Dave Allen. Director, Interactive Strategy

Cash vs credit – what should you do?

I know this is off topic [although what stands for "topic" here is rather malleable.] As someone who doesn’t use credit cards I found this very interesting and thought I’d share it.

The Federal Reserve Bank of Boston has released a Discussion Paper – Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations.

Here’s 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. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.

What does this mean? Well, in a nutshell, if like me you pay for a good with cash, you are subsidizing all those folks who pay by credit card and who benefit from card rewards programs. This is because the card companies charge merchants 1-2% of the price of a product when a customer uses their credit card. The merchant then raises her prices to compensate for those charges, yet if you pay by cash you don’t get to pay less – which would be the true cost of the item; i.e., minus the card company charges. Apparently the credit card companies make the merchants do this. Therefore we cash payers are subsidizing credit card users.

It also gets a bit complicated as [the mysteriously named] Economist blogger M.S. posted:

The Boston Fed paper argues that cash users lose from bundling, while credit-card users win. But an alternative view would be that both lose, since credit-card users lose the opportunity to save money by using cash. For example, on a recent purchase of airline tickets in an emerging-market country, I saved about $200 by paying cash rather than using a credit card. In America, I wouldn’t have been able to do that. Using the credit card would have been “free”.

I’m sticking to cash. Meanwhile American Express is offering select customers $300 if they pay off and close their credit card accounts. It’s not a gift really, they are worried that people will default on their loans.

Tags: American Express, Cash vs Credit, Economy, Finances, Thinking

Comments

6 Responses to “Cash vs credit – what should you do?”

Tweets that mention Cash vs credit – what should you do? : NORTH : brand engagement for the digital and natural worlds -- Topsy.com
July 28th, 2010 @ 11:43 am

[...] This post was mentioned on Twitter by jascha kaykas-wolff, Dave Allen and JulieMa, Dave Allen. Dave Allen said: Should you use cash or credit cards? http://bit.ly/cash_credit The answer may surprise you.. [...]
Crystal Beasley
July 28th, 2010 @ 4:19 pm

Credit companies write into their contracts that it’s not allowed to give cash customers a discount. Even the common practice of having a credit minimum is not technically allowed, although I think it too difficult to enforce.

Unfortunately, I don’t think a few individuals choosing to use cash over credit has much effect because of the economies of scale. If you are a small business and your transaction volume goes down, you just end up paying a higher marginal rate.

A little bit of oversight by the federal or state governments could clear this up. You hear me Democrat in office? We elected you to DO SOMETHING for consumers, not just stand by and let the right continue to systematically transfer wealth from the poor to the rich.
Samuel
July 28th, 2010 @ 4:28 pm

There are actually a growing number of cafes, gas stations, etc. that offer a cash price along with a credit price for an item (with cash being less, of course).

I believe the credit card companies lobbied to only allow this to happen if it’s presented as a “discount” for cash, not an “extra fee” for credit purchases, however.

Also, the 1-2% transaction fees were around long before things like rewards programs, which I view as more of marketing differentiators than a money-in, money-out proposition.

Regardless, I wouldn’t see swipe fees go away if you cut the rewards programs. The credit card companies are the ones who are ultimately making out well in this arrangement, not the credit users.

If a cafe increases their rates to compensate for fees and the credit and cash payers alike pay those fees, how are the credit users really benefiting in any meaningful way?
Dave Allen
July 28th, 2010 @ 10:08 pm

Samuel, as the Boston Fed abstract shows, credit card users benefit by getting the ‘rewards’ via their card, which means those of us who pay cash technically subsidize their rewards by paying our own out of pocket inflated price. The economics of it add up to a net flow to credit card users and a net flow from cash payers…
Samuel
July 30th, 2010 @ 3:39 pm

Look at the effects of credit card company policies (interest rates, late fees, convenience charges, etc.).

I think we can agree that those charges more than offset any savings a credit card user receives in sky miles or bonus points.

The “net flow” is to the creditors, not the purchasers, regardless of the mode of transaction.
Dave Allen
July 30th, 2010 @ 5:00 pm

Samuel,

Yes and thanks for the comment. Nothing is free. Points, air miles, rewards whatever they are called all have a cost. It’s almost bait & switch – credit card co’s push you to spend more [most likely on things you don't need] and reward you with points etc. And here’s the thing – the cards usually have an annual fee that is added to your balance annually which adds to your payback amount.

If one was able to use a rewards card by paying for groceries and gas each month, then paying off the balance, you’d find yourself penalized by the card companies as they want you to carry a balance.

It’s a rat race that I’m glad I got out of…

Cash vs credit – what should you do?

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