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.
In 2010, researchers at the Federal Reserve Bank of Boston published their findings that, because merchants pay higher interchange fees for credit cards with rewards benefits, consumers who pay with cash, debit, and non-rewards credit cards are effectively subsidizing rewards card users when they pay the higher retail prices that merchants charge in an effort to pass on the cost of interchange fees. Since rewards card users tend to be more affluent than other customers, the paper concluded, this arrangement serves as an upward transfer of wealth.
To address this purported transfer of wealth, some propose capping credit-card interchange fees, just as debit-card interchange fees are already capped under what’s known as the “Durbin Amendment.” The reasoning is that the cap would lower merchants’ costs and those savings would, in turn, be passed on to consumers in the form of lower prices.
But there are serious problems with the “Reverse Robin Hood” hypothesis. Indeed, the entire narrative is more mythical than Robin Hood himself. Rather than returning wealth to the poor, capping interchange fees would largely benefit big box stores and other major retailers.
Credit-card networks connect merchants, banks, and consumers through a complex series of agreements. Interchange fees and card rewards help to balance this system to the benefit of all parties.
Interchange fees let issuing banks recover their investments in the network, including in valuable features like fraud prevention. This benefits both cardholders and merchants, who are able to engage in mutually beneficial exchanges with fewer concerns about fraud and theft.
Meanwhile, rewards give cardholders incentives to use their credit cards. Consumers obviously benefit from the rewards themselves, while merchants benefit from the additional business they do because cardholders want to earn rewards.
While some merchants may complain about high card fees, the reason they continue to accept them is that, compared to store credit and checks, payment cards are extremely safe and secure. The increased size and volume of purchases also more than makes up for the costs of accepting cards.
Understanding how each side of the market benefits from card networks helps to explain what’s really going on here: public arguments about regressive burdens on the poor aside, merchants really just want a larger slice of the pie.
For the “reverse Robin Hood” hypothesis to be true, each income group would have to buy the same basket of goods and services from the same merchants. In real life, consumers of different income cohorts frequently shop in different places and buy different things. In this more realistic scenario, merchants are able to adjust prices based on the incidence of card usage, weakening any redistribution effects. In other words, rewards-card users largely pay for their own benefits.
Merchants also don’t typically pass through 100 percent of the costs of interchange fees to consumers in the form of higher prices. The literature suggests a pass-through range of between 22 percent and 74 percent, with a long-term median of about 50 percent. This means that reducing interchange fees won’t necessarily lead to lower prices, either. That’s exactly what happened after the Durbin Amendment imposed caps on interchange fees for debit cards in 2010: nearly all of the savings from lower interchange fees were captured by larger merchants, with very little passed on to consumers.
Finally, contrary to the narrative pitting rich rewards card users against poor cash users, consumers in practically every income group have access to, and use, rewards cards. In fact, data suggests that rewards benefits are tied more to credit score than to wealth or income. And a study from the Federal Reserve suggests that credit scores are only mildly correlated with income, with credit history having a much stronger correlation.
In the end, we should learn from our experience with the Durbin Amendment that interchange fees caps actually tend to harm poorer consumers. Studies show that banks recouped revenue lost following Durbin’s implementation by raising fees for ATMs and ending most free checking account offers. Merchants, however, didn’t pass on lower prices to a degree that would make up for those losses for lower-income consumers.
Much like the debit-card experience, capping credit-card interchange fees will likely harm the poorest consumers most. Banks will make up lost revenue somewhere, likely through higher annual fees for cards or by reducing rewards. Wealthier rewards-card users can afford higher annual fees, but the poorest can’t. Australia’s experience is informative. One study there found a 40 percent increase in annual fees for standard rewards cards after the introduction of interchange fee caps.
Ironically, interchange fee caps may generate a real “reverse Robin Hood” effect, with the shareholders of big-box retailers benefiting at the expense of lower-income consumers.
Julian Morris is a senior fellow with the International Center for Law & Economics (ICLE). Ben Sperry is ICLE’s associate director of legal research.