Death by a thousand caps: State laws could kill credit card rewards

Imagine booking a long-awaited family vacation only to realize that your once-generous credit card rewards have vanished. Picture a world where free checking accounts are nearly extinct, and the cost of everyday banking services continues to rise. That world is practically here, driven not by market forces but by a seemingly coordinated push from state legislatures to impose various price controls. What may seem like a minor tweak to transaction fees is, in reality, a sweeping effort to regulate the financial system through backdoor price controls, jeopardizing the benefits that millions of Americans use to save money and manage their finances.

The steady creep of government price controls is nothing new, but the latest efforts to regulate interchange fees on card transactions are alarming. Across the country, a growing ad-hoc coalition of state legislatures is pushing laws to cap interchange fees. These are the fees that merchants pay to banks and card networks to process electronic payments. Looming state-level regulations threaten to upend the financial system, increase consumer costs and undermine national economic cohesion. Worse yet, this movement may constitute an interstate compact, requiring preemptive intervention from Congress.

At least 19 states and Washington, D.C., have either introduced or advanced bills targeting interchange fees. The effort is far from isolated, ranging from New Mexico’s HB 476 and Arizona’s HB 2629 to even New York’s SB 5587. While technically state-specific, these bills employ similar legislative frameworks that imply multistate coordination. The goal? To impose regulatory restrictions on the same financial process across multiple jurisdictions, creating a patchwork of price controls that would ultimately function as a de facto national policy.

The issue here is twofold. First, financial markets, particularly payment processing systems, operate nationally. Selective fee caps disrupt uniformity, increasing compliance costs for banks, payment processors and retailers while harming consumers with supplemental fees and reduced access to credit. Second, a coordinated state effort to impose uniform regulation on an economic activity traditionally governed by federal law may constitute an interstate compact, which cannot legally take effect without congressional approval.

An interstate compact is an agreement between two or more states that seeks to regulate an issue beyond state borders. The Supreme Court has ruled that compacts require congressional consent when they interfere with federal supremacy or encroach upon federal regulatory powers. The financial services industry, including the application of interchange fees, falls squarely under federal banking regulations. These state-level fee caps directly impact national economic policy by dictating terms to financial institutions that facilitate interstate and intrastate commerce.

The complexity of modern financial transactions exposes the fundamental flaw in any state’s attempt to impose price controls. Consider a scenario where a customer in Arizona uses a credit card issued by a Texas-based financial institution, which imports a rate from Delaware. The transaction is processed by a payment network headquartered in Tennessee, while the purchased product is drop-shipped from a warehouse in Arkansas. This intricate web of interstate commerce raises a crucial question: How does Arizona’s cap apply to a transaction that involves multiple jurisdictions?

The reality is that no single state can neatly regulate an interchange fee without broader disruption, as these transactions do not begin and end within Arizona’s borders. Arizona risks violating the Commerce Clause, overstepping its jurisdiction, and creating regulatory uncertainty that could result in restricted financial services and increased costs for consumers and businesses.

The roots of the interchange fee price control movement can be traced back to the federal government’s intervention in the payments industry through the Durbin Amendment, a provision of the 2010 Dodd-Frank Act. This amendment mandated that the Federal Reserve cap debit card interchange fees for banks with more than $10 billion in assets. The cap dramatically reduced the revenue financial institutions collected on debit transactions.

While the Durbin Amendment saw a significant reduction in payment processing costs with merchants and retailers, studies by the Federal Reserve Bank of Richmond found that 98% of retailers failed to pass these savings on to customers, and some even raised prices. The Atlanta Federal Reserve Bank supported these findings. Meanwhile, financial institutions, particularly those reliant on interchange revenue, responded by eliminating free checking accounts, increasing account maintenance fees and scaling back debit rewards programs.

Now, state legislatures are attempting to apply a similar regulatory approach, this time to credit card interchange fees. By carving out specific portions of transactions — such as sales tax and gratuities — from interchange fee calculations, states like Arizona and New York are advancing a piecemeal form of price control. Technically, while the interchange fee cap may only apply to sales tax, the practical limitations of credit card processing at the terminal would compel the application of the fee cap to the entirety of the transaction.

If these measures continue, banks and credit unions, particularly small or regional, may be forced to offset lost revenue through higher monthly account fees, reduced cash-back rewards and stricter credit availability, especially for lower-income consumers.

In 2022, the Government Accountability Office found that regulatory restrictions on banking services, such as limits on debit card fees, contributed to higher account maintenance costs and reduced access to financial services, disproportionately affecting lower-income and minority households. This scenario already occurred with the overnight abandonment of debit card rewards programs after the Durbin Amendment. The same could happen with credit cards, which generated over $35 billion in rewards from the largest U.S. banks in 2019.

The logistical nightmare of complying with differing interchange fee regulations across multiple states will drive up operational costs for financial institutions and merchants alike. Is this a burden the economy can afford to bear? If interchange fees require regulation, shouldn’t it be done at the federal level with transparency, economic reasoning and apparent legal authority rather than through a fragmented state-by-state approach?

For millions of Americans expecting their credit card rewards to fund their annual family summer vacations, the stakes are too high to ignore.