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Beginning July 1st, consumers in the state of Illinois may be in for an unpleasant surprise. That date will mark the Interchange Fee Prohibition Act (IFPA) going into effect in the state. The law is set to radically upend payments logistics in the state through its imposition of burdensome, ambiguous regulatory demands on merchants, banks, and payment processors.
The IFPA will prohibit the application of interchange fees on the tax and tip portion of a transaction. Interchange fees are transaction fees paid by merchants to cover the cost of fraud protection, chargeback disputes, customer service, and other benefits for cardholders.
Aside from the ramifications of seeing those benefits being potentially limited, there is a glaring problem in the legislation that none of its proponents foresaw or have addressed to date: The technology to implement or carry out such a regulation without affecting the consumer experience is currently non-existent. Payment networks and banks only have access to the date, time, amount, and location of the transaction, but they cannot differentiate between the subtotal, tax, and tip segments of a transaction. That makes the IFPA’s aim of exempting interchange fees from certain parts of the transaction impossible to enforce in the real world.
The law could wreak havoc on payment logistics for consumers. For example, taxes and tips may have to be manually entered as separate transactions, and customers may have to face the inconvenience of swiping twice at checkout or using cash or check to pay taxes. Customers may wind up being disincentivized from tipping altogether because of the inconvenience.
The lack of guidance and clarity provided by the Illinois legislature has created confusion and uncertainty regarding how payments will function in Illinois beginning July 1st. Fortunately, the White House is considering an executive order directing the Office of the Comptroller of the Currency (OCC) to preempt the law.
The Trump administration should step in and preempt the Illinois IFPA. Doing so would set a much-needed precedent to deter other states from adopting similar measures and weakening a functioning payments system that is universal and beneficial to consumers and merchants alike.
The law has been the subject of a legal challenge between the Illinois Bankers Association and the Illinois Attorney General and is currently being litigated in the Seventh Circuit Court of Appeals.
Last year, the Northern District Court of Illinois initially granted an injunction to national banks, and later out-of-state-chartered banks, finding the law to be incompatible with interstate banking laws.
The primary legal issue currently under examination is whether the National Bank Act (NBA), which preempts state regulation of banks, applies in Illinois’ case. There is good evidence to believe that the NBA preempts the IFPA.
An amicus brief filed by the plaintiffs describes how the NBA grants nagional banks the power to engage in core banking functions such as receiving deposits, paying checks, and lending money. Interpretive letters from the OCC and past cases support the assertion that credit and debit card programs are a “core” function of banking.
Prior precedents also uphold the notion that state laws are preempted if they interfere with a national bank’s “exercise of powers”. And since the IFPA interferes with banks’ ability to receive compensation for the services they render to operate their core functions, the IFPA is preempted by federal law.
Allowing the IFPA to go into effect would be tantamount to creating a loophole in federal preemption doctrine. It means states can regulate banking activities by “regulating the third parties on which banks rely to carry out their federal powers”, rendering NBA preemption meaningless and opening a pandora’s box for state governments to regulate other areas of financial services.
In any case, proponents of the IFPA are unlikely to achieve their aim of lowering costs for consumers. The Federal Reserve has shown that interchange fee regulation failed to lower prices for consumers in the past. Additionally, cardholders pay interest and fees on credit cards. Since merchants also benefit from faster payments and higher ticket spending from cardholding customers, they too should pay for the benefits they receive from electronic transactions.
The Trump administration should use its executive power to preempt the IFPA and deter legislators in other states from doing the same. The unified, convenient, and secure payments system that millions of Americans rely on emerged through innovation and agreements between multiple parties. State legislatures have no role in upending these networks and subsequently harming consumers, tipped workers, and small businesses.
