By Julian Morris | Thoughts on Innovation
Lobbyists for big box retailers want Arizona’s legislature to impose price controls on card transaction fees. They claim that doing so will save merchants millions of dollars that will be passed on to consumers.
But, we’ve heard this story before and it doesn’t end well. It’s also probably illegal.
House Bill 2629 seeks to prohibit issuing banks from retaining interchange fees on the sales tax portion of a card transaction. Proponents make two arguments in support: First, that merchants should not bear the cost of collecting tax on behalf of the state and, second, that savings resulting from the removal of interchange on sales tax will be passed on to consumers. Neither argument holds water. Indeed, the proposed change would harm most merchants and nearly all consumers.
Arizona merchants are already fairly compensated for collecting and remitting sales taxes. They can discount the state “transaction privilege tax” (TPT) by 1.2% if they file electronically, up to a maximum of $12,000 per year. (This falls to 1% and $10,000 for paper filers.) These caps only affect merchants with annual revenue over about $10 million, reflecting the fact that much of the cost of collecting and remitting the TPT is fixed, so the discount helps small and medium-size retailers who would otherwise be at a greater disadvantage.
By contrast, excluding sales tax from interchange fees would itself have relatively high fixed costs for smaller retailers. Interchange, the fee retained by card issuing banks as part of each transaction, is currently calculated on the entire transaction amount. As such, POS machines generally don’t need to collect separate information about sales tax – and most don’t. Merchants would either have to upgrade their equipment or implement new systems for recording the sales tax on transactions. So, HB 2629 effectively discriminates against smaller merchants. No wonder the big box merchants are pushing for this change!
The idea that cutting interchange on sales tax would help consumers misconstrues what interchange does. Essentially, card issuers use interchange fees to subsidize consumer benefits — such as fraud protection, zero liability, and rewards programs. Merchants benefit from more rapid throughput (card sales are quicker than cash, especially when using contactless tap-to-pay) and larger purchases (because consumers can spend more than the amount of cash in the pocket). By incentivizing consumers to use cards, these benefits have driven near-ubiquitous adoption and use of electronic payments – to the benefit of consumers and merchants alike.
When banks lose even a fraction of this interchange revenue, they recoup the shortfall by reducing cardholder benefits or imposing higher fees on other aspects of their service. We know this because it is what has happened everywhere interchange fees have been capped, including in the U.S.
Meanwhile, there is scant evidence that merchants pass on savings from interchange fee price controls. In the case of HB 2629, the savings would mostly accrue to big box retailers that would have little incentive to pass them on, not least because their costs for cash transactions would remain the same. In other words, if HB 2629 becomes law, Arizona consumers would almost certainly lose out through reduced card benefits and/or higher fees, while experiencing little if anything in the way of reduced costs of goods and services.
The bill also raises legal red flags. A judge in Illinois recently extended a preliminary injunction striking down much of the Act as violating pre-emption provisions of federal legislation. If that injunction is made permanent, it seems highly likely that HB 2629 would suffer the same fate.
HB 2629 is couched in the language of fairness and simplicity, but its effects would have the very opposite result. Smaller merchants would face disproportionate costs, while consumers would face higher fees and fewer benefits from payment cards that would not be offset by any reductions in cost.
Editor’s Note: Julian Morris is a Senior Scholar at the International Center for Law and Economics, and the author of a recent white paper on State Regulation of Interchange Fees.
