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Unpublished Paper
Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses From Credit Card Payments? Theory and Calibrations
ExpressO (2012)
  • Steven Semeraro, Thomas Jefferson School of Law
Abstract: Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations For two decades, economic and legal academics have speculated about the impact of the fees that merchants pay for credit card acceptance. Since all customers pay the same price, the theory goes, everyone pays for the benefits that go only to credit card users. A recent Federal Reserve Bank of Boston (FRBB) policy paper written by economists Scott Schuh, Oz Shy, and Joanna Stavins entitled Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations has taken the argument a step further, contending that existing credit card programs reduce consumer welfare by transferring money from low-income households that purchase goods and services with payment mechanisms other than credit cards to high-income households that pay with reward cards. In response, the authors suggest (1) eliminating card system rules that prohibit merchants from surcharging credit card transactions and (2) directly regulating merchant fees and reward rates. This article shows that the FRBB economists’ proposals would certainly reduce the value of reward card programs and thus the welfare of all reward card users. By contrast, any potential benefit to those not using cards would be quite speculative. To support their welfare predictions, the FRBB authors claim that one can draw meaningful conclusions about consumer welfare effects by assuming that (1) merchants pass on the marginal cost of card acceptance through their retail prices to all consumers on a dollar-for-dollar basis; and (2) the only relevant benefit in assessing the consumer welfare impact of payment system choice is the reward paid to credit card users. The data on which the FRBB authors rely do not confirm these assumptions. On the contrary, they are almost certainly wrong. Credit card acceptance benefits merchants, banks, and even consumers using other payment mechanisms in ways that impact the net prices paid by all customers. Merchants would not mark up their retail prices by the full marginal cost of credit card acceptance costs over other means of payment if, for example, card acceptance (1) increases sales by enabling consumers to shop more efficiently – alleviating the need to predetermine the amount of cash needed or knowing ones checking account balance – enabling a merchant to spread its fixed costs over more sales or (2) reduces other costs such as the risk of unpaid checks, late payment, default, and collection expenses. And banks may use reward card system profits to innovate and expand products that benefit all consumers, such as more effective fraud protection, enhanced security, and systems that speed up transactions at the point of sale. Moreover, although consumers who choose not to use credit cards by definition do not receive rewards, they benefit from their payment choice in other ways. First, reward card use, like all card use, creates spillover effects – such as faster checkout times – benefiting all customers. Second, overwhelmingly consumers choose to use non-credit-card payment mechanisms for some purchases and reward credit cards for others, necessarily benefitting themselves in ways not fully accounted for in the FRBB policy paper. As a result, the FRBB authors’ welfare calculations are at best overstated and potentially entirely inaccurate. Finally, the FRBB authors’ specific policy proposals – encouraging surcharging and regulating fees – could have serious, negative unintended consequences. The ubiquitous nature of rewards programs and other retailing strategies that benefit those who spend heavily suggests that these programs have economic benefits. Rather than undermining card rewards, any regulatory activity in credit card markets should focus on expanding the availability of consumer-welfare enhancing reward programs to those consumers who currently choose not to use them. The FRBB authors’ proposals designed to reduce reward card availability thus point in precisely the wrong direction.
  • credit cards,
  • rewards,
  • merchant fee,
  • interchange fee,
  • consumer welfare
Publication Date
March 20, 2012
Citation Information
Steven Semeraro. "Assessing the Costs & Benefits of Credit Card Rewards: A Response to Who Gains and Who Loses From Credit Card Payments? Theory and Calibrations" ExpressO (2012)
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