The Biden administration is cracking down on “junk fees” — the hidden fees that are not transparent at the time of purchase and are added on to your final bill. If all goes according to the plans recently laid out by the Consumer Financial Protection Bureau (CFPB), hotel “resort fees” and concert ticket “convenience fees” may soon become a thing of the past. And many of the hidden or add-on fees associated with credit cards, checking accounts and other financial products could be significantly reduced or eliminated.
I’m an economist at Stanford University who studies fee regulation. While I’m pretty sure that opponents of the CFPB’s efforts will cast them as regulatory overreach – an interference with the efficient functioning of the free market – I’m not buying it. Well-done regulation to limit junk fees is good for consumers and good for markets. Let me explain.
Markets work when consumers observe the full price (and quality) of a good or service when they are making their purchase decision. If consumers observe only an upfront price – and are unaware of add-on charges – when making a purchase, they won’t choose the product with the best value, gumming up the market.
To see this, suppose that you book a hotel based on an upfront fee of $150 per night. But when you go to check out, you are charged an additional resort fee of $50 per night that you weren’t expecting. If you had only read the fine print, you would have chosen that other equally good hotel that was charging $160 per night everything included.
While it’s obvious that you would be better off if you made this decision, it would also make for a better functioning market. The $160 per night hotel was offering better value for your dollar and should be rewarded with your business. If the market rewards pricing gimmicks, rather than value, then we’ll end up with too many firms that specialize in creative pricing gimmicks and not enough that focus on providing higher quality at a lower price.
In addition to improving the performance of markets, junk fees regulation could also save consumers money. Banks, for example, earned $31.3 billion in overdraft fees in 2020 and billions more in fees for late payments, non-sufficient funds, among a plethora of other charges. Given how much banks earn from these fees, it is natural to ask whether fee regulation would result in large savings for consumers.
As I’ve described in my research, the economics of whether clampdowns on fees lead to large savings for consumers is somewhat subtle and depends on the context. In highly competitive markets where firms earn razor-thin margins, firms will need to raise their upfront prices to break even, so we’re likely to see lower junk fees offset by higher upfront costs. But in less competitive markets where firms have pricing power, it is more plausible that firms will not raise upfront prices enough to offset any reduction in fee revenue, saving consumers money on net.
This later scenario is exactly what happened when Congress limited credit card fees under the 2009 CARD Act. In my research, I found that the reduced fees saved consumers $11.9 billion per year. Moreover, credit card companies were unable to make up for the lost revenue with higher interest rates or other changes, and there was no evidence that they cut back on access to credit. While it is hard to make projections before the policy is announced, it is reasonable to expect that at least some of their crack downs will generate substantial savings for consumers.
Like all policies, the details matter. In designing the junk fee regulation, the Biden administration should be careful about which fees they target. Reasonable late fees incentivize consumers to pay on time. Add-on fees that reflect the cost of actual service provision are appropriate and shouldn’t be eliminated. As always, there is the potential for overreach, and thought and care is required to strike the right balance.
In my view, we’re currently erring on the side of doing too little. Too many firms rely on hidden fees for too much of their revenue. A well-considered and balanced approach to junk fee regulation is pro-consumer and pro-market.
Neale Mahoney is a professor of economics at Stanford University and the George P. Shultz Fellow at the Stanford Institute for Economic Policy Research (SIEPR).