This week the US Senate voted to outlaw earning frequent flyer miles from credit card transactions.  Of course Sen. Durbin, the amendment’s sponsor, would not put it that way.  Durbin rather said that by capping the fees charged to retailers, small businesses would benefit.  Sadly, Durbin is wrong on both counts; his proposed law would outlaw frequent flyer miles and harm small business.

Credit card companies like Visa and American Express charge both interest on consumer debt and transaction fees to merchants who accept their cards.  The fees vary, but can be as high as 2.5% of the purchase price for the more expensive American Express.  Durbin wants to help consumers by authorizing regulators to cap transaction fees at something like 0.7%.  As with all the consumer regulation coming out of Washington, capping fees sounds nice until the price of regulation comes due.

Credit card companies use the fees to pay for operating expenses like billing and customer service, but in order to compete for customers they also rebate some of those fees back to cardholders.  Sometimes the rebate comes in the form of frequent flyer miles, and sometimes plain cash.  American Express offers a Fidelity Investments affinity card that gives back 2% of most purchases.  Obviously if transaction fees are capped at 0.7%, such cards can no longer exist.  Durbin compared the costs of operating a credit card company to the fees it currently charges, but he ignored the marketing cost of consumer rebates.

Durbin’s amendment would force credit cards to quit innovating perks to attract the best consumers.  In Durbin’s world, all credit cards would be the same, since they would be regulated into offering exactly the same services to all.  Currently, consumers can choose from hundreds of options that best suit their needs, but that kind of choice is always the first victim of government regulation.

Even worse, Durbin’s amendment would reduce the quality of customer service for cardholders.  Since the cost of agressively investigating and reversing disputed charges does not appear to be in Durbin’s cost formula, credit cards will likely provide less consumer services.  Durbin’s amendment would turn credit cards in to regulated commodities with limited value to consumers.  Expect far fewer people to use credit cards when they offer limited service and no perks.

This brings up Durbin’s second misrepresentation – that his amendment would help small business.  Contrary to Durbin’s understanding, credit cards help small business.  Prior to the dominance of Visa and American Express, only large corporations issued credit cards for their customers.  Major department stores and gas stations issued their own cards.  There is nothing in the Durbin amendment to discourage large companies from offering credit card perks on their own cards.  Companies like Visa allow small businesses to better serve their customers and thereby compete with larger companies.  Without the ubiquity of Visa, consumers will be incented to shop at large retailers with their own credit cards and customer perks.  As is most common with Washington, this bill will actually harm small businesses and enrich the big ones.

Which company might benefit the most form the Durbin amendment?  PayPal stands to gain because it charges fees for processing credit card transactions.  PayPal would continue to charge unregulated fees for moving money, but would pay out far less to the credit cards it accepts.  Not to get Glen Becky here, but Ebay, PayPal’s parent company, did give Durbin $1000 the last time he was up for election.

So, a far left Senator from Illinois puts through a surprise amendment that stifles consumer choice, harms small retailers in favor of big businesses, and handsomely rewards one of his corporate donors.  Hardly news, to be sure, but it is one more reason to turn out at the polls this November.