CREDIT CARDS AND THE TWO‐TIER PRICING CONTROVERSY: A COMMENTARY

Abstract

This study evaluates the cost and benefits of credit cards as they relate to the two-tier pricing controversy concerning the use of credit cards. A two tier pricing system is one in which merchandise has two prices -- one for cash and one for credit. Under a two-tier pricing system, a cash customer may be charged lower prices than credit card customers. Without such a system it is sometimes argued that cash customers could be subsidizing the cost of credit card plans. In theory, the point of two-tier pricing systems is to permit a reallocation of costs in which the merchant can offer a price differential to cash customers to reflect the alleged savings realized by not having to pay the card issuer a percentage of the sales price to service the transaction.The two-tier pricing controversy involves several major issues. Of paramount concern is the validity of the underlying premise of two-tier pricing, namely, that cash customers are subsidizing credit card customers and should be charged a lower rate. If so, another issue involves whether a price differential should be offered In the form of a discount for cash customers or a surcharge for credit card customers. Finally, the issue concerning federal preemption of state usury laws is a matter of controversy. At the present time these three issues have been tentatively resolved with the passage by Congress on February 6, 1976 of S.2672 (Public Law 94-222). This legislation provides permission for merchants to grant discounts of up to 5% for the payment of cash but prohibits imposition of surcharges on credit card sales under the Fair Credit Billing Act. Cash discounts above 5% are permitted but the merchant would have to comply with truth-in-lending and state usury laws, which effectively precludes discounts exceeding 5%. This legislation will expire three years from date of enactment.This study contends that considerable research is needed to resolve these issues before final legislation is promulgated. As a preliminary step in this direction, a review, analysis, and synthesis was made of much of the literature concerning credit cards and their relationship to the two-tier pricing controversy. Cost data were also generated to provide a partial empirical basis for the analysis.To begin to develop a sound and equitable solution to the two-tier pricing controversy, including the cost benefit characteristics of credit cards and their alternative means of payment and credit, empirical answers to several questions must be found. At the present time much of what is known is based on advocacy hearsay, opinion, simplified and/or abstract theory, and rules of thumb. Among the questions that need answers before a rational decision can be made concerning two-tier pricing are the following:1.How would the real world competitive nature of trading area retail markets affect the so-called economic equivalency of discounts and surcharges?2. Is the impact of discounts on consumer behavior the same as that of surcharges?3. Would two-tier pricing discriminate against segments of the credit card using public?4. Is it equitable to impose two-tier pricing as a means of isolating credit card costs without also legislating separate pricing for each identifiable service offered by merchants?5.What would be the impact of discounts and surcharges on the level of economic activity?6. What are the costs (net) and benefits to the affected parties of alternative payment mechanisms (e.g., cash, checks, charge accounts, credit cards) and how can these factors be isolated, measured, collected, and compared?7. What are the costs (net) and benefits to the affected parties of alternative sources of credit (e.g., check credit and overdraft plans, installment credit, charge accounts, credit cards) and how can these factors be isolated, measured, collected, and compared?The last two questions are directly related to the purpose of this study. The others are outside the scope of this study.Based on the analysis and synthesis of the relevant information to the purpose of this study, the following tentative conclusions were reached:1. No “final” legislation concerned with two-tier pricing should be enacted until this important issue can be resolved on the basis of rational, objective, and empirical research. This research should include the economic, psychological, and equity aspects of two-tier pricing as related to card issuers, banks, merchants, consumers, and the economy.2.Those who favor two-tier pricing are implicitly assuming a partial unbundling of the costs of alternative payment mechanisms and sources of credit without sufficient evidence concerning their relative size and the benefits of these alternatives to the various affected parties.3. From the standpoint of the consumer, merchant and bank, the costs and benefits of credit cards combine to offer both a desirable market proven alternative method of payment and source of credit. These advantages are too important to the affected parties to be risked by legislation not based on valid empirical research.