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It’s become standard practice for credit card issuers to offer rewards on their cards such as cash back rebates and airline miles that provide an incentive for cardholders to use their cards more often.

But for those millions of families living below the poverty line, are these rewards cards just another way for the rich to get richer at their expense?

A recent study from the Federal Reserve Bank of Boston, entitled “Who Gains and Who Loses from Credit Card Payments” provides support for the longstanding position some academics and certain economists have been squawking about for years: America’s poor are unfairly shouldering the burden of these credit card rewards programs.

Should we be rethinking our use of rewards cards? Is there a way to modify or improve rewards cards so that everyone benefits, including the poor?  Or should we boycott rewards cards entirely because of their undue burden on the poor? But before we go any further in our analysis, let’s start with some background and a history of rewards programs.

Discover Financial Services originated the concept of rewards cards back in 1986. Searching for a way to differentiate itself from industry leader American Express, the fledgling company introduced its “Cashback” program, a ground-breaking new feature that rewarded cardholders with an annual cash rebate tied to their annual spending. The results from their new Cashback rewards program were startling, showing a dramatic increase in customer loyalty and card applications. The enormous success of Discover’s Cashback program resulted in a spike in fee revenue that accounted for 70% of the company’s overall profits that year. Discover came to realize that the true value of rewards programs was the ability to build loyalty for a credit card brand. As Julie Loeger, Discover’s Vice President of Marketing and Rewards describes it, “Loyalty means usage, and that’s where we make the money.”

To date, Discover has issued over 50 million rewards cards to an increasing number of well-to-do consumers – and Discover only serves a portion of the market. According to The 2009 Survey of Consumer Payment Choice from the Federal Reserve Bank of Boston, every major card issuer now offers some type of rewards card, which now accounts for at least 60% of all active credit card accounts in the marketplace.

In addition to a broad selection of providers to choose from, today’s consumers also have far more rewards redemption options to choose from than ever before. No longer limited to cash back rebates, cardholders’ reward bonuses can now be applied toward discounted airfare, gas rebates, gift cards, vacations and more. With so many options, popular cash back cards like the American Express Blue Cash or the Chase Freedom offer deals too good for many consumers to pass up – which is exactly the source of the problem.

Every time credit cards are swiped in a store, the merchant must pay a transaction fee known as a “restraint” to the card issuer. According to the Federal Reserve of Boston, these restraints or fees are the origin of the wealth transfer that occurs as a result of rewards programs.

“Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $21 and the highest-income household ($150,000 or more annually) receives $750 every year.”

Georgetown University law professor Adam Leventin identified this trend as early as 2008 in his article for the Harvard Journal on Legislature. “Credit cards,” he said, “create significant costs for merchants and, most strikingly, for consumers that do not use credit cards.”

Card issuers target a very specific, higher income, frequent spending demographic for their rewards programs. Cardholders with higher incomes who buy more expensive items and spend more frequently on their cards to capture rewards are far more lucrative for the card issuers than low-income cardholders. Since merchants don’t allow variable pricing for different methods of payment, cash-only consumers are forced to subsidize the higher prices that merchants must charge from the higher fees associated with the rewards cards. As a result, low-income households wind up paying a disproportionately higher amount for purchases relative to what rewards cardholders pay.

The exorbitant merchant fees collected by the card issuers are the easiest target of criticism when it comes to the rewards disparity, but at this point, significantly altering the fee structure seems highly unlikely. As New York Times reporter Ron Lieber notes, “Bringing that cost down to zero means that everyone would have to quit cards cold turkey. That’s a tall order, given that the campaign wouldn’t work unless all Americans were in on it.”

While the Federal Reserve report hinted at the possibility of limiting the amount of rewards that card issuers can pay out to consumers, regulating these newfangled rewards programs through government oversight seems highly unlikely any time in the near future especially given the political stalemate in which Washington is currently embroiled.

Now that rewards cards have become so popular, most Americans won’t be keen to give up one of the favorite new forms of currency – and justifiably so. They like them, and they want to keep them. Despite their complaints about the costs and fees, the benefits of maintaining these programs still outweigh the costs for merchants. In fact, a report on externalities in payment networks from Sujit Chakravorti of the Federal Reserve Bank of Chicago found that 83% of U.S merchants saw increased sales and 58% increased their profits after they started accepting credit cards.

