Acceptance and Use of Electronic Payments for State Taxes and Fees

8/20/2019 Acceptance and Use of Electronic Payments for State Taxes and Fees

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Prepared for:

The Council of State Governments

Financial Services Working Group

April 25, 2007

ELECTRONIC PAYMENT

for State Taxes and Fees

Acceptance and Use of


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Prepared for:

The Council of State Governments

Financial Services Working Group

April 25, 2007

ELECTRONIC PAYMEN

for State Taxes and Fees

Acceptance and Use ofDwight V. DenisonMerl M. Hackbart

Juita-Eleana (Wie) Yusuf

Jay H. Song

University of Kentucky

Martin School for Public Policy and Administration419 Patterson Office Tower ß Lexington, KY 40506


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The Council of State Governments—Financial Services Working Group

Foreword and AcknowledgementsWe would like to acknowledge the members of the Study Advisory Committee who were helpful in identifying

the key issues for examination and in developing the electronic payments survey questionnaire. Our thanks also

extend to CSG staff, especially Sujit CanagaRetna, for their assistance during this project.

Members of the Study Advisory Committee were:

ß Mr. Kenyatta Chandler (former Manager of ePayment Services, Revenue Management Department, Ohio)

ß Mr. Robert Tetz (Department of General Services, California)

ß Mr. Dennis Colling (Chief Administrator, Administrative Services, Department of Motor Vehicles, Nevada)

ß Mr. Billy Hamilton (Deputy Comptroller, Executive Administration, Texas)

ß Mr. Terry Straub (Division of Treasury, Department of Financial Services, Florida)

ß Mr. Andrew Chang (Chief Deputy Director, Department of General Services, California)


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Acceptance and Use of Electronic Payments for State Taxes and Fees

Foreword and Acknowledgements.......................................................................................................................... ii

Executive Summary ...............................................................................................................................................1

Chapter 1: Introduction and Overview ..............................................................................................................3 1.1 Research Objective ............ ............... .............. .............. .............. .............. .............. .............. ..............3

1.2 Research Approach ............ ............... .............. .............. .............. .............. .............. .............. ..............4

1.3 Report Structure ............. .............. .............. .............. .............. ............... .............. .............. .............. ....4

Chapter 2: Evolution of Payments and Growth in E-payments ......................................................................5 2.1 Evolution of Payments .............. ............... .............. .............. .............. .............. .............. ............... ......5

2.2 Growth in E-payments .............. ............... .............. .............. .............. .............. .............. ............... ......5

2.3 Non-cash Payment Instruments ............... .............. .............. .............. .............. ............... .............. ......6

Chapter 3: Electronic Payment of Government Taxes and Fees ......................................................................9 3.1 Benefits and Costs to State Governments of Accepting Electronic Payments...................... ..............9

3.2 Credit Card Payments for Government Services ............... .............. .............. .............. .............. .......10

Chapter 4: Findings of Previous Studies on Government Tax and Fee Electronic Payments .................... 13 4.1 Overview of Previous Studies ............. .............. .............. .............. ............... .............. .............. .........13

4.2 How Extensive is the Acceptance and Use of Credit Card Payment for Taxes and Fees? ............. ..14 4.3 What Taxes or Fees Can be (and Are) Paid by Credit Card? ............. .............. ............... .............. ....15

4.4 Why Should Government Agencies Allow Payment of Taxes and Fees by Credit Card? ............... .15

4.5 Who Pays the Transaction Fees Associated with Credit Card Payments? How are they Paid? .......17

4.6 What is Required for State Agencies to Accept Credit Card Payments? .............. .............. ..............19

Chapter 5: State Taxes and Fees E-payment Survey Findings.......................................................................21 5.1 Survey Overview and Methodology ............ ............... .............. .............. .............. .............. ..............21

5.2 Acceptance and Use of Electronic Payments ............ ............... .............. .............. .............. ..............22

5.3 Benefits of and Challenges to Accepting Electronic Payments .............. .............. .............. ..............23

5.4 Electronic Payment Policies and Practices .............. .............. .............. ............... .............. .............. ..26

