There is an entire ecosystem dedicated to gaming the credit card rewards system — the Points Guy, who has made himself a household name, and a web of websites and influencers who teach all sorts of tricks and hacks. What people might not realize is that the system is already gamed, just not in the way they think: Credit card perks reward rich Americans to the detriment of the poor. The $200 in cash back you got using your fancy new rewards card often comes at the expense of someone who can’t afford it.
The US financial system is racked with inequities. Sometimes, they’re obvious: who can and can’t get approved for a loan, who has a bank account and who doesn’t. But other times, they can fly under the radar.
Many people who use rewards cards have some idea that those rewards are coming from somewhere. But they likely imagine it’s the bank, not their fellow consumers and businesses, picking up the tab.
Every time a credit card is swiped, the bank charges a fee. It seems trivial, but those fees add up — enough to help pay for rewards like points-funded hotel rooms and cash back. To compensate, businesses raise prices, and so cash users (who tend to be poorer) are often subsidizing the perks going to credit card users (who tend to be richer). And the higher the rewards, the bigger the cost to the unsuspecting people paying for it.
“The American payment system has evolved into a reverse Robin Hood whereby middle-class and working-class Americans who pay with a debit card, prepaid card, or cash are subsidizing the wealthy, who pay less for everything,” said Aaron Klein, a senior fellow in economic studies at the Brookings Institution who has studied and written about this issue extensively.
The catch on credit card rewards and points is that for the richest consumers, there might not be one. Instead, the catch is for everyone else.
When you pay with a rewards card at the bodega, the guy paying in cash behind you is picking up the tab
Credit card issuers — think American Express, Chase, and Citi — make money in three main ways: fees, like annual ones to have the card or penalties on late payments; interest on unpaid credit card bills; and interchange fees, meaning the amount they charge every time you swipe plus a small fixed fee. Generally, issuers charge about 1 to 3 percent of the total transaction amount. These swipe fees can be big moneymakers for some companies: American Express clocked $24 billion in them in 2018 alone.
“The interchange is a steady, almost annuity kind of revenue stream,” said Ted Rossman, senior industry analyst at Bankrate and CreditCards.com. He estimates swipe fees currently average about 2.3 percent, and the more elaborate the rewards card, the higher the fees. “Merchants hate paying interchange fees, but if you don’t accept credit cards, you’re turning off a huge part of your audience.”
Part of the money that banks get from interchange fees goes back to their customers in the form of rewards. In 2018, American Express spent about $10 billion on rewards.
About seven in 10 Americans have at least one credit card, and many people have multiple credit cards. The vast majority of credit card spending takes place on rewards credit cards, and over the years, rewards have become more elaborate as companies try to compete — more cash back, more perks, more miles and hotel rooms. “In some ways, the last few years have been the golden age of credit card rewards,” Rossman said.
With more credit cards and more rewards come more swipe fees. And merchants don’t want to pay those fees out of their own pockets — so they pass some of them on in prices that everybody pays, not just the credit card holders. People paying with cash or debit cards wind up footing the bill to pay for the rewards of people who pay with credit cards — people who tend to be more well-off.
“You have this phenomenon at the point of sale, which is consumers who use credit cards — and rewards cards more specifically — tend to be cross-subsidized by consumers who use cash or debit cards,” said Joanna Stavins, senior economist and policy adviser at the Federal Reserve Bank of Boston, who has studied the issue extensively. “It’s specific to what you pull out of your wallet. It just so happens that payment instrument use is correlated with income pretty strongly, so higher-income consumers are more likely to hold a credit card in their wallet.”
Stavins is the co-author of a recent paper from the Boston Fed that looked at who winds up paying for credit card reward purchases. They found that in the US, high-income consumers pay an average of $13 less per month through retail prices, and low-income people pay 60 cents more, because of swipe fees on merchants. Rich consumers spend more overall on fees, but it’s because they spend more in general. When it comes to a percentage of transaction values, it’s poorer people who lose out.
“So let’s say I spend $1,000 on my purchases and you spend $100. I may spend more in terms of all the different fees and surcharges and cost of credit card transactions that merchants will transfer to higher retail prices. But in terms of the percentage, I’ll pay a lot smaller fraction than you are,” Stavins said.
Planet Money has a short TikTok video of how this all works.
A 2010 paper, of which Stavins was also a co-author, found that in this wealth transfer system, households that use cash pay about $149 on average to households that use credit cards, and each of the credit card households gets $1,133 from cash users every year. And, again, because lower-income people are likelier to pay in cash than high-income people, that means the poor are losing out at the hands of the rich.
To be sure, not all rewards card holders are alike. To really reap the benefits of rewards, Rossman emphasized, people shouldn’t carry a balance on their credit cards from month to month. Otherwise, the interest they’re charged could very well wipe out the benefits. “Some people say that if you’re using cash, you’re losing cash, and it’s a missed opportunity. But it’s only a missed opportunity if you can pay in full,” Rossman said.
