Surcharges versus discounts for credit cards


The U.S. Department of Justice, Visa and MasterCard have had a settlement approved by the US Courts. Broadly speaking, this means that U.S. merchants will now be able to:

  1. let customers know the different costs (to the merchant) associated with different cards that the customer might use for payment;
  2. represent a preference for some type (or types) of card to customers; and
  3. give discounts off the standard price for particular cards.

The details are here. If reading Court documents is not your cup of tea, a news report is here. Note, discounts for cash are already allowed.

The interesting thing for Australia’s regulators is not the decision but its implementation. In Australia, card surcharging is allowed and may be leading to price discrimination. See my post here. In the UK, the use of debit cards as the ‘base’ or numeraire instrument for internet transactions is being investigated – see here. So a key difference between the three situations is the choice of ‘base price’ or numeraire and how the price differential for cards is expressed:

  • (Australia) The base price is ‘cash’ with the ability to surcharge from that base price.
  • (UK) The base price for internet transactions could be debit cards with the ability to surcharge from that base price.
  • (US) The base price the ‘highest card price’ with the ability to discount off that price for other cards and cash.

Simple economics would normally say that there was no difference between these three situations. It is simply changing the numeraire and the customer will correctly work out the pricing from whatever base is used. For example, the customer shouldn’t care if an item is $100 cash with a $5 card surcharge or $105 for card with a $5 cash discount.

However, clearly US law makers do not agree with this view. Despite the settlement today allowing for the more extensive use of discounts, the ‘economically identical’ policy of using cash as the base price and surcharging for cards is explicitly outlawed in ten states.

So, what are the implications? Either the US law is silly and is effectively simultaneously banning and promoting economically identical conduct. Or consumers react differently to surcharges and discounts.

Now, I suspect that my behavioural economics colleagues will shake their heads and tell me that there is a well known experimental literature on the later (and if someone has a good reference – please post a comment).

However, if this is the case, then it has implications for credit card reform in Australia. In particular, as I noted in my earlier post, should the Payments System Board be thinking about defining the numeraire in, say, internet transactions, rather than thinking about capping surcharging?

3 Responses to "Surcharges versus discounts for credit cards"
  1. my issue with the surcharge models is the quoting of prices and then the charging of a credit surcharge without providing another option for payment. I have many times called up to pay for something been told the price and they told there’s a credit card surcharge, upon asking if there is another payment method been told no. I think it’s a mistake to think that there is 0 cost to cash or cheque when there clearly is a cost, however it involves wage cost in terms of banking the money and the velocity of the funds reaching your account were you can draw on it to pay creditors or take it as profit

  2. The Thaler/Sunstein blog discusses surcharges and discounts here. Kahneman’s 2003 paper on bounded rationality and prospect theory is here. Kahneman proposes that people’s attitudes are affected less by the absolute cost of a transaction than to the extent to which it ends up being a win (discount) or a loss (surcharge) compared with the nominal price, and people tend to be loss-averse.

    The US model encourages people to buy, especially if they can obtain a discount. The Australian model discourages people, especially if they have to pay a surcharge. While the latter is currently bad for the local economy, to the extent that it discourages rampant consumerism, it may be good for quality of life.

    I know of no research on the effect on consumer sentiment of “gotcha” surcharges – ones that appear after you have already committed to a transaction – but I doubt that it is positive. I fail to see though why the Australian model is to become illegal in the US. No business with any sense would adopt it unless all its competitors did as well (a phenomenon that seems however to have occurred in the mobile phone market). 

  3. Yep, that law is very silly.  All sensible retailers will speak of “discounts for cash” than “surcharges” for anything, and those who are not sensible should pay the price for their own lack of marketing nous.

    Mind you given the costs of handling cash I’m surprised that Coles and Woolies aren’t spruiking “discounts for EFTPOS”.

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