Chapter 6: Summary and Conclusions ............................................................................................................31

Endnotes .............. .............. ............... .............. .............. .............. .............. .............. .............. ............33 References ............... .............. .............. .............. .............. .............. ............... .............. .............. .........34

Appendix A: Survey Instrument .........................................................................................................................35

Table of Contents


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v The Council of State Governments—Financial Services Working Group

List of FiguresFigure 2.1 Number of Credit and Debit Card Transactions in the U.S. (in millions), 2001–2005 .............. ........6

Figure 2.2 Dollar value of Credit and Debit Card Transactions in the U.S. (in $ billions), 2001–2005 ............. .6

Figure 2.3 Number of Credit and Debit Cards in the U.S. (in millions), 2001–2005 ............... .............. .............7

Figure 3.1 Two Primary Credit Card Payment Systems for Government Agencies .............. .............. ..............11

Figure 4.1 Responsible Party for Paying Fees Associated with Tax Payments ............. .............. .............. .........16

Figure 4.2 Citizen Willingness to Pay for On-line Government Services .............. .............. .............. .............. ..18

Figure 5.1 States that Responded to the E-payments Survey .............. .............. .............. .............. .............. .......22

Figure 5.2 Form of Electronic Payments Accepted for State Taxes ............. .............. ............... .............. ...........23

Figure 5.3 Initial Acceptance of Credit or Debit Card for Tax or Fee Payment ............. .............. .............. .......24

Figure 5.4 Average Credit Card Payment Transaction Amounts by Tax Category .............. .............. .............. ..26

Figure 5.5 Average Debit Card Payment Transaction Amounts by Tax Category ............ ............... .............. ....26

Figure 5.6 Fees Paid by States for Accepting Credit Card Payments ............. .............. .............. .............. .........27

Figure 5.7 Criteria Cited by States as Basis for Awarding Third-Party Provider Contracts .............. .............. ..27

Figure 5.8 States’ Satisfaction with Existing Credit Card Payment Programs ............. .............. .............. .........28

Figure 5.9 States’ Perceptions of Taxpayer Willingness to Pay Convenience Fees

or Transaction Surcharges .................................................................................................................28

List of TablesTable 2.1 Growth in Electronic Payment Transactions .............. .............. .............. .............. .............. ............... .7

Table 3.1 Transaction Fees by Payment Channels and Payment Types ............ ............... .............. .............. ....10

Table 4.1 Trends in Credit Card Payments of Federal Income Taxes .............. .............. .............. ............... ......14

Table 4.2 Credit Card Payment Transactions for State Taxes and Fees............... .............. .............. .............. ...19

Table 5.1 Forms of Electronic Payments Accepted for State Fees ............. .............. ............... .............. ...........22Table 5.2 Percent of Tax Payment Dollar Volume by Different Payment Options ............. .............. .............. ..23

Table 5.3 Percent of Tax Payment Transactions Made by Different Payment Options ............. .............. .........23

Table 5.4 Credit or Debit Card Acceptance by Tax Category ............. .............. ............... .............. .............. ....24

Table 5.5 Accepted Methods of Credit Card Payment ............... .............. .............. .............. .............. ..............24

Table 5.6 Reasons for States’ Accepting Electronic Payments .............. ............... .............. .............. .............. ..25

Table 5.7 Cost Savings Realized from Accepting Credit and Debit Cards, by Tax Type ............ ............... ......25

Table 5.8 Breakdown of Net Savings from Credit and Debit Card Acceptance .............. ............... .............. ....25

Table 5.9 Reasons for Not Accepting Debit Cards for Payment of Taxes and Fees ............. .............. ..............25

Table 5.10 Required Initial and Annual Investments in Infrastructure, Marketing, Staffing

and Training: Examples from Three States.......................................................................................27Table 5.11 States’ Use of Convenience Fees or Transaction Surcharges ............ ............... .............. .............. ....28

Table 5.12 States’ Use of Third-Party Provider by Tax Type .............. .............. .............. .............. .............. .......28

Table 5.13 Proposed Changes to Credit and Debit Card Policies or Procedures .............. ............... .............. ....29


