Why low-income Americans often have to pay more
WHEN Ken Martin, a hat-seller, pays his monthly child-support bill, he uses a money order rather than writing a cheque. Money orders, he says, carry no risk of going overdrawn, which would incur a $40 bank fee. They cost $7 at the bank. At the post office they are only $1.25 but getting there is inconvenient. Despite this, while he was recently homeless, Mr Martin preferred to sleep on the streets with hundreds of dollars in cash—the result of missing closing time at the post office—rather than risk incurring the overdraft fee. The hefty charge, he says, “would kill me”.
Life is expensive for America’s poor, with financial services the primary culprit, something that also afflicts migrants sending money home (see article). Mr Martin at least has a bank account. Some 8% of American households—and nearly one in three whose income is less than $15,000 a year—do not (see chart). More than half of this group say banking is too expensive for them. Many cannot maintain the minimum balance necessary to avoid monthly fees; for others, the risk of being walloped with unexpected fees looms too large.
Doing without banks makes life costlier, but in a routine way. Cashing a pay cheque at a credit union or similar outlet typically costs 2-5% of the cheque’s value. The unbanked often end up paying two sets of fees—one to turn their pay cheque into cash, another to turn their cash into a money order—says Joe Valenti of the Centre for American Progress, a left-leaning think-tank. In 2008 the Brookings Institution, another think-tank, estimated that such fees can accumulate to $40,000 over the career of a full-time worker.
Pre-paid debit cards are growing in popularity as an alternative to bank accounts. The Mercator Advisory Group, a consultancy, estimates that deposits on such cards rose by 5% to $570 billion in 2014. Though receiving wages or benefits on pre-paid cards is cheaper than cashing cheques, such cards typically charge plenty of other fees.
Many states issue their own pre-paid cards to dispense welfare payments. As a result, those who do not live near the right bank lose out, either from ATM withdrawal charges or from a long trek to make a withdrawal. Other terms can rankle; in Indiana, welfare cards allow only one free ATM withdrawal a month. If claimants check their balance at a machine it costs 40 cents. (Kansas recently abandoned, at the last minute, a plan to limit cash withdrawals to $25 a day, which would have required many costly trips to the cashpoint.)
To access credit, the poor typically rely on high-cost payday lenders. In 2013 the median such loan was $350, lasted two weeks and carried a charge of $15 per $100 borrowed—an interest rate of 322% (a typical credit card charges 15%). Nearly half those who borrowed using payday loans did so more than ten times in 2013, with the median borrower paying $458 in fees. In 2014 nearly half of American households said they could not cover an unexpected $400 expense without borrowing or selling something; 2% said this would cause them to resort to payday lending.
Costly credit does not mix well with lumpy welfare payments. The earned-income tax credit (EITC), an income top-up for poor families, is paid annually, as part of a tax refund. The total refund can run into thousands of dollars, making it worth more than many families’ monthly pay cheque. Unsurprisingly, cash-strapped households seek to borrow against this windfall in advance. Regulators have recently nudged banks away from issuing high-cost short-term loans secured against imminent tax refunds. But it is still common to borrow to cover the cost of applying for the EITC. In 2014 almost 22m consumers used “refund anticipation cheques”, which offer a loan to pay the filing costs and collect repayment automatically when the refund arrives. These products typically cost between $25 and $60 for credit that lasts only a few weeks, according to Chi Chi Wu of the National Consumer Law Centre, an advocacy group.
How might financial services be made cheaper for the poor? Mr Valenti sees promise in mobile banking. But the poor are not yet well placed to benefit from the mobile revolution, in financial services or otherwise. Only half of those earning less than $30,000 per year own a smartphone, compared with 70% or more of those in higher income groups. Nearly half those who do manage it have had to temporarily cancel their service for financial reasons. That might itself be the result of disparate prices: those with poor credit ratings rely on pre-paid SIM cards, which unlike normal monthly contracts do not come with a hefty discount for the handset.
Low smartphone penetration in turn makes life more expensive in other ways. The unconnected do not benefit from the cheap communication, education, and even transport the app economy provides. A quarter of poor households do not use the internet at all, which makes seeking out low prices harder.
Inflation has also squeezed the poor more in recent years. The prices of items which soak up much of their budgets—such as rent, food and energy—have risen faster than other goods and services. Falling oil and energy prices may be reversing that trend, though typically the poor own fewer cars, so benefit less from cheaper petrol.
From 2000 to 2013—the latest year for which figures are available—inflation has been higher for those in poverty for 139 of 168 months, according the Chicago Federal Reserve. As a result of this inflation premium, prices rose 3.2% more for the poor over this period. These figures may understate the disparity, because they do not include employer contributions to health insurance, which are widely thought to hold down pay cheques, and make up a bigger proportion of the total pay of the poor.
The high cost of being poor has two main implications. First, inequality is worse than income figures alone suggest. This is true even before non-financial disparities, such as the implications for health of living on a low income, are considered. Second, finding ways to reduce these costs, for instance by making it easier to claim the EITC without borrowing, or by changing the rules on overdraft fees (which at the moment are used to cross-subsidise banking for other customers), would be a cheap way of helping low earners—and bargains are rare for the poor.