The Wall Street Journal reports today that Social Security is planning on disbursing funds using prepaid debit cards instead of checks. 

This is significant for two reasons.  First, it redistributes the costs of Social Security payments among the federal government, social security recipients, merchants, and banks.  Second, it represents the federal government’s most major outsourcing of payments and creates a potential benefits provision monopoly.  The Because of this monopoly situation, Treasury and Social Security Administration need to ensure the reasonableness and fairness of any consumer fees associated with Social Security debit cards.

The Journal notes that "the card could mean significant cost savings for benefits recipients as well as the federal government."  Unfortunately, The Journal fails to note that the card could result in significant additional expenses for merchants, which could result in higher prices for Social Security recipients…and everybody else.  It’s unclear, then, in the end what the net social savings will be.

Every time a Social Security recipient uses the prepaid debit card to make a purchase at a merchant, the merchant is charged a fee by its acquirer bank.  The Journal implies that the Social Security debit cards are a PIN-based debit system, which has much lower fees than the signature-based (check card) systems, but for some merchants this will still be more expensive than cash or checks.  For starters, it requires merchants to have the equipment to accept debit card transactions. 

While the prepaid Social Security debit cards are more secure than checks, and help unbanked Social Security recipients avoid check-cashing fees, they have costs of their own for Social Security recipients.  The Journal notes:

"Cardholders will get one free ATM cash withdrawal per deposit per month, but Comerica will charge 90 cents for each additional withdrawal. Like other debit-card holders, users may also face surcharges at many ATMs. Other fees include $3 for international ATM withdrawals, 3% on international currency exchanges, 50 cents for each online bill payment and 75 cents per month for paper statements."   

It’s hard to know what the net social welfare impact of the change from checks to debit for social security will be.  The traditional check clearing system is wildly inefficient–the paper check had to be transported around the country (that’s why Teterboro airport exists).  But existing net social cost estimates of various payment systems do not appear account for decreased check costs due to the Check 21 Act.  The Check 21 Act not only eliminates the requirement of paper check clearing, but with Regulation E, it allows for conversion of checks to low-cost automated clearing house (ACH) debit systems without shuffling the physical check around.  Many checks are still cleared the old fashion way, but as ACH conversion becomes more common, it is possible that the net social costs of checks will come closer to those of PIN debit.  Most likely the switch from check to debit is good in net efficiency terms, but it has redistributional effects that might ultimately eat away at its efficiency.   

The second point of note about the switch to debit is that this is (to my knowledge), the federal government’s largest foray into using private payment providers to disburse government funds.  There is nothing inherently wrong about this.  The government contracts its business out all the time.  And, as the Journal’s report notes, states have been using prepaid debit cards to disburse various types of benefits and welfare payments.  Special prepaid debit cards are taking the place of food stamps, for example.  You can see this on the PIN pad at the grocery store checkout–often there will be a button or option for EBT (electronic benefit transfer). 

My concern here is that the Treasury Department and Social Security Administration take care to regulate the fees associated with Social Security debit cards.  Currently, Social Security recipients have to opt-in to receiving the debit card.  But it seems reasonable to think that eventually Social Security will phase out the check option entirely.  When Social Security recipients are required to get their benefits by prepaid debit card, they will be a captive market for the bank that provides the cards.  This monopoly situation (rather analogous to tax farming) that invites abusive and excessive fees, which are bad in and of themselves, but also undermine the purpose of Social Security benefits. 

Treasury and SSA should insist on reasonableness and fairness of fees as a condition for awarding such a potentially plum monopoly.  While it seems reasonable for the debit card provider to charge fees to cover costs imposed by particular cardholder actions, the card provider’s profits should come solely from its government contract payments, as that is the only way to ensure that fees are not excessive and are fairly distributed without cross subsidization.