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In fact, the economy-wide shift towards electronic

payments continues to gain momentum. In December

2003, the Federal Reserve announced that e-payment

transactions had, for the first time, exceeded the num-

ber of check payments (NECCC 2005). For the year

2003, e-payment transactions (credit cards, debit cards,

and ACH transactions) totaled 44.5 billion, compared

to 36.7 billion check transactions. In 2000, research by

the Federal Reserve showed check payments exceeding

electronic transactions by 42 billion to 31 billion. Thischange represents an average annual growth rate for

electronic payments of 13.2% from 2000 to 2003. For

the same time period, the use of checks for non-cash

payments declined by 4.3% annually. Also, according

to statistics published by the National Automated Clear-

ing House Association (NACHA 2005), the distribution

of payment transactions in the U.S. has shifted over the

past 20 years, from 96% checks and 4% electronic to

49% check and 51% electronic. Electronic payments

through ACH increased 14.5% from 2005 to 2006 to

slightly under 16 billion transactions.

Given these national trends, the principal purpose ofthis study was to determine current state government

acceptance and use of electronic tax and fee payments.

Related purposes included an analysis of policies and

procedures implemented by the states to more effec-

tively facilitate and manage electronic payment pro-

cesses. Among such policies are alternative ways of

financing transactions fees associated with electronic

payments and policies designed to encourage electron-

ic tax and fee payments. Such information is useful to

state policy makers who might be considering changes

in their states’ policy regarding the acceptance of elec-

tronic payments and/or initiating new programs and

activities to encourage

greater use of electronic

payment processes and

mechanisms.

Among the findings of

this study were first that

citizens will take advan-

tage of electronic pay-

ment options if state gov-

ernment agencies accept

electronic payments and

establish policies and pro-

cedures which encourage

and facilitate such pay-

ments. Citizens appreciate

the convenience, flexibil-

ity (including credit card

payments to meet time-

lines of tax payments),

security, and efficiency

of these payment options.

Second, there are major financial management benefitsfor states associated with accepting electronic payments

including reducing processing costs, accelerating funds

availability and reducing delinquent payments. Third, a

potential barrier to expansion of electronic payments is

managing the transactions costs associated with such

payments. Currently, states have two principal options

for addressing the issue of transaction fees including

direct state payment for such fees or passing the fees

to taxpayers via a convenience fee or surcharge (direct-

ly or through a third party). In addressing this issue,

states may make the distinction between “required”

payments such as taxes and payments for services. Be-

Executive Summary

Results of a 50-state survey s

that states are becoming increa

supportive of the use of electronic

for the receipt of payments from ci

Rapidly expanding proportions of retail- and business-related

payments, traditionally made by cash and check, are now be-

ing made electronically through Automated Clearing House

(ACH) or using credit or debit cards. Increasingly, the shift to

electronic payments is also occurring in the public sector.


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cause states are typically required to collect 100% of

the taxes owed, electronic transactions fees may have

to be paid by the taxpayer while fees for services (such

as licenses and registrations of various types) may be

absorbed by the respective state agency. Innovative ap-

proaches to dealing with this important issue are sum-

marized in this report.

Following a review of previous federal, state and lo-

cal government studies of electronic tax and fee pay-

ments, the research team administered a 50 state study

of current state policies and practices regarding elec-

tronic tax and fee payments with the support and assis-

tance of CSG staff and an advisory committee. Among

the findings of the survey, responded to by 37 states,

are the following:

ß ACH was the most commonly used electronic

payment option for business-related taxes while

credit cards were the most commonly used elec-

tronic means for individual income tax payments

as well as licenses or permits.

ß Of the responding states, 95% indicated that they

provided citizens the option of paying some form

of state taxes or fees with a credit card while 54%

permitted debit card payments.

ß The major reasons cited for accepting electronic

payments were to expedite fund deposits and to

reduce the time it takes for funds to be available,

and to reduce the costs of collecting and process-

ing payments.

ß Cost savings were identified as the major reason

for accepting payment by credit or debit cards al-

though estimated cost savings varied considerably

among the states that responded to this inquiry.

