Colorado legislature joins Illinois in breaking national payment system

One of the glories of the modern economy is that you can walk into a store anywhere in America, or indeed much of the world, pay with a credit or debit card, and complete the transaction seamlessly and speedily. This payment system has also facilitated the rise of ecommerce, allowing online ordering and a thriving array of businesses without physical storefronts. Illinois and Colorado, however, have passed bills that threaten to break this system. In Colorado’s case, Governor Jared Polis has the opportunity to veto this legislation. He should.

The payment system relies on networks that provide the invisible plumbing of commerce. These networks contract with banks that issue payment cards. In turn, those banks work with various parties offer benefits like rewards programs. This system, however, has costs, not least of which is fraud detection and prevention. The networks absorb the costs of fraud, which is why when consumers aren’t charged or punished when disputing fraudulent transactions. The system works well for everyone’s benefit.

Merchants are one of the major beneficiaries this payment system. They attract more commerce through the convenience of card payments, and their own costs in dealing with cash are reduced (contrary to popular belief, dealing with cash is expensive due to problems like theft). Nevertheless, merchants bridle at the costs they pay to access the payment system. One of these costs is the interchange fee, and large retail stores in particular have campaigned for years for government intervention to reduce these costs.

A recent tactic adopted by the Illinois and Colorado legislatures is to allow banks to assess interchange fees on the portions of a bill represented by taxes. While such a change would slightly reduce the cost per transaction for merchants, it would break the payment system as currently constituted, which is not designed to separate out small elements of individual charges.

It is unclear how the system would adapt to such laws given the global nature of the infrastructure. At the very least, it would create severe uncertainty about card transactions in Colorado. It could also lead to card transactions simply being declined, which would hurt customers and merchants in the Centennial State, not just the banks.

It would also disproportionately burden smaller financial institutions like credit unions. These institutions have narrower revenue streams and would struggle to make up the losses, thereby hurting their members. Given the importance of military personnel in Colorado, the Defense Credit Union Council is sounding the alarm about potential harm to its military customers.

Previous restrictions on interchange fees, including those imposed on debit card charges under the Dodd-Frank Act, have proven to significantly harm consumers. Banks replaced the lost revenue by raising fees, restricting free checking, and ending rewards programs. Merchants did not provide relief by passing on the savings either. Instead, they pocketed the savings to increase their profits.

Moreover, if rewards programs are on the chopping block, other industries will be feeling their necks nervously. For example, banks and airlines maintain extensive partnerships through the sale and purchase of airline miles. Without rewards programs, airlines will have to raise prices and cut flights. That’s why the Association of Flight Attendants-CWA, AFL-CIO, the flight attendants’ labor union, opposes this legislation.

Nor are merchants united in their desire for this law. Many small businesses worry about the effects on the bill will have, particularly about the complexity it could introduce for handling previously routine payments, as well as the loss of business and goodwill from declined transactions.

One thing that could partially save consumers, small businesses, credit unions, and even airlines from the ill effects of this bill is that the Office of the Comptroller of the Currency (OCC) has recently used its power under the National Bank Act to pre-empt the Illinois law and similar potential legislation from applying to federally-chartered banks. Although the Colorado law attempts to regulate payment networks instead of banks, the effects on the banking system are the same. The OCC recognizes that these types of laws pose a threat to the national banking system.

Unfortunately, the OCC actions will likely be litigated and will not even apply to credit unions and state-chartered banks that issue many credit cards to Colorado consumers and businesses. Governor Polis, who has often proved himself to be a friend to freedom and free enterprise, could save all his constituents a lot of headache and wasted expense by vetoing this law.