The True Costs of “Charging it” in America

The True Costs of “Charging it” in America

February 24, 2010

American consumers gained a few basic protections this week regarding their credit and debit cards, but they’re only the beginning of the reforms needed here. One of the largest issues remains untouched and unmentioned: The big credit and debit card networks, along with the large banks that issue most cards, impose “interchange” or “swipe” fees on merchants of 1.5 percent to 3.25 percent of every credit or debit card purchase. This should matter to everyone, because most of these fees are passed along in higher prices on every purchase, whether or not it involves a credit card. To be sure, merchants and consumers gain economic benefits from the credit card system. But the fees attached to every card purchase are some five-to-six times the actual costs of processing a credit card transaction; and the card networks and card-issuing banks have managed to insulate themselves from any competitive pressures that might bring down those fees.

These findings come from an analysis we just completed for Consumers for Competitive Choice. Our study found that in 2008, merchants paid the credit card networks and the banks issuing the cards some $48 billion in these swipes fees. Of that, less than 20 percent went to cover the actual costs of processing credit and debit card charges and to covering fraudulent charges, with the remaining 80 percent going for a variety of forms of gravy. Only the absence of real market forces enables the card companies and banks to maintain these fees at levels that so far exceed their actual costs.

And all of us bear the costs of these excessive fees. We calculated that merchants pass along about 56 percent of these fees in higher prices. And since the credit card networks bar merchants from charging their customers a lower price if they don’t charge it, the high swipe fees raise the price of everything bought by consumers or businesses — from food, clothing and computers to gasoline, restaurant meals, or furnishings. In all, these excess swipe fees cost the average household some $230 per-year. And if the fees were limited to the actual processing costs plus a normal profit, the lower prices for everything would expand real demand enough to create nearly 250,000 more jobs.

All of this comes about because our credit-card system operates along the lines of two interlocking cartels, allowing limited competition among their members while insulating themselves from outside price pressures. Just three card companies — Visa, MasterCard and American Express — account for more than 95 percent of all consumer charges and two-thirds of all business card transactions. That means that merchants have no choice but to accept most or all of these cards, which in turns means that consumers and businesses that want to charge it have no choice but to do so with these cards.

Furthermore, most of these charges occur on cards issued by just four financial institutions: 70 percent of all charges are placed on cards issued by JP Morgan Chase, Bank of America, Citigroup, and American Express. The four issue a bewildering variety of cards, with various rewards and annual fees attached to different swipe fees for merchants when they’re used. For example, between Visa and MasterCard, merchants are subject to more than 300 separate swipe rates and fees. But under the rules set down by the card networks and banks, a merchant that accepts one Visa or MasterCard has to accept all of them, regardless of the swipe fees imposed for charges on particular cards.

These arrangements tend to push up the swipe fees. Most of the fees go to the banks. So, Visa, MasterCard and American Express compete for bank business by promising higher swipe fees; while the banks compete for new subscribers by offering increasingly elaborate rewards programs financed by the higher fees. Nor do the cartel-like rules imposed by the card networks and banks allow downward pressures on those fees: Merchants cannot choose which cards to accept based on the fees they pay, which might put pressures on high-fee cards; nor can they charge less for those paying by cash or using low-fee cards, which would allow consumers and businesses to put the pressure on the high-fee cards.

These arrangements are also baldly unfair. More than half of all lower and moderate-income Americans don’t carry credit or debit cards at all, and relatively few of those who do have cards qualify for the rewards programs. Yet, they’re forced to pay higher prices for everything they purchase, just in order to help finance the card-rewards programs offered to more affluent people.

It’s long-past time to fundamentally change this part of the system. Australia used to have swipe fees averaging just 0.95 percent. They adopted reforms limiting the fees to the actual processing costs, plus reasonable profit, and they fell to an average of 0.50 percent. Through it all, Australia has retained a healthy credit and debit card system. We should follow Australia’s example and grant the Federal Reserve or the Federal Trade Commission new authority to set reasonable rules for swipe fees.



The Perverse Politics that Now Surrounds Economic Policymaking

February 18, 2010

The most remarkable aspect of our current economic predicament is the politics surrounding it, which are now as dysfunctional and perverse as Bear Stearns or AIG just before they tanked in 2008. The latest illustration is the partisan analysis of the effectiveness of last year’s stimulus, one year after its passage. While every cable TV loudmouth with economic opinions calls himself or herself an economist, there was never a debate among real economists over whether an $800 billion, two-year package of spending and tax cuts would help turn around growth and employment. Whether one thinks that economic relationships were better described by John Maynard Keynes and Robert Solow, or by Friedrich von Hayek and Milton Friedman, the conclusion is that it would. And one year later, the data show that it did: Growth is back, albeit still weak; and the rapid ascent of joblessness slowed sharply, not from a spurt of new job creation but because many fewer people lost their jobs.

