A guest post by fellow Personal Finance Blogger, Mike –
Back when I was a kid, there was a friend of mine whose family owned a restaurant in town. One day while visiting, I remember hearing the father harp about credit card payments. Was he ranting about the 1-3% surcharge? Nope. He was whining about the fact that he was forced to pay taxes on those transactions (or in other words, he couldn’t break the law and make money under the table with them).
In the years since, the battle over card payments have only grown stronger. You rarely hear a company like McDonald’s, Target, or even a mid-size chain complaining, but rather the mom and pop businesses; independent liquor stores, gas stations, dry cleaners, eateries and the like. Which has naturally led me to wonder – How much of this hoopla is about the actual fees? And how much of the card hating has more to do with small biz owners paying Uncle Sam his fair share?
The argument for small businesses
On one hand, I sympathize with the mom and pops. Keeping a small business out of the red is hard enough as it is, so any fee or expense is a burden. This is especially true for small transactions, whereas the percentage paid for processing is higher. There’s the inquiry fee (say, 12 cents) and then the percentage fee (2% for example). On a $100 purchase that would only be $2.12 (2.12% of the price). However if the customer were just buying a $1.50 bottle of soda, then 2% plus 12 cents = $0.15 (which is a whopping 10% of the purchase price). Sure enough, the industries which are affected by this model the most seem to be those who are most vocal in complaining – the convenience stores, gas stations, and so forth.
Another obstacle for mom and pop businesses is that they have little to no negotiation power. That being said, the wiggle room is not as large as you may think. The card’s issuing bank (e.g. Citi) and the payment network (e.g. MasterCard) get the lion’s share. The portion that can typically be negotiated is the piece of pie that the processing service gets, which is a sliver. So while it’s true big business pay less, the difference might not be as drastic as you think. However the uber-big (think Walmart and Costco) do sometimes have the ability to negotiate the payment network’s cut, too.
Lastly, to say the fees are confusing for a mom and pop would be an understatement. There are multiple risk tiers, which all cost different rates. Take an online retailer, who would probably pay a higher rate than a restaurant where the card is physically swiped. To further complicate matters, different cards have different fees. For example, my business credit cards and Joe’s 2% cash back card are amongst the most expensive to process. All of this can lead to sticker shock each month, when the business owner sees just how much they’re forking over for those card transactions.
The argument for banks
For the pro-credit card camp (which admittedly, I am a part of) there are several aspects which even the naysayers must at least consider.
For starters, credit cards are a service that must be paid for. While it’s true that some people carry a balance and pay interest, the majority of cardholders pay their bill in full every month (Joe and I being two such examples). The fraud protection, insurance benefits, cash back, travel rewards, customer service, printed statements, and other expenses must be paid for somehow, right? Well that’s where those processing fees come in handy.
Secondly, thanks to Senator Durbin, businesses small and large have the ability to now place a minimum spend requirement on debit and credit card purchases (before the payment networks wouldn’t allow that). So that $1.50 soda conundrum can be circumvented by imposing a $10 minimum. Problem solved.
Third, there’s a good reason why you don’t see big business rallying against the card industry. Why? Probably because they’ve discovered that cards encourage spending. A few years ago when McDonald’s was trying to decide whether or not to accept plastic, they ran a pilot program and reportedly found that the average transaction size rose from $4.50 to $7.00 when paying with a card. After the discovery, they rolled out card acceptance nationwide in a hurry. Reportedly there is also a Dunn & Bradstreet study out there which claims a 12-18% increase with credit cards, though I have yet to read it myself. Either way, there is ample evidence to suggest that more will be spent. Is it worth paying 2-3% in fees for your business to rake in significantly higher purchase volume? You be the judge.
The argument for taxes
Last but certainly not least, we come to the taxes. If you’re up for some reading, check out this 30+ page article titled Cash Businesses and Tax Evasion. It was authored by three faculty members from various law schools in California. Nearly 275 interviews were conducted with cash business owners, as well as their tax preparers and bankers. They offer a fascinating insight into how cash payments from customers and to suppliers are used to grossly under-report income. The paper concludes:
ìCash business owners rely on parallel cash economies to under-report receipts and thereby evade income, employment and sales taxes. Many preparers in this sector adopt a “don’t ask, don’t tell” attitude toward their clients reported receipts. A small minority of preparers, however, actively aid in their clients’ evasion. Evasion seems best explained by opportunity, including the low-perceived likelihood of detection and penalty, and by peer norms. The perceived equity of the tax system has less importance, and the complexity of the tax law does not appear to play a significant role.î
While each page is riddled with example after example of how cash is drastically under-reported, the finding for credit card payments are a stark contrast: ìmost interviewees reported that credit card receipts were generally reported as taxable revenue.î
Going back to the industries mentioned above which appear to be most against cards, I find it interesting that they also seem to be the mom and pops who, historically, have largely been cash-based. While I sympathize with the high cost on processing small transactions, I find it ironic that large chain eateries (who are more likely to report all income, regardless of source) seem to feel the complete opposite ñ they love credit cards, even for the small transactions.
So which is it?
So that brings us back to the question, is it really the fees on the bottom line? Or the fact that card payments make tax evasion tough to pull off?
This post was written by Mike, the guy behind Credit Card Forum. Thanks, Mike, you looked at this topic from an angle that never really occurred to me before, very interesting.