ß Issues surrounding the payment of transactions

fees were one of the major challenges to accept-

ing or expanding the use of electronic payments.

ß The study indicated a high degree of satisfaction

with electronic payments by the states responding

to this study.

These and other results of this study are summarized

in the various sections of this report. It appears that

states, like private businesses are becoming increasing-

ly supportive of the use of electronic media for the re-

ceipt of payments from citizens. This trend is supportedby citizens as well as state governments as they im-

prove the efficiency of the collection and accountabili-

ty associated with the various sources of state revenues.


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One way to maximize net revenues is to enhance the

efficiency of tax and revenue collection. Such efficien-

cy can be enhanced by reducing the cost of collecting

and processing payments and/or ensuring that all rev-

enues are collected. Revenues can also be enhanced by

processing funds into interest-bearing accounts sooner

to maximize investment revenue.

Many government organizations are attempting to

meet these financial management goals by taking ad-vantage of the digital revolution, moving away from

traditional collections and processing structures based

on cash and check payments toward electronic-based

payments using such means as ACH, credit cards and

debit cards. Over the past decade or so, many govern-

ment agencies have allowed businesses and individuals

to pay their taxes and government fees electronically

using ACH. Today, many states are providing taxpay-

ers with expanded options for paying for government

services, taxes and fees using credit or debit cards as

well as other electronic means.

For decades citizens have been using cash and

checks to pay taxes and user fees or to reimburse states

for services. More recently, as credit card acceptance

has become virtually universal as a payment method

within the private sector, state and local governments

have also begun to accept credit card payments for ser-

vices, taxes, and fees. Both governments and citizens

have encouraged policy changes that permit greater ac-

ceptance of credit card payments by government agen-

cies and encourage the use of credit cards by citizens

for tax and fee payments.

Studies suggest that citizens and businesses realize

the benefits associated with electronic payments for

products and services includ-

ing the convenience and safe-

ty of such transactions. At the

same time, governments, like

businesses, are beginning to

perceive the benefits associ-

ated with receiving revenues

electronically. Such benefits

include: (1) reduced trans-action processing costs, (2)

more immediate receipt and

recording of revenue receipts,

and (3) greater transparency

and enhanced payment trails

which can facilitate auditing

and payment verification.

1.1 Research Objective

There is little empirical evidence, other than anec-

dotal comments and suggestions, of the benefits that

governments actually realize from accepting electronictax and fee payments. As a result, states are making pol-

icy decisions to accept or encourage expansion of elec-

tronic tax payments (particularly taxpayer credit card

payments) without the benefit of broad-based informa-

tion about state experiences with credit cards and other

forms of electronic payments. Therefore, the purpose

of this research was to examine the use of electronic

payments—particularly credit and debit cards—for the

payment of state taxes and fees and to obtain evidence

regarding the advantages and disadvantages of elec-

tronic payments. Specifically, the goal was to assess

current and future state policies and practices regarding

Chapter 1

Introduction and Overview

As credit card acceptance has b

virtually universal as a pa

method within the private

state and local governments ha

begun to accept credit card pay

for services, taxes an

As states face what Osborne and Hutchinson (2004) call a “per-

manent scal crisis,” cash-strapped state governments are fo-

cusing on becoming more and more aggressive in searching

for ways to maximize revenues without raising taxes.


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the use of electronic payments for state taxes and fees,

along with financial implications for states of accepting

electronic payment. The five key issues or questions

addressed in this study regarding government accep-

tance of credit card payment for taxes and fees were:

1. How extensive is the acceptance of credit card

payment for taxes and fees?

2. What taxes or fees can be (and are) paid by creditcard?

3. Why should government agencies allow payment

of taxes and fees by credit card?

4. Who pays the transaction fees associated with

credit card payments and how are they paid?

5. What actions are required for state agencies to ac-

cept credit card payments.

1.2 Research Approach

To answer the five questions discussed above, a two-

phased research approach was utilized. The first phase,completed in November 2006, involved identifying and

analyzing previous studies regarding electronic pay-

ments for taxes and fees to determine trends in elec-

tronic payment acceptance, use, policies, and practices.