The short-term benefits of the stimulus have been willingly acknowledged by conservative economists from Harvard’s Martin Feldstein (Reagan’s CEA chair) to AEI’s Kevin Hassett (McCain’s economic tutor). That makes the current carping by GOP leaders either mindlessly uninformed or willfully misleading.

To be sure, economists have serious and legitimate differences about stimulus, principally about whether their long-term costs outweigh the short-term benefits. Ironically, here’s where the perverse and dysfunctional streak in our current economic debate really kicks in. While a neoclassical economist would expect smaller short-term benefits and larger long-term costs from stimulus than a Keynesian colleague, both would agree that the prospect that government borrowing will continue to expand even after a real recovery takes hold calls for long-term deficit reduction. So, how to explain GOP opposition to the President’s call for pay-as-you-go budget rules and a bipartisan deficit reduction commission? In this case, the ideological blinders which dictate no tax increases even to control runaway deficits reinforce their political calculus that any achievement by the President could diminish the public’s anger at incumbents. The result is the GOP’s perverse and dysfunctional “just say no” approach to the economic debate.

With public concerns over long-term deficits heating up — especially among the Tea Party followers currently being courted furiously by Republican leaders — the GOP probably won’t be able to maintain its blanket opposition to any serious move to reduce those long-term deficits. But in other areas of economic policy where the politics are less clear-cut, most notably financial reform, their across-the-board opposition will be easier to maintain. Moreover, the economics of financial reform are also less clear-cut, producing diverse views among Democrats as well. With most Republicans unwilling to even consider a bipartisan meeting of the minds over these reforms, the structural problems that led to the market meltdown of 2008-2009 will remain unaffected. In the wake of a financial crisis that very nearly tipped the world into a global depression, the politics that produce this outcome are unconscionable.

The final irony may come if this political strategy succeeds. If Republicans pick up large numbers of seats in Congress come November, their enhanced numbers and especially their new members will force them to show they can produce some real change. And those pressures, in turn, will require compromises with the President and congressional Democrats that seem utterly out-of-reach today.



The New Dominos as the Economic Crisis Enters its Latest Phase

February 10, 2010

The dislocations from the worldwide, economic meltdown aren’t over by a long shot. Nearly two years after Bear Stearns’ collapse, the crisis continues to generate a stream of nasty twists and turns. Moreover, most of these developments have global dimensions, almost all of them are highly complex and only partly understood, and many require rapid responses that must be carried out under relentless public and partisan scrutiny. This constitutes the largest policymaking challenge since the dawn of the postwar era in foreign policy and international economic arrangements.

The most recent, nasty twist is the specter of a sovereign debt default in Greece. Technically, it means that Greece is running such large deficits, relative to its economy and private savings, that it may find itself unable to finance them while also servicing and refinancing its existing debt. Countries default on their debts regularly — it’s virtually a national habit for places like Argentina — but the crisis makes this situation different. First, the government bonds of Greece and countries like it are held mainly by Western financial institutions such as Citigroup and Deutsche Bank. Another round of big losses for them will mean more delays before normal credit flows to businesses resume, which in turn will mean slower growth, and longer and higher unemployment, for Europe and the United States.

The second ugly twist is that Greece is not alone. For months, international finance experts have worried about the sovereign debt status of not only places such as Portugal, Ukraine and Lithuania, but also Ireland, Spain and Italy. These concerns will heighten if Greece’s debt goes down, which in turn could make additional defaults more likely. And if the debt of a major country fails, we could find ourselves back to the financial conditions of Autumn 2008, but this time with much less fiscal and monetary capacity to address them.

While even President Obama couldn’t explain a U.S. taxpayer bailout for Greece, its implications for the European Union should be enough to spur a European bailout. While Greece represents just 3 percent of the EU’s total GDP, a Greek debt default would trigger a crisis for the Euro — and a Euro crisis in turn would drive up interest rates across Europe and choke off their recovery. An EU bailout of Greece, however, will demonstrate that the EU cannot enforce its own, basic rules on deficits and national debts. That lesson will also weaken the Euro — which means a stronger dollar later this year and weaker U.S. exports to help pull our own economy out of its ditch.

