August 6, 2010
My philosophy on credit cards has changed completely in the last five years. I've gone from anti-credit-card to pro-credit-card -- but only for those who can use them responsibly. I think they're a great convenience, and I like getting cash back when I use mine.
But not everyone thinks this cash-back feature is a good thing. In fact, my inbox is a-flutter with folks who want me to comment on the recent credit-card study from the Consumer Payments Research Center. This study (which can be downloaded as a 810kb PDF from the Federal Reserve Bank of Boston) found that credit cards transfer wealth from the poor to the rich. How? Through fees and rewards programs.
From the abstract:
Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or "cash") users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year.
Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year.
To summarize: Wealthy people are more likely to use credit cards than poor people (and more likely to receive rewards for doing so). But because prices are generally the same whether you pay with cash or credit -- in most cases, credit-card companies prohibit stores from adding a fee for credit-card use -- poor people usually pay more for things than wealthy people do. This is, effectively, a transfer of wealth from the poor to the rich. This isn't just hypothetical or abstract; the paper lays out the details for just how this occurs.
Note: There are many other ways in which the poor pay more than the rich. Wealthy people are more likely to negotiate. (No evidence -- my own belief.) Wealthy people usually have the ability to wait before buying something. Wealthy people tend do have more buying options (and thus find lower prices). And so on.
There's a lot of interesting information in this study, and if you have time, you ought to read it. It's thought-provoking. And it has created quite a stir in the media.
Even before this study was released, Ron Lieber at The New York Times was contemplating the damage of rewards cards. Lieber has been "fanatical" about using his mileage card for fifteen years, but recognizes that he may be part of the problem. Since the release of the study, the NYT Bucks blog has posted a follow-up about how much credit card rewards cost the poor.
The Wall Street Journal blog post on the study offers no opinions, but the commenters make some interesting points. (Well, those that aren't being internet idiots, that is.) I particularly like the comment from Jay on July 27th at 10:48am (which describes the reasons low-income earners shouldn't use credit cards).
GRS reader Alan forwarded this article from the Portland Oregonian, in which Brent Hunsberger does a good of explaining the complicated web of fees and payments in the current system. (And the comments on his article are surprisingly rational; OregonLive.com is not known for its intelligent discussions.)
The article from the Oregonian also includes this video, in which Hunsberger diagrams the web of credit-card fees and payments:
Out of curiosity, I pinged my pals at Index Credit Cards. Their new spokeswoman, Dr. Mary Ann Campbell, had this to say:
The problem, as I see it, is that there aren't enough options to incentivize the poor, such as discounts for cash or no-fee cards with low limits and strict rules to help them build their credit. Increased options and incentives for the poor without taking away the reward for good behavior earned by people who are managing their money well would be a smart and healthy way to address this dilemma.
It's all about incentives and options. The incentive of credit card companies to get people who have the money to spend more is working through reward cards. As the economy is driven through more spending, so are more jobs created, and tax revenues increased, which I see as actually helping the poor.
So, what do you think of this research? I understand the research and accept that it's true, yet it's unlikely to change the way I use credit cards. Yes, I could take a moral stand and refuse to use credit for most of my purchases. But doing so would cost me a lot of money -- roughly the same as my dining-out budget for a few months. (And I like my clams in butter sauce!)
The main problem is that the system already exists, and it's deeply entrenched. It's not going away. By electing to opt out, smart consumers -- wealthy or not -- cost themselves money. If using a rewards credit card without carrying a balance is a way for me to save a few hundred dollars a year, that qualifies as one of those Big Wins I'm always preaching about. It seems foolish to give this up.
But maybe I'm just being selfish.
What about you? Does this study make you think twice about your own use of credit cards?