The second phase involved conducting a survey of the

50 states to:

1. Determine acceptance of electronic payments;

2. Determine current policies and procedures;

3. Estimate financial implications of electronic pay-

ments;

4. Determine best practices regarding e-payments;

and

5. Determine policy changes that might enhance use

of electronic payments

The survey was initiated in October 2006 and the

analysis of survey data and compilation of survey find-

ings were completed in March 2007. Thirty-seven states

responded to the survey for a response rate of 74%.

1.3 Report StructureThis report is structured to address the study’s five

key research questions in the following manner. Chap-

ter 2 provides an overview and background of payment

instruments available to consumers for reimbursements

for private goods and services. It provides a discussion

of the different payment options, paying particular at-

tention to different forms of non-cash payment options.

This is followed by a review of the growth trends in

electronic payments. Chapter 3 shifts away from the

consumer market to discuss payment instruments avail-

able to citizens and taxpayers for reimbursing govern-

ment agencies for government services. Chapter 4 re-

views the existing literature regarding electronic pay-

ment of government taxes and fees, and discusses their

findings in terms of the extent of acceptance and use of

credit card payments, benefits to be realized by gov-

ernment agencies from accepting credit card payments,

transaction costs associated with credit card payments,

and challenges to state governments in accepting credit

card payments. Preliminary findings from the existing

literature are then strengthened by the findings of the

national state taxes and fees electronic payment survey.

This national survey is discussed in Chapter 5 and key

findings are highlighted in this chapter. Chapter 6 con-

cludes the report with a summary of the study’s findings.


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2.1 Evolution of Payments

Beginning in the 1950s, credit cards became more

and more accepted as a payment media, particularly for

personal travel. The Automated Clearing House (ACH)

joined the mainstream payment system in the 1970s.

The ACH network developed in response to the rapid

growth of check payments, and was perceived to be an

efficient, electronic alternative to checks. The use ofdebit cards began in the 1980s and has recently gained

popularity. The most recent electronic payment option

is the electronic check or e-check, an ACH payment

option that is used for consumer payments.

2.2 Growth in E-payments

As noted, many payments traditionally made by

cash and check are now being made electronically

through ACH or by using credit or debit cards. Be-

tween 2000 and 2003, the use of checks for non-cash

payments declined by 4.3% annually, while ACH, debitcard and credit card transactions exhibited average an-

nual increases of 13.4%, 23.5%, and 6.7%, respectively

(Gerdes et al. 2005). A summary of electronic payment

transactions for 2000 and 2003 are shown in Table 2.1.

According to statistics published by the National

Automated Clearing House Association (NACHA),

the distribution of payment transactions in the U.S. has

shifted over the past 20 years, from 96% checks and

4% electronic to 49% check and 51% electronic. “As

a general proposition, this evolution from traditional

methods to electronic alternatives has been mirrored in

the public sector. However

… there is still plenty of

room for continued move-

ment away from paper

and towards alternatives”

(NECCC 2005, p. 1).

The migration towards

electronic payments contin-ues to gain momentum in the

U.S. In December 2003, the

Federal Reserve announced

that e-payment transac-

tions had, for the first time,

exceeded the number of

check payments (NECCC

2005). For the year 2003, e-

payment transactions (credit

cards, debit cards, and ACH

transactions) totaled 44.5

billion, compared to 36.7

billion check transactions.In 2000, similar research by

the Federal Reserve showed

check payments exceed-

ing electronic transactions

by 42 billion to 31 billion.

This change represents an

average annual growth rate for electronic payments of

13.2% from 2000 to 2003, and a corresponding average

annual decline in check payments of 4.3%. The 44 bil-

lion electronic payment transactions in 2003 had a dol-

lar value of $27 trillion, and included consumer, busi-

Chapter 2

Evolution of Payments and Growth in E-payments

The distribution of pa

transactions in the U.S. has shifte

the past 20 years, from 96% chec

4% electronic to 49%

and 51% elec

—National Automated Clearing House Association

In the non-barter world, cash was the dominant form of pay-

ment for goods and services up to the middle of the 20th cen-

tury. Paper checks then entered the payment landscape and

became dominant in the 1960s.