According to CreditCard.com’s data, more than half of people with credit card debt have had it for a year, more than a third for two years, and more than one in 10 for five years. “It’s easy to get into debt and hard to get out of it,” he said.
How else the system’s stacked, and how to maybe try to fix it
The US economy is stacked in favor of the wealthy and corporations in all sorts of ways, including the stock market and taxes. And the same goes for rewards cards.
Credit card rewards aren’t generally taxed like regular income, so to a certain extent, they’re even a bigger benefit than they appear on paper. In a 2019 piece for NBC News, Klein offered up a concrete example: Say a family spends $80,000 a year on a credit card and gets 1.5 percent cash back, translating to $1,200. By his estimate, that’s equivalent to about $2,000 in pre-tax earnings.
“Rich people get a large subsidy on everything they buy,” Klein told Vox. “The fact that they’re tax-free is a big deal also, because wealthier people pay higher income taxes, so the tax-free advantage is higher the richer you are.”
In other words, the more you spend, the better the rewards, and the better the tax break.
Klein also said that interchange fees that go up with rewards cards can disproportionately impact small businesses compared to large corporations, many of which are often able to negotiate lower fees or strike deals with big credit card companies. According to the Wall Street Journal, Walmart, Costco, and Amazon have all been able to leverage their size and reach to bring down their fees. “Not all businesses pay the same swipe fee, and many larger companies negotiate,” he said.
Businesses do have some options to try to lessen the blow of swipe fees — and therefore the price hikes they pass on to consumers — but they don’t always use them. Merchants can put a surcharge on purchases made with a credit card, though outside of gas stations, the practice is quite rare. They’re afraid of alienating customers, and training cashiers to make the calculations can be difficult. Alternatively, they can offer discounts to people who pay in cash.
Consumers are much more amenable to discounts than they are surcharges, Stavins noted. She also thinks merchants just being more transparent about the fee they’re paying with a credit card transaction could make a difference, even just a sign telling customers, “Hey, if you pay with a card, it costs me money.” They don’t prevent credit card use, but they try to discourage it.
Of course, not all businesses accept all credit cards, or accept credit cards at all. American Express has the reputation of having high transaction fees that many merchants avoid. And the nice rewards cards often have higher swipe fees than more basic cards issued by the same company. But once a merchant says that they’re going to accept one brand of credit card, whether it’s AmEx or MasterCard or Visa, they can’t really discriminate among the cards under those brands. In 2018, the Supreme Court decided that credit card issuers were allowed to bar businesses from offering consumers incentives to pay with less expensive credit cards. Essentially, if a retailer accepts one type of AmEx, it’s going to accept all of them.
Klein says he thinks if merchants were more easily able to discern which rewards cards to take and which to avoid, some of the poor-to-rich transfer problem could be solved. “A reasonable way for the market to help solve this problem is for the merchants to be able to say, ‘I’m not going to take the Sapphire, the swipe fee is too high,’” he said. “The economist in me is like, the market can correct this to some degree.”
The published fee for a Visa Signature Preferred card on a restaurant charge, for example, is 2.7 percent.
Another potential policy fix would be to lower interchange fees, which the Durbin Amendment, part of the 2010 Dodd-Frank bill, did for debit card transactions. If swipe fees for credit cards were capped, rewards would almost certainly diminish, too. But so would the regressive nature of credit card spending.
A lot of America’s financial setup is like this
Lack of access to basic financial products and services can impact people’s lives in myriad ways, many of which are invisible. The guy paying in cash at the local hardware store probably doesn’t realize the $20 purchase he’s making is partially subsidizing the next vacation of the guy who paid with a rewards card before him.
There are all sorts of places where it’s more expensive to have less access to financial services. During the pandemic, people without bank accounts often wound up being charged to cash their stimulus checks, losing out on money they were entitled to.
For many people without credit cards, the problem isn’t that they don’t want one, it’s that they can’t get one because their credit score is too low or they don’t have enough of a credit history to get approved. It’s harder for the unbanked to build up savings, get traditional loans, or pay basic bills. And so they wind up losing money — they turn to expensive payday lenders that charge exorbitant interest rates and risk getting pulled into debt traps or resort to financial products that charge them more specifically because they have less. Rich people reap most of the benefits of the stock market’s rise, a rise that’s fueled by the productivity of workers.
To put it plainly, it’s expensive to be poor in America. And when it comes to rewards cards, it’s expensive to the benefit of the rich.
“The rewards keep getting bigger, the competition to offer large rewards generates larger swipe fees, and that generates greater income inequality,” Klein said. “Unless somebody makes a substantial change, this is going to keep going in the same direction and getting worse at a time in which income inequality and historical inequalities are some of the great challenges facing our country. We have a system hiding in plain sight offering richer people ‘free money’ paid for by those who ‘don’t qualify.’”