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Optimal Payment Cards Fees

Feb 2007
Working Paper
06-019
By  Assaf Eilat
Credit card rebates, which are paid to all credit card users regardless of borrowing, have grown substantially. This paper analyzes this phenomenon by comparing the socially and privately optimal interchange fees in debit and credit cards. Compared to debit cards, credit cards raise efficiency by allowing convenient borrowing, but also tax nonholders in order to finance the rebates paid to credit card users. A welfare enhancing and legally feasible policy is suggested, under which the regressive tax is cancelled while the efficiencies of credit cards are preserved. An outcome of the proposed policy is that credit cards are used for credit purposes only, while debit cards are used as a convenient payment instrument.