When You Swipe a Card, Who Should Pay -- and How Much, to Whom?

When you go into a convenience store, should you be able to get a discount for using a debit card instead of a credit card? Should a store owner be allowed to refuse credit cards on transactions under $10?

These questions are part of an increasingly heated debate about so-called swipe fees, the estimated $48 billion that merchants pay to banks and credit card companies for the use of those ubiquitous terminals in every shop from convenience stores to luxury retail emporiums.

Swipe fees are now being fought over in a congressional conference committee that's considering a package of reforms for the financial services industry in the wake of the crisis that nearly destroyed the global economy in 2008.

Setting a Limit on Swipe Fees

A measure sponsored by Sen. Richard J. Durbin (D-Ill.), would make several changes. Most important, from the banks' perspective, it would require the Federal Reserve to set "reasonable and proportionate" fees that merchants will have to pay banks and Visa (V) and MasterCard (MA) to process debit card transactions. Currently, merchants pay a percentage of the total transaction, not a set fee based on the cost of the transaction.

The second part of Durbin's proposal would allow merchants to set minimum and maximum transaction amounts, and also allow them to offer customers a discount for using a debit card rather than a credit card (on which they pay higher fees) or even offer a discount to people using a Discover card rather than Visa.

Adam J. Levitin, an associate professor of law at Georgetown University, says that the Durbin proposal is aimed at the fees merchants pay, but it will ultimately benefit consumers. "While credit cards cost more than cash, merchants can't just pass those costs to credit card users, they get passed to everyone," Levitin says. "All the evidence indicates that merchants eat some of those costs, and they pass some of them on to consumers. Poor cash consumers are subsidizing your first-class upgrade. As a social fairness issue, it's pretty terrible."

The Banks Stage a Defense

Not surprisingly, with $48 billion at stake, banks don't seem to care too much about social fairness. Instead, they've mounted a major lobbying campaign to oppose the measure. Peter Garuccio, a spokesman for the American Bankers Association, says the debit card issue has nothing to do with the financial crisis and does not belong in the financial reform bill.

"What this bill does is insert the government into a price-fixing role in a private marketplace," Garuccio says. It requires the Fed to set reasonable prices, but then limits what the Fed can use to determine costs. "You can't look at account maintenance or fraud detection and protection, which is a huge cost to maintaining and improving the system," he says.

The bank's opposition campaign has drawn the support of politically powerful small-town credit unions, which receive about one-third of their return on assets from the interchange fee on debit cards. (Durbin would exempt all but three large credit unions from the rules, but the unions are still opposed.) Patrick Keefe, vice president for communications at the Credit Union National Association, says the credit card companies will never create a two-tiered system that exempts credit unions from paying lower fees. "What will happen is they will move everybody to a lower rate," he says.

The political clout of the credit unions became evident when 131 House members expressed "grave concerns" about the Durbin amendment in a bipartisan letter to their colleagues. Rep. Debbie Wasserman Schultz (D-Fla.), says the amendment "destroys the economics of prepaid debit card programs, which are increasingly relied on to deliver banking products to underserved and unbanked recipients."

Big Expenses for Small Businesses

The proposal would also have a dramatic impact on merchants like Dave Carpenter, the CEO of J.D. Carpenter, a chain of six gas station convenience stores in Urbandale, Iowa. Carpenter says his credit card and debit card processing fees have risen from $50,000 a year in 2000 to $900,000 a year today.

"We're paying for all the reward points and all the air miles -- everybody thinks they free, but they're not," Carpenter says. "It would be okay to pay some fair amount for a reasonable processing fee, but there is no negotiating with Visa and MasterCard."

Carpenter says 80% of his transactions are with debit and credit cards. He pays 2% of the transaction amount, plus a transaction fee. So on a gallon of gas that costs $3, he pays 6 cents to the credit card companies, plus a transaction fee. His profit margin on a gallon of gas is a mere 10 to 12 cents, so he reckons the swipe fees are taking about half his profits. He acknowledges that he tries to pass most of those costs on to his customers.

In reality, the swipe fees are separate charges for the banks and credit card companies. If a merchant pays a $2 fee on a $100 transaction, about $1.60 of that goes to the customer's bank and a smaller amount goes to the merchant's bank, which together constitute an interchange fee. Visa and MasterCard also get a fee called a network fee.

Levitin of Georgetown University says the interchange fee doesn't correspond to the cost of processing a transaction. "A $2,000 debit transaction has the same cost to process as a $20 transaction," he says, "but the cost to the merchant is 22 times greater."