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ness, and government-initiated electronic payments.

Figures 2.1 and 2.2 show the trends in credit and

debit card use over the past 5 years. Figure 2.1 sum-

marizes the number of transactions by credit and debit

cards from 2001 through 2005. Figure 2.2 summarizes

the total value of credit and debit card transactions for

the same period. Combined, they show that while al-

most equal numbers of card transactions take place for

credit and debit cards, the total payment value for cred-

ource: CPSS (2006), Table 7 (p. 157).

igure 2.1

Number of Credit and Debit Card Transactions in the U.S.

in millions), 2001–2005

0

5,000

0,000

5,000

0,000

5,000

2001 2002 2003 2004 2005

■ Debit card ■ Credit Card

2001 2002 2003 2004 2005

■ Debit card ■ Credit Card

$0

$200

$400

$600

$800

1,000

1,200

1,400

1,600

1,800

2,000

Figure 2.2

Dollar Value of Credit and Debit Card Transactions in the U.S.

in $ billions), 2001–2005

ource: CPSS (2006), Table 8 (p. 158).

it card transactions were between two- and three-times

higher than the value for debit card transactions.

2.3 Non-cash Payment Instruments

Until the emergence of electronic payments, cash

payments accounted for most small transactions and

checks were used for larger value items and were the

dominant method for non-cash transactions. However,the use of paper checks is increasingly being replaced

by electronic payment media, made possible by the

development of the Automated Clearing House (ACH)

and e-check, and credit and debit card payment net-

works. The various non-cash payment instruments and

trends in their use are briefly discussed next.

Paper Checks. Paper checks are the most frequently

used non-cash payment instrument in the U.S., with an

estimated 42.5 billion checks (valued at $39.3 trillion)

written during 2000. However, the number of check

payments and the number of check payments as a share

of non-cash payments have declined over time, with

data indicating a decline in check payments since 1995

(Gerdes & Walton 2002). Over the past decade, private

and public sector efforts to shift away from paper check

payments to electronic media, such as ACH and credit

or debit cards, appear to be gaining ground. The ex-

pansion of online point-of-sale terminals and the wide-

spread acceptance of debit and credit cards at retail

establishments have presented consumers with signifi-

cant payment alternatives to traditional paper checks.

The use of checks was further decreased by the Debt

Collection Improvement Act of 1996 which mandated

that most federal government payments be made elec-

tronically starting in 1999. As a result, the U.S. federalgovernment made 262 million check payments in 2000,

a 40% decline in check volume from the 436 million

checks the government wrote in 1996 (CPSS 2003).

Automatic Clearing House (ACH). The ACH net-

work is a processing and delivery system that provides

for the distribution and settlement of electronic cred-

its and debits among financial institutions. It is a batch

processing, store-and-forward system with transactions

received by the financial institutions during the day be-

ing stored and processed later in a batch mode.

ACH transactions are a common form of electronic

funds transfer used to make both recurring and non-recurring payments. Depository institutions originated

6.8 billion ACH transactions during 2000 for them-

selves and their customers, twice as many as were initi-

ated during 1995 (CPSS 2003). ACH has typically been

used for payroll direct deposits, government benefit pay-

ments, corporate payments to contractors and vendors,

mortgage and loan payments, insurance premium pay-

ments, corporate cash concentration transactions, and

payments to and from the state or federal government.

Pricing for ACH transactions is typically negotiated

between the originator and the originating financial


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institution. Individual transaction origination and re-

ceipt fees can vary from $0.029 to $0.10, depending

on volume and compensating balances (NECCC 2005).

While the costs of ACH payments compare favorably

with credit and debit cards and checks, ACH does not

afford citizens and consumers the same protection fromfraud as are afforded credit card users.

