The Perils and Promise of Payroll Debit Cards

New financial products can certainly help workers, if they aren't abused.

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Last week, New York Attorney General Eric Schneiderman started looking into the controversial new practice of issuing workers debit cards in lieu of paychecks. The practice first came to light last month when an employee of a McDonald's franchise in Pennsylvania sued over being forced to accept pay in the form of debit cards. Soon after, the New York AG's office sent inquiries about debit card payroll practices to several companies, along with a request to see a list of fees associated with the cards.

Some of the companies that were contacted by the AG's office were high profile brands such as Wendy's, Costco, Darden Restaurants and Walmart. As the list suggests, these are enormous corporations with lots of hourly workers. Instead of a physical paycheck or direct deposit, workers get debit cards they can use to purchase items or access cash via ATMs.

So far so good. But workers soon discovered that such transactions are often laden with income–reducing fees on common transactions such as balance inquiries and even penalties for periods of inactivity.

Why are banks so eager to push debit cards? The explanation, ironically, goes back to the Dodd–Frank financial regulations, which were intended to protect consumers from fees banks charge retailers for using their debit card (known as a swipe or interchange fee).

The Durbin amendment, a late addition to Dodd–Frank by Sen. Dick Durbin, D–Ill., was introduced with the intention of keeping a lid on these fees so they would not get passed on to consumers. Instead, as banks looked to replace the estimated $14 billion in lost revenue, they turned to transaction fees on items like debit cards. Aite Group, a research consulting firm in Boston, estimates that by 2017, some $68.9 billion will be distributed through payroll debit cards.       

[Read the U.S. News Debate: Should the Dodd–Frank Act Be Repealed?]

And it's not only the financial institutions that are benefitting. Large companies and organizations can save millions of dollars on payroll costs by switching to the debit method. For example, if Walmart were to eliminate the 18 million paper paychecks it distributes every year, it could conservatively save more than $36 million (not to mention more than 3,000 trees).

Helping workers access their hard–earned pay in a quick and reliable way is a good idea. Electronic debit cards could actually help many people acquire goods and services online, where they might not usually be able to shop due to lack of credit. But when workers are forced to accept their wages in the form of debit cards, and then get dinged for big fees, we have a problem.

Instead of junking the whole experiment, however, public officials should work with the financial companies that issue debit cards to lower and even eliminate fees, which fall hardest on hourly wage earners and part–time employees. If the banks refuse to go along, employers should be required to offer their workers other payment options, like paper paychecks or direct deposit.

One group that could benefit from this approach is the unbanked. According to a 2011 survey by the Federal Deposit Insurance Corporation, 8.2 percent of U.S. households – nearly 10 million households with 17 million adults – don't have bank accounts. They must rely instead on "alternative" financial institutions like expensive check cashing services. The survey notes that four million households have someone receiving wages with a payroll debit card. 

[See a collection of political cartoons on the economy.]

In the wake of the 2008 financial crisis, magnified in intensity by a raft of exotic financial instruments like synthetic collateralized debt obligations, innovation in the financial arena has gotten a bad name. That's unfortunate, because we need innovation across all economic sectors to boost the nation's anemic growth rate (just 1.8 percent in the first quarter of this year).  

But the public is understandably angry at the financial industry, and Congress is determined to tighten the regulatory screws on it. As always, we need to be wary of overcorrecting for errors and abuses that aren't likely to recur.

But how can we tell good financial innovations from bad? Well, one way is to determine whether a new financial product or service serves all parties in the transaction. That doesn't seem to be the case when the financial facilities are loading fees onto payroll debit cards and employers aren't offering any other options, so both can increase their bottom lines while Joe Part–Time foots the bill.

So rather than just having payroll debit cards used to cut costs, employers need to help make debit cards work for the employees.

The AG's office is investigating whether any labor laws were broken by not offering choices and if fees are excessive. Lets hope that this scrutiny from public officials will help make payroll debit cards the right kind of financial innovation – one that serves the workers as well as the employers and banks.

Jason R. Gold is director of the Progressive Policy Institute's "Rebuilding Middle Class Wealth Project" and senior fellow for financial services policy. Keep up with his work at PPI here and follow him on Twitter at @PPI_JGold.

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