By Patti Murphy
Hampered in their efforts to secure a federal law regulating credit card interchange, merchants have turned to the states. A new law in Illinois prohibits interchange assessments on sales taxes and gratuities, effective next July, and legislation pending in at least four other states would impose similar prohibitions, including Pennsylvania which is poised to vote on its iteration as of this writing.
Proponents of these laws argue that paying interchange on the tax portion of a sale to paying a tax on a tax. The cost of non-compliance in Illinois is high, at $1,000 per incident, paid by the offending processor.
Not surprisingly, Senator Dick Durbin, D-Ill., praised lawmakers in his home state, who included the Interchange Fee Prohibition Act in a budget bill that was nearly 1,300 pages in length.
"The Illinois state legislature took a major step forward in pushing back against the swipe fees that are charged by credit card companies – fees that are nonnegotiable for merchants and that big banks use to pad their already high profits," Sen. Durbin said in a statement.
The senator went on to urge fellow lawmakers in Washington to "take a page out of Illinois' book" and pass the Credit Card Competition Act, a bill he authored that has the backing of a handful of Democrats and Republicans in the Senate and the House. That bill would require large credit card issuing banks to render their cards capable of being processed through two competing networks, only one of which could be owned by Visa or Mastercard.
Those familiar with the Illinois law and similar legislation pending in other states warn implementation will be time consuming and costly, especially for small businesses.
Ken Musante, founder of Napa Payments and Consulting, noted the new law will require merchants in Illinois to maintain two merchant accounts: one for tax and tips and another for everything else. It would also necessitate a new merchant category code specifically for businesses in Illinois, he pointed out, adding that "we would need to police how each account was utilized."
Musante likened the situation to a municipality that decided to charge lower rates for water used for personal consumption and a greater amount for irrigation. "Unless, either there were two pipes to every household (and there was policing to ensure water meant for personal consumption was not used for irrigation), or there was a complete retrofit at the meter of every household and a completely new set of pipes which bifurcated the water, at the meter, it would be impractical to tally," he said.
Esther Pochron, chief sales and marketing officer at EPNA, a Chicago-based ISO, said EPNA has begun working with partner platforms to ensure compliance, but she warned the new law could have negative consequences for all parties: acquirers, issuers, merchants and consumers. For example, she noted, issuers are apt to reevaluate rewards programs to offset the reduced revenues.
"If more states enact similar legislation, card issuers may also respond to the decreased revenue by increasing the overall interchange rates for certain retail and restaurant interchange categories in order to offset the revenue loss as a result, thus affecting merchants' overall cost of interchange pass-through fees, defeating the purpose of the legislation in the first place," Pochron added.
"The squeeze is not worth the juice," said Scott Talbott, executive vice president at the Electronic Transactions Association.
The ETA unsuccessfully urged Illinois Governor JB Pritzker to consider a line-item veto of the bill. "This provision would put the state of Illinois on a global and nationwide payments island by upending how consumers conduct electronic transactions in Illinois with no benefit to the consumer or additional revenue to the state," the ETA wrote in a letter to Pritzker.
It also would be impractical from an implementation standpoint, in one year, as "merchants would need new, yet-to-be-developed, specialized terminals and software to itemize and communicate segmented data to the card networks at the time of sale," the ETA added.
Big box retailers might be able to adjust their systems to accommodate such requirements, ETA wrote in a letter to Pennsylvania lawmakers, but not so smaller merchants who use POS terminals with more limited functionality. "The ability for small merchants to offer a multitude of payment options is critical to their ability to compete with big box retailers, give their customers the options they desire, and remain flexible in times of crisis," the ETA wrote.
The Illinois law and similar legislation also raise serious privacy considerations as they would require the collection of detailed, itemized SKU-level purchase information, the ETA noted.
"This is information we do not currently collect," the association wrote in a letter to the Pennsylvania House Finance Committee. If the legislation pending there is passed, the ETA added, "each transaction purchased would have to be itemized and audited to determine the correct application of a state sales tax exemption or local tax." Then there is the $1,000 per incident fine for non-compliance, which ETA wrote "would be deemed unacceptably severe, especially for small transactions such as the purchase of a pack of gum."
The ETA isn't alone in lobbying lawmakers to ditch plans to exempt taxes and gratuities from interchange. Airlines for America, a trade group representing U.S. airlines, penned a letter to leaders of the Pennsylvania House urging they reject the legislation prohibiting interchange assessments on sales and use taxes.
"We understand and appreciate that there are a number of significant challenges before the General Assembly, and we respectfully ask that the General Assembly leave undisturbed a system that works and with which consumers are happy," Sean Williams, vice president for state and local government affairs, wrote leaders of the Pennsylvania House.
Williams warned that passage of the legislation, HB 2394, would seriously hamper rewards programs.
"Pennsylvanians love to travel and the miles that customers earn with their credit cards facilitate family vacations, visits to loved ones and weekend getaways," Williams wrote. "These rewards programs also bring thousands of visitors to Pennsylvania and are a critical part of the tourism sector. This proposal introduces unnecessary risks to their important sources of value and economic contribution across the state's economy."
Legislation to exempt sales tax from interchange was rejected in the Florida legislature last year. This year, lawmakers in the Sunshine State have introduced a proposal to study the move. A similar proposal is pending in the Georgia Senate.
Americans for Tax Reform, a conservative advocacy group that lobbies for simpler, lower taxes, is among the groups panning that plan.
"The issue of whether or not the government should mandate new regulations around interchange fees is actually very simple: it is another example of one private entity using the government to get their preferred terms for a contract with another private entity put in law," the group states on its website.
"The government should not be meddling in these business-to-business negotiations." 
Patti Murphy, self-described payments maven of the fourth estate, is senior editor at the Green Sheet. She also co-hosts the Merchant Sales Podcast, and is president of ProScribes Ink.
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