America, of course, has its own serious problems dealing with deficits and national debt. The GOP “party of small government” won’t agree to President Obama’s proposal to create a bipartisan commission to tackle the long-term problem, something Republican presidents and leaders had supported until Obama won the White House. GOP congressional leaders also have said no to pay-as-you-go rules to limit future deficits — rules they also liked in the 1990s — because paying for future tax cuts could mean fewer of them. In the land well beyond Washington, where economic sanity still rules, contemplating tax cuts in the face of trillion dollar deficits makes no sense. And even Ronald Reagan, the fiscal godfather of today’s GOP leaders, agreed to large tax hikes on business (1982), payrolls (1983) and energy (1984) when he faced unmanageable deficits. Yet, even George W. Bush’s catastrophic example of what happens when a serious recessions collides with large underlying deficits hasn’t convinced them to reexamine their talking points on tax cuts.

That’s one reason why the rating service Moody’s acknowledged last week that it might downgrade America’s debtor status from AAA to AA. A downgrade remains pretty remote — unless the economy swoons again, coming this time on top of a $1.4 trillion deficit instead of a $400 billion one. And debt defaults by Greece and another country could certainly trigger such a swoon. As it is, Greece’s problems have produced billions of dollars in speculative bets on Wall Street against the Euro. In fact, these bets follow recent and even more widespread Wall Street speculation against the dollar, winning bets which produced the record profits and large bonuses reported recently by Goldman Sachs and others.

All of this confirms, with disheartening certainty, that the forces which created the global economic crisis are still with us, and most of the policy challenges remain unmet.



Cutting Payroll Taxes to Create Jobs

February 4, 2010

Looking for ways to jumpstart job creation, the White House and Senate heavyweight Chuck Schumer have both come around to the same idea, cutting the payroll taxes that employers pay on new hires. The economic sense of this idea is straight-forward: If you want to induce businesses to hire people whom, under current economic conditions, they wouldn’t otherwise take on, you have to reduce their costs of doing so. A payroll tax cut is the most direct and targeted way to reduce those costs, which is why the Congressional Budget Office found recently that it’s about the most powerful policy option available to both create new jobs and boost GDP growth.

The President and Senator Schumer have the right idea, and it should be the centerpiece of the jobs bill now making its way through Congress. In fact, they should think about this in a larger context. Payroll tax reform can be more than just one of the pieces of a package of job-friendly tax breaks for “small businesses,” and more than a temporary measure to deal with double-digit unemployment. America’s job-creating power has weakened over the past decade, creating serious reasons to approach payroll tax cuts as not merely a measure to deal with our current double-digit unemployment, but a key part of a new economic policy.

For decades, the cost of payroll taxes had no apparent effect on job creation in the United States, the economic area in which we have long led other large, advanced economies. In the 1970s, when almost nothing else went right with the U.S. economy, we created more than 21 million new net jobs. In the expansion of the 1980s, while productivity and income gains slowed, we still created more than 20 million more new jobs. And the expansion of the 1990s added 19.5 million more. This record of steady, strong job creation came to an abrupt end in the six-year expansion of 2002-2007, when we managed to create less than 11 million new jobs. So, even before the economy gave back most of those job gains in the 2008-2009 recession, American businesses in this decade were creating new jobs at just about half the rate they did in the 1980s and 1990s.

America’s vaunted job-creating machine has collided with globalization. The problem is not simply or even mainly that American businesses have been sending jobs abroad — in fact, the foreign-based workforce of U.S. multinationals has barely grown at all since 2002. The real issue is that globalization intensifies competition, which makes it harder for businesses to pass along any new costs in higher prices. The good news is that these forces keep inflation low. The bad news is that when a business’s costs do go up — most notably, for health care and energy — and competition stops them from passing along these cost increases in higher prices, they have to cut other costs. The costs they’ve been cutting are jobs and wages.

Since the chances of Congress passing health care or energy reforms that would contain those near-term costs are slim, it’s time for a new approach that directly reduces the costs to companies of creating new jobs.

So, Congress should cut the employers’ side of the payroll tax for new hires, covering the new employee’s first two years on the jobs. Over that period, most workers will pick up considerable new, job-specific skills, so employers will want to keep them on when the special tax break no longer applies to them. To prevent businesses from gaming the system, the policy also should apply only to new hires that increase both the company’s total workforce and its total payroll — safeguards already included in both the Schumer proposal and the President’s plan. Finally, under the revived pay-as-you-go rules, Congress will have to replace the foregone revenues for Social Security, perhaps even as part of a larger tax reform effort.

Payroll tax reform could be the leading edge of a renewed commitment by the administration to bolster jobs and wages. At a minimum, it’s an approach to job creation that just about everyone will understand and most Americans may well appreciate, come November. On that basis alone, a payroll tax cut should be the core of whatever Congress chooses to call its new jobs bill.