NBC News, February 6, 2018: America’s poor subsidizes wealthier consumers in a vicious income inequality cycle
Being poor is expensive. This problematic paradox is evident with basic financial services. And judging by Bank of America’s recent decision to impose fees of almost $150 a year on what were free checking accounts, the problem is getting worse. Too bad (almost) no one is paying attention.
In January, The Atlantic’s Gillian White noted that, “free checking is basically a thing of the past.” White’s headline captures a reality for many Americans who regularly live near the bottom of their bank account. But it also misses the other side of the coin: financial services are cheaper the richer you are. This hidden driver of income inequality is embedded in something that we use every day and never think twice about: the payment system.
It isn’t what or where you buy, but rather how you pay that determines whether you ultimately benefit or lose from our economy’s payment system. Antiquated and unnecessarily slow, this system indirectly imposes large costs on middle and working class families, in the process actually redistributing money up the income scale. Indeed, substantial portions of the $14 billion that people pay in overdraft fees a year, and the $9 billion in payday loans fees, are partially the result of a U.S. payment system that is slower than similar ones used in Mexico or Poland. Meanwhile, credit cards that lower-income consumers are ineligible to receive reward wealthy users for money spent. The richer you are, the better your rewards.
Did you realize that working and middle class Americans subsidize the wealthy when they pay in cash or use debit cards? Everyone appears to pay the same price, regardless of how you pay. But that’s not the case. How you pay changes what stores receive, and ultimately how much is in your wallet.
If you pay in cash, you are paying full freight. If you use a debit card, the merchant pays a relatively small processing fee. You likely get zero or very little back in rewards. On the other hand, if you use an American Express credit card, the merchant will lose quite a bit: 3 percent goes to AmEx, plus a fixed fee. So where does that slice go? Some goes to American Express, but a fair amount goes right back to the credit card user in the form of cash back, reward points, or frequent flier miles.
As long as merchants do not vary the price based on payment, economics dictate that people who pay using cash or debit cards are subsidizing people who use credit cards. The fancier the credit card, the larger the subsidy. Payment methods are correlated with income: lower income people are more likely to use cash, pre-paidor debit, while higher income use credit cards.
The system does not have to be like this. The technology and alternative structures exist. Unfortunately, absent fleeting moments like the Bank of America announcement, most people and policy makers do not think about or appreciate the magnitude of the problem — or the solutions that could address it.