When writing this we found a lot of the material was already collated by Scott Blakely and Ruth Fagan in their A History of Credit Card Transaction Costs and the suppliers Newly Minted Right to Surcharge to Make Credit Cards a More Competitive Payment Channel.
Honestly the title reminded us of Borat’s movie title: Borat: Cultural Learnings of America for Make Benefit Glorious Nation of Kazakhstan
Aside from the longwinded name, it has legitimately good content and we will be borrowing from their work.
Credit cards were launched domestically in the 1950’s. In the first few decades, the percentage of card transactions was pretty low, and honestly accepting card payments wasn’t even electronic: a merchant would call in the charge, or use a reference book of card numbers to ensure the card numbers were valid.
This made the concept of surcharging difficult: even if a merchant wanted to surcharge, how could they?
But merchants were no dummies: they knew that paying by plastic came with additional fees, so they were constantly searching for ways to – rightly – avoid such levels of effective taxation.
In 1968 legislators passed the Truth in Lending Act, aimed to promote the informed use of consumer credit. Per usual it’s a sprawling bill with all sorts of overreach, but for the purposes of our conversation this law made it explicitly permissible for merchants to cash discount:
(a)Cash discounts
With respect to credit [1] card which may be used for extensions of credit in sales transactions in which the seller is a person other than the card issuer, the card issuer may not, by contract or otherwise, prohibit any such seller from offering a discount to a cardholder to induce the cardholder to pay by cash, check, or similar means rather than use a credit card.
(b)Finance charge
With respect to any sales transaction, any discount from the regular price offered by the seller for the purpose of inducing payment by cash, checks, or other means not involving the use of an open-end credit plan or a credit card shall not constitute a finance charge as determined under section 1605 of this title if such discount is offered to all prospective buyers and its availability is disclosed clearly and conspicuously.
Summary: as long as merchants didn’t discriminate, they could surcharge or cash discount.
But.
The purpose of the law was to make clear the cost of using credit.
And for charge cards, banks charge APR interest on balances.
In practical terms, this made it rather onerous for merchants to quantify the true costs of paying with cards, and of course the card schemes didn’t like consumers being confronted with the lending costs of using their plastic.
The schemes did what was in their best interest: they drafted new language in their merchant agreements that precluded surcharging for merchants that were part of the program.
The first challenge was levied against AMEX by the Consumers Union in 1974 under antitrust violation. Consumers Union, the plaintiffs, prevailed, and AMEX merchants were allowed to offer dual pricing.
There are some interesting facts worth calling out from the New York Times reporting of the lawsuit.
- AMEX merchant fees were between 3% and 6%
- Consumers Union thought consumers would see a 3-6% decrease in pricing (presumably because there weren’t processors to eat the entirety of the savings)
- They also thought people would slow their rate of card adoption if given such discounts, but they drastically overestimated the financial literacy of your average American
- 87,000 establishments accepted AMEX cards in 1974
- AMEX had 6 million cardholders vs 133M global cardholders and 56M US ones today
- Spencer Nilson (yes, of Nilson report fame) estimated 503M credit cards in circulation at the time (there are 1.2B today)
Then in 1976 an amendment was made to the Truth in Lending Act that made surcharging impermissible:
No seller in any sales transaction may impose a surcharge on a cardholder who elects to use a credit card in lieu of payment by cash, check or similar means.
Pub. L. No. 94-222, 90 Stat. 197
The amendment lapsed in 1981, so the card schemes amended their merchant agreements to prevent surcharging. They also took to the states and lobbied that surcharging violates consumer rights.
In 1985 California banned surcharging (but not cash discounting) in Civil Code section 1748.1 and other states followed.
The laws swung back into merchants’ favor when an 8-year class action against the card schemes broke in favor of merchants in 2013, forcing the card schemes to permit surcharging in their merchant agreements.
Once merchants prevailed, the states that still banned surcharging faced increasing pressures to align with majority rule.
As of this writing, only Connecticut and Massachusetts forbid surcharging.
Note, however, that surcharge amounts are still shifting.
Visa and Mastercard previously allowed a 4% surcharge but it’s now capped at 3% for Visa (and soon Mastercard) cards.
For high end establishments that see a lot of corporate or travel cards, blended interchange might be even more than 3%, meaning that merchants are still losing money to take cards, despite passing on a 3% surcharge.
Which begs the question: can the card schemes lower surcharging caps until it’s a joke of a program?
Here’s language from Mastercard to show you what we mean:
The level of the fee that a merchant may charge a cardholder is capped in relation to the merchant’s cost for Mastercard credit acceptance. For merchants who choose to impose a brand level surcharge, a merchant may only surcharge a Mastercard cardholder at the lesser of the merchant’s average effective merchant discount rate that the merchant pays its acquirer for Mastercard credit acceptance or the Maximum Surcharge Cap, which can be found below. For merchants that impose a product level surcharge, the surcharge must not be more than the merchant’s cost to accept the particular Mastercard credit product, minus the Durbin Amendment’s cap on debit interchange fees.
https://www.mastercard.us/en-us/business/overview/support/merchant-surcharge-rules.html
This is effectively useless if Mastercard keeps lowering their surcharging cap.
And the effective merchant discount rate that the merchant pays its acquirer is a joke because the acquirers add so much nonsense it’s impossible to nail this down.
For instance, what about processors who add convenience fees without merchant consent?
We’re going to need another article to dig into surcharging compliance, which is where we’ll end this post.
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