Against Credit Cards

It's well documented that people paying with plastic are willing to spend more than when paying with cash—a phenomenon everyone fancies themselves immune to.

Lauren Giordano / <i>The Atlantic</i>

There is some nuance to the argument for never using a credit card again, but this line, from a New York Times article last fall, is a fair, if reductive, distillation of it: “In certain contexts, people were willing to pay up to twice as much for the same item when paying with a credit card instead of cash.” People using the same nation’s dollars, buying the same products, under the same experimental conditions, found it acceptable to part with twice as much money if they used a credit card instead of cash. Twice as much.

The country surely has a problem with credit-card debt, which, per capita, increased 1,500 percent between 1980 and 2010. That’s what most people assume to be the issue with using a credit card. (“Most people," by the way, are likely wrong: A 2009 study found that two-thirds of Americans don’t actually know how credit cards work.) But their other damaging quality—one that applies even to people who pay all their bills on time—is their ability to anesthetize the pain of a transaction by delaying payment.

Credit cards effectively give people interest-free loans (for those who pay their bills on time), which in part explains why people would pay extra to use them. But the amount of overspending they induce more than eats up any financial gain from an interest-free loan. Essentially, using a credit card means agreeing to pay a hefty tax to make transactions seem less painful. No matter how much rationalizing one tries to do—"But I get so many frequent-flier miles from my card!”; "But I can always pay my bill!"—the overspending induced by a credit card will, except in tandem with the most un-fun, disciplined rules, outweigh its perks.

Consumers fancy themselves immune to this financial anesthesia. But study after study has documented credit cards’ ability to get people to spend more than they otherwise would, even when cash, credit, and debit were randomly assigned to experimental subjects: Credit cards make people more likely to forget how much they spent on something. They make frugal people spend recklessly. They make people willing to spend a lot more on one-off purchases. And large credit limits promote the illusion that daily purchases are inconsequential.

A seminal 2001 study by Drazen Prelec and Duncan Simester titled “Always Leave Home Without It” firmly established a “credit card premium” that arises under certain circumstances. That premium was identified decades earlier, by Richard Feinberg, a professor of consumer behavior at Purdue University, in a 1986 study. Feinberg's experiments suggested that simply seeing a credit-card logo was enough to make people willing to spend more money on a product.

Prelec and Simester’s findings downplayed the importance of logos, but further solidified the theory that credit cards extract more money from people than cash in identical circumstances. The two researchers found that their Boston-based experimental subjects were willing to pay strikingly different amounts of money on tickets to a Celtics game, depending on their method of payment. Those paying with cash found roughly $30 to be a reasonable price, while those paying with credit on average were satisfied with $60. This Celtics experiment suggests that the premium is largest and most dangerous when people are making one-off purchases or buying things with uncertain value.

“Twice as much” is a finding so outlandish that many will consider themselves exempt from credit cards’ dark magic—in fact, even the people who have rigorously studied it themselves use credit cards. Prelec told The New York Times last year that he uses one occasionally—only to book travel or make big purchases, which, he claims, doesn't violate the recommendations of his own research. The University of Maryland’s Joydeep Srivastava, the author of another study scrutinizing plastic, still uses one too. “Mostly because my credit card is giving me lots of miles,” he explained to the Times.

There are without a doubt certain circumstances under which using a credit card is a good idea. If you need a cheap line of credit before a paycheck comes (and you’re absolutely sure you can pay off the bill), use a credit card. If you need to build good credit in order to get a loan, use a credit card. And if you have determined that a credit card’s perks make absolute total sense for you personally, use that credit card. (For example, one of my colleagues, an avid magazine reader, uses a credit card that gets her significant discounts on more than one of her subscriptions. Miles and cash-back programs, though, are often too stingy to justify risking the credit-card premium.)

But surely not all of the 26.2 billion U.S. transactions that credit cards are responsible for annually fall under those three categories of exceptions. In the U.S., where individuals hold 3.7 credit cards on average, they remain the predominant plastic means of payment, accounting for a little more than half of consumer payments made in the U.S. by value. (It's likely that cards owe part of their current popularity to the fact that they're the best way to buy things online—but it seems wiser to link your Amazon account to debit, not credit.)

Percentage of Noncash Consumer Transactions in the U.S. (by Value)
Federal Reserve

So if academics have been so clear about the perils of credit cards, what have they proposed to mitigate the damage? The solutions that are currently out there range from the obviously quixotic to the hilariously desperate. It’s unclear whether the advice to freeze your credit card in an ice cube and hold off on a purchase until it thaws was offered sarcastically by the behavioral economist Dan Ariely; in any case, his advice has popped up earnestly in more than one discussion of budgeting. The results of a 2002 study Ariely authored underline the value of self-imposed spending rules—but Americans don’t have a great track record imposing things on themselves.

There's another crop of potential solutions that doesn't depend on consumers’ discipline. Because a broad push for financial-literacy education hasn’t done all that much, academics have become interested in tweaking the experience of swiping a credit card. Perhaps a light-colored card that turns darker as you approach your credit limit would work, they’ve suggested. Or what about texting people reminders to be frugal? A study published last year found that printing someone’s credit-card balance on all of their receipts could reduce expenditures by as much as 10 percent.

However, changes like these would require either the cooperation of credit-card companies (not likely) or a concerted effort by the federal government (perhaps even less likely). A Mastercard pilot program in Turkey with cards that display account balance is a potential bright spot, but it hasn’t spread anywhere else, and it’s only available for debit cards.

Without the help of the government or credit-card companies, the responsibility falls to individuals. A rational starting place would be to keep using a credit card and make a note of every transaction for a month. Then, do the same with debit, and see if there’s a difference. The answer isn't necessarily to cut credit cards out of one's financial diet entirely, but it's possible to continue building a good credit score and still kick the daily habit.