Total ACH consumer debit volume (both commercial

and government) increased by 53% between 2000 (2.7

billion transaction) and 2003 (4.2 billion). This growth

rate is slightly higher than the overall 45% growth rate

for ACH volume (6.9 billion in 2000 and 10.0 billion

in 2003), and also represents just under half of the total

ACH transaction volume increase (Nelson 2004). NA-

CHA recently announced, in its Payments 2007 confer-

ence, that 16.0 billion ACH payments were made in the

U.S. in 2006, representing a 14.5% increase from 14.0

billion payment transactions in 2005.1

Electronic Check (e-check). More recently, elec-tronic checks (e-checks) have become a popular ACH

transaction. An e-check is an electronic debit to a

checking account that can be initiated at the point-of-

sale, on the internet, over the telephone, or via a bill

remittance sent through the mail. An e-check is pro-

cessed using the ACH network. If payment has been

negotiated (i.e. the check is presented for payment),

the process of changing the paper check document into

an electronic transaction is referred to as “truncation.”

Otherwise, the electronic transaction is referred to as

check “conversion.” Check truncation is covered by

check law while check conversion is covered by Regu-lation E, which was issued by the Federal Reserve as

part of the Electronic Funds Transfer Act and contains

more explicit consumer protection that is stronger than

the check law (NECCC 2002). ACH operating rules

limit e-check transactions only to consumer payments.

Between 2000 and 2003, e-check transactions ac-

count for nearly all the growth in ACH consumer debit

volume. The cumulative 1.9 billion consumer debit

transaction increase from 2000 to 2003 is more than

accounted for by the 2.0 billion e-check transactions

over that period (Grant 2004).

Number of Value of Average Number of Value of Average

payments payments value payments payments value

Type of payment (billions) (trillions) of payment (billions) (trillions) of payment

ACH 6.1 $18.2 $2,984 8.9 $24.6 $2,766

Debit card 8.3 $0.3 $42 15.6 $0.6 $40

Credit card 15.6 $1.3 $82 19.0 $1.7 $89

Source: Gerdes et al. (2005) from the 2001 and 2004 electronic payment surveys (Dove Consulting 2004).

2000 2003

Table 2.1

Growth in Electronic Payment Transactions

Credit Cards. The credit card industry began in

1914, when Western Union, department stores, oil

companies and hotels began offering cards for custom-

ers to pay for their services. Since then, the industry has

grown rapidly, and consumers today can pay for a wide

range of goods and services, from major purchases likecars and appliances to everyday requirements like food

and gasoline.

Originally, credit cards were used by consumers

to spread payments on large ticket items. In the mid

1990s, however, the pattern of credit card use has

changed such that credit and debit cards are used for

all types of purchases. This accelerated use of credit

and debit cards can also be attributed to the rise in mail

order and internet purchasing.

Credit cards are the most frequently used electronic

payment instrument in the U.S. They combine a pay-

Figure 2.3

Number of Credit and Debit Cards in the U.S.

(in millions), 2001–2005

Source: CPSS (2006), Table 6 (p. 156).

2001 2002 2003 2004 200

■ Debit card ■ Cred

0

200

400

600

800

1,000

1,200

1,400


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ment instrument with a credit arrangement. Bank credit

cards are generally issued by a bank under a license from

a national organization, such as Visa or MasterCard,

and typically involve a revolving credit agreement. In

addition to bank-issued cards, other credit cards are is-

sued directly to businesses and consumers such as Dis-

cover Card, American Express, and limited-use propri-

etary cards (e.g. those issued by retail stores and oil

companies). A 1998 survey of consumers indicated that68% of U.S. households had at least one general pur-

pose credit card, a 21% increase since 1989. In 1998,

limited-use cards issued by retail stores and oil compa-

nies were held by 50% of U.S. households compared

to only 19% of U.S. households in 1989 (CPSS 2003).

Debit Card. Debit cards are also known as checkcards. They look like credit cards or automated tellermachine (ATM) cards, but operate like cash or personalcheck. Debit card transactions involve the transfer offunds from a cardholder’s transactions account (typi-cally a checking account) at an issuing bank. There

were 9.5 billion debit card transactions processed dur-ing 2000, valued at $419 billion. Cardholders authorize

debit card transactions either by entering a personal

identification number (PIN) directly into a merchant’s

online terminal or by a written signature. An estimated

2.8 million online debit terminals were available at

U.S. retail locations in 2000 and involving approxi-

mately 4 billion PIN-based transactions and 5.5 billion

signature-based transactions (CPSS 2003).

