Developments in Merchant Surcharging: Hold the Champagne

Those following the payments industry press on surcharging may have noticed headlines touting recent events in state legislatures and in the courts, which deceptively suggest that the state laws prohibiting merchant surcharging are falling away.  But, as is often the case, the devil is in the details and the positive headlines mask a more sobering reality.   Colorado Governor Jared Polis, for example, recently signed into law the repeal of the state’s prohibitions against surcharging.  Colorado legislators congratulated themselves for a job well done and for helping “struggling small businesses,” based on the logic that the new law will empower merchants to address their ever increasing costs of credit card acceptance through surcharging.  But industry experts and merchant advocates recognize that under the hood lies a familiar story that belies the headlines that Colorado’s law actually empowers surcharging.

Surcharging Credit Cards

Surcharging is the practice of adding a fee to a credit card transaction to offset the merchant’s costs for processing the card payment.  The ability to surcharge, in theory, gives merchants leverage to negotiate better terms with payment card networks, and failing that, to charge the consumer paying with more expensive credit cards.  Absent a surcharge, all consumers, including the less-affluent cash customer, absorb those costs.   Since 1984, when the federal government ended its surcharge prohibition, the dominant payment networks have maintained a multi-pronged strategy to restrict surcharging.  Visa, Mastercard and American Express lobbied state legislatures to ban the practice, and those efforts succeeded in getting 10 states, representing over 40% of commerce, to pass such restrictions.  The networks also maintained rules that prohibited the practice.  With those rules in place, the expense of credit cards were passed along to all consumers while being hidden from the cardholders who used them.

Over the years, as payment card networks repeatedly increased the merchant fees for credit card transactions, especially for rewards cards, merchants increasingly demanded the ability to address the expense of credit cards, including by surcharging.  In 2005, merchants brought a class action antitrust lawsuit against Visa and Mastercard, the leading payment card networks, which demanded, among other things, that merchants be allowed to surcharge.  As part of their settlement in 2013, Visa and Mastercard agreed to allow surcharging of credit card transactions, but only on paper, and even then under strict rules.

Visa and Mastercard maintained this fiction through the so-called “level playing field,” in which they permitted surcharging only if equally expensive networks (i.e. American Express) permitted surcharging too.  But since American Express maintains an effective prohibition on surcharging (as long as the merchant also accepts debit cards) and is accepted by virtually all of the major merchants that accept Visa and Mastercard, the “level playing field” effectively kept Visa’s and Mastercard’s prohibitions against surcharging intact, notwithstanding their disingenuous claims to have liberalized their rules.  And for the handful of small merchants that might surcharge under the new rules (because they don’t take American Express), Visa and Mastercard imposed onerous requirements.  Merchants would need to consult an attorney to comply with these intentionally cumbersome requirements, and not surprisingly, the few merchants that are truly permitted to engage in the practice have largely not done so.

Additionally, Visa and Mastercard prohibit differential surcharging by issuing bank.  That means if a merchant surcharges, it must charge the same surcharge on all Visa and Mastercard banks.  That helps perpetuate the market failure that propels Visa’s and Mastercard’s enduring market power – the lack of competition between issuing banks for merchants’ business.  To this day, Chase and Bank of America do not have to worry about competing against each other to lower their costs of acceptance to merchants, and so there is no incentive for either to lower their fees.  Merchants pay more, and consumers pay more.

A Familiar Regime

Even though the 2013 settlement enabling surcharging was a fiction, it at least put the spotlight on the states that continued to openly prohibit surcharging.  The result was a host of lawsuits aimed at rescinding those laws, and one by one surcharging prohibitions fell.  Some state legislatures followed suit and repealed their bans.  Colorado was the most recent, and now surcharging is currently permitted in every state except Connecticut and Massachusetts.

While laudable on the surface, these laws reflect years of the card networks lobbying and convincing legislators that surcharging is an anti-consumer practice and must be restricted in any way possible.  The result is a patchwork of state laws that again make surcharging impractical. In New York and Maine, for example, the merchant must display in dollars and cents both the regular price and the credit card price.  That is a nonstarter for many merchants who would have to relabel every item in their stores.  Notice requirements are also strict and vary.  And none of the states explicitly authorize merchants to be able to surcharge differentially by issuing bank, regardless of their costs of acceptance.  That means none of the states are helping to create a vibrant competitive environment in the payments industry.

In other words, Visa’s and Mastercard’s concerted efforts paid off.  As one payments newspaper correctly reported, the Colorado law actually “mirrors the surcharging rules implemented by Visa Inc. and Mastercard Inc.,” cementing the fiction that surcharging is now permitted under their rules when, for most merchants, it is not.  And now, the only states that currently maintain surcharging prohibitions, Massachusetts and Connecticut, are considering following Colorado’s lead.  As a result, state laws will further enshrine Visa’s and Mastercard’s problematic rules, while unsophisticated observers and legislators pop the champagne.

A Common-Sense Solution

It does not have to be this way.  Merchants should be permitted to surcharge freely based on their costs of acceptance, which is what the surcharging initiatives are supposedly predicated on, and payment networks and legislators should not be imposing roadblocks while publicly touting how they are “helping” small businesses.  That means the ability to surcharge both credit and debit card transactions, by brand, product type, digital wallet, or by issuing bank.  This should come through federal legislation, which would help merchants avoid the pitfalls and expense of dealing with varying state laws, a reality which arguably dampens interstate commerce.  At a minimum, merchants should be allowed to surcharge their full costs of acceptance. That would mean no artificial percentage caps.

With merchants able to freely surcharge, payment card networks cannot hide their costs from consumers.  And if the networks and issuing banks want to ensure their cards are not surcharged, they have a simple solution: compete to lower their fees and negotiate with merchants to induce them not to surcharge.  That would mean lower costs for consumers, who would then have more money to inject into the American economy. That is simple economics and a win-win for all.