged the store, then this redistributive element would go away. Right now everybody pays the same price, but some get the perk, and some don't.

SHAPIRO: So if every business owner just said, you use a credit card; you're going to pay 1% more or whatever it is, this problem would more or less be solved.

XU: This problem would be mitigated by a lot. Yes.

SHAPIRO: That's Stanford Business School finance professor Chenzi Xu. Along with Jeffrey Reppucci, she wrote an opinion piece in The New York Times with the headline "The Dirty Little Secret Of Credit Card Rewards Programs." Thank you.

XU: Thank you. Transcript provided by NPR, Copyright NPR.

Ashley Brown is a senior editor for All Things Considered.
Ari Shapiro has been one of the hosts of All Things Considered, NPR's award-winning afternoon newsmagazine, since 2015. During his first two years on the program, listenership to All Things Considered grew at an unprecedented rate, with more people tuning in during a typical quarter-hour than any other program on the radio.