In addition to that, many economists argue that the predisposition of rewards cardholders to use their cards to capture incentives more frequently is actually good for an ailing US economy. According to research published by the Journal of Experimental Psychology, consumers who pay with cards are inclined to spend 18% more than they would if they were paying with cash. Like it or not, rewards card use has encouraged consumers to stimulate the economy, critical for a country desperate to climb out of its economic malaise. As Wall Street Journal correspondent Jeff Bater says, “Consumer spending is a big part of the economy. Rising spending at the end of 2010 made the economy grow faster.”

That being said, it feels decidedly un-American and unfair to force low-income wage earners to subsidize tropical cruises and ski trips for those in the upper income tax brackets. Unfortunately, there’s no mechanism in place to reward less-fortunate yet financially responsible citizens.

A better way to bridge the gap between cash and credit card consumers would be for creditors to develop and customize a line of rewards-based cards that target the country’s lowest-earners. Despite the challenges with the existing fee structure for merchants, there’s still a case to be made for a modified rewards system that can accommodate disenfranchised low-income consumers while still maintaining profitability for card issuers. With unemployment, foreclosure rates and debt at record levels, the lowest-earning sector of the population assuredly needs that gas and grocery discount far more than the highest earners do.

The plan is more feasible than it seems. A low-income rewards program has the potential to shift more of the economic burden to the merchants and card issuers, who stand to gain the most from their use. While it might seem unfair to burden merchants disproportionately with rewards programs, they would also see a trade off from an offsetting lift in revenue and profits when former cash buying households begin to spend more often with their cards.

Another thing to consider is that prepaid debit cards and no-background-check credit cards that offer credit to consumers with questionable financial histories already exist. These products, however, rarely provide any rewards incentives.

Building a low-income rewards program would be very similar to the steps that consumers already have to take to build good credit. For instance, low-income rewards cards would come with no fees but with low limits to control the spending of new cardholders. As the cardholders slowly build a history of card use, the card’s limit could be adjusted to reward those who pay their bills on time and improve their credit worthiness. Alternatively, the cards could function like prepaid cards, where after a period of regular use and transaction history, a small line of credit could be established.

In terms of the types of rewards offered, low-income rewards cards would do away with more “discretionary” type items, vacations and frequent flyer miles and instead offer a limited selection of discounts on groceries, gas and other necessities. The variety and discretionary nature of the rewards offered might improve as the cardholder builds their income and their credit history over time. Additionally, these low-income cards would come with the same APR tiers as the prime-rate rewards cards: an introductory 0% APR, no-interest period that moves to a higher ongoing APR after a year. Most importantly, a line of low-limit rewards cards for low-income families would encourage responsible spending habits without destroying the privileges that standard rewards-card members have come to expect and enjoy.

If there’s anything to be learned from the current economic predicament, it’s that a balance between the cardholders, the card providers and the disenfranchised is critical for success in building more fairness into credit card rewards programs. Without it, the rewards card market will remain lopsided and unfair for low wage earners.  Therefore, as new studies continue to discover the extent to which the credit card industry influences our economy, we must be vigilant and decisive in reshaping our credit card policies. It’s the responsibility of every American to be vocal about bringing parity to the credit card market.

Credit Card Processors- What Choices Do You Have?

Whether you operate your business online, offline or both, as a business owner offering credit cards as a form of payment can increase your potential for sales tremendously. When it comes to selecting credit card merchant account services you have a few options to look closer at.

• One option is to look toward independent sales organizations (ISO). If you are not sure what these are ISO services are organizations that represent lending institutions such as banks. The ISO is a middle man essentially and makes an agreement with a bank to sell services to business owners in need of them. While ISO services are quite popular they can also be expensive. They most often mark up their fees when it comes to signing up merchants for the services they offer. This is how they make a profit.
• You can also look to the bank you deal with for your regular personal and professional business. Banks are a good source to look to in terms of finding a potential merchant account provider. In most cases however banks do not do this kind of processing on their own but contract out the work to a third party. What they may do though is to offer you merchant account services as well as a business account package. This can sweeten the deal even more!  Find out if your bank offers such services.
• Credit card associations also offer merchant account services. These include MasterCard, Discover, Visa and American Express.  Each one of these companies handles their merchant accounts in a different manner. Discover, MasterCard and Visa expects their merchant clients to have an established account by way of an intermediary organization before they are willing to offer credit card processing services. On the other hand American Express will work with business owners directly to start a merchant account from the ground up.

Another option for merchant credit card services is to look to a registered credit card broker. These can be thought of as independent sales organizations and most of the time they represent a great number of ISO processors at any particular period of time. A registered credit card broker will not process any merchant transactions on his or her own but instead will set up an account with those organizations that do that. This is a good option for small to middle sized merchants who very much want to find service that are personal in nature.

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