Merchant Card Acceptance: An Extension of the Tourist Test for Developing Countries

Abstract

The paper extends the tourist test proposed by Rochet and Tirole (2011) to the situation of emerging countries which are characterized by informality (tax evasion through cash payments). We introduce a government which faces a cost associated to cash (resources to fight against crime minus seigniorage) and tax evasion in the base model. The main idea is that merchants benefit from tax evasion since they do not provide a receipt in cash transactions and thus pocket a fraction of the VAT. In the presence of informality, the tax benefit of cash reduces the merchants’ net operating benefit of accepting card sales. The tourist test aims to determine a maximum interchange fee (the fee that the acquirer pays to the issuer whenever a card transaction is done) which makes the merchant indifferent between accepting cash or card. In this new environment, the tourist test threshold now internalizes this tax benefit of accepting cash. We assess the socially optimal interchange fees in this new model setup derived from three different social maximization functions.

Card Acceptance by Small Merchants: An Application of the Tourist Test to Peru

“…In this context, issuers receive a lower income, that constraints their ability to give rewards to cardholders. Aurazo and Vasquez (2020) show that the interchange fee in Eq (2) is compatible with the level of the interchange fee that maximizes total user surplus (cardholders utility and merchants profit), as in Rochet and Tirole (2011). See Appendix A.…”

“…In this context, we take the extended version of the tourist test that considers tax evasion when accepting cash payments. This extension was developed by Aurazo and Vasquez (2020), who introduce evasion of the Value Added Tax (VAT) in cash payments. Small merchants do not usually provide a receipt when consumers make cash payments and, since the retail price includes VAT 14 , merchants pocket a fraction of VAT and thus obtain an additional benefit per cash transaction 15 .…”

“…Following Bolt et al (2013), Gorka (2014), Fung et al (2018) and Aurazo and Vasquez (2020), the marginal cost functions per cash payment and per card payment are:…”

“…This paper presents a first attempt on estimating the interchange fee, in the case of debit card payments, for small merchants in Peru using the tourist test framework extended by Aurazo and Vasquez (2020) that includes tax evasion (broadly interpreted as informality), when merchants do not provide receipts.…”

“…Section 2 describes the concepts related to the card industry and the regulatory caps imposed on interchange fees in some jurisdictions. Section 3 discusses the base model of the tourist test (Rochet and Tirole, 2011) and the extension that includes tax evasion (Aurazo and Vasquez, 2020); also presents the empirical standard methodologies used to estimate the tourist test threshold and it discusses a new methodology to estimate the tourist test threshold, the cash-flow approach, considering tax evasion. Section 4 describes Peru's payment cards market, the results from the Survey for small merchants in Peru, and discusses the interchange fee estimations obtained from the cash-flow approach and the standard approach applied in other papers.…”