Should credit card rewards be taxed?

Abstract

AbstractRewards that consumers receive on credit card payments influence their payment choice. They are not taxed but merchants deduct card fees from their taxes. This article analyzes the tax effects in a model where card companies set interchange fees, merchants decide whether to accept card payments, and consumers choose their preferred payment method. I find that card companies raise interchange fees when merchants are allowed to deduct these fees from their taxes. Taxing consumers' card rewards reduces interchange fees. The optimal distribution of cash and card payments cannot be supported without a policy combination of taxes and regulated interchange fees.