Unlike a credit card, funds are withdrawn directlyfrom the purchaser’s checking or savings account at a

bank when a debit card is used. While a credit card is a

way to “pay later” a debit card is a way to “pay now.” Be-

cause debit card transactions are directly subtracted from

the consumer’s related bank account, debit card trans-

actions are limited to the amount in the bank account.

Figure 2.3 summarizes the total number of debit and

credit cards held by consumers in the U.S. from 2001

through 2005. This chart shows that the number of

credit cards has reached a plateau at just under 1.3 bil-

lion. The number of debit cards has seen steady growth

over the past five years, but the total amount still com-

prises less than a quarter of the number of credit cards.


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3.1 Benets and Costs to State Governments

of Accepting Electronic Payments

Citizens have, for decades, been using cash and

check to pay taxes and registration fees and to reim-

burse states for services. Meanwhile, ACH transactions

have primarily been used for payment of state taxes and

fees, especially large payment amounts made by cor-porations and other major employers. Credit and debit

cards, while being a payment option for some govern-

ment agencies, are still not as prevalently accepted as

other payment media.

Electronic payments for government taxes and

fees—whether in the form of ACH, credit card, or debit

card—offer many benefits to government agencies and

citizens. These include:

ß Reduced processing costs associated with cash

and check payments;

ß Reduced transaction processing time and costs;

ß Improved payment verification and auditingthrough real-time authorization and verification;

ß Reduced accounts receivables and payment delin-

quencies, and fewer need for debt collection ac-

tivities;

ß Improved fund availability by reducing check float

and enhancing cash flow;

ß Added convenience for citizens.

Beyond these benefits, electronic payments offer

government agencies the opportunity to automate ac-

counting, banking and reconciliation functions and

processes. Electronic payments can also speed up the

receipt of tax and fee pay-

ments from citizens and tax-

payers.

While electronic payments

provide several benefits and

cost savings, the acceptance

of electronic payments also

involves several costs. If de-cisions are made to accept

electronic payment, policies

must be established to ad-

dress how and by whom such

costs will be covered. The

costs associated with elec-

tronic payments include:

ß Equipment expenses in-

cluding specialized soft-

ware, keypads, comput-

ers, etc.;

ß Administrative expens-es including employee

training, process stream-

lining, and marketing activities and user education

programs; and

ß Social costs associated with electronic payment

media such as lack of access to electronic payment

options by certain categories of citizens or misuse

of electronic payment options such as increased

debt burden due to increased use of credit cards.

The costs associated with electronic payments vary

both according to the type of payment media and the

Chapter 3

Electronic Payment of Government Taxes and Fees

Electronic payments for gover

taxes and fees offer re

processing costs for gover

agencies and

convenience for cit

Electronic payments offer government agencies the opportu-

nity to automate accounting, banking and reconciliation func-

tions and processes. Electronic payments can also speed up the

receipt of tax and fee payments from citizens and taxpayers.


16/61

0 The Council of State Governments—Financial Services Working Group

payment channel. These payment channels are:

ß Point-of-sale. Point-of-sale systems allow thepublic to pay for government services with debit

cards and credit cards, checks and cash over the

counter at walk-in service centers. It provides citi-

zens with a cost-effective and convenient way of

paying for government services while allowing

for quick and efficient updates to payment re-

cords. For credit card transactions, the point-of-

sale is a location where the credit card payment is

performed with the cardholder present. The credit

card is read magnetically, and the cardholder’s sig-

nature is generally obtained as insurance against

the transaction. This is the most secure form of

credit card payment.

ß Pay by Telephone. Interactive voice response(IVR) is a telephony technology in which con-

sumers use a touch-tone telephone to interact with

a database to acquire information from or enter

data into the database. IVR or pay-by-phone sys-

tems eliminate the inconvenience and costs associ-ated with postage and check-writing. Studies have

shown that electronic bill payment reduces these

costs by 60% by eliminating the cost of stamps

and paper checks and by reducing consumers’ ex-

posure to late fees and bounced checks (NECCC

2005). The costs associated with a pay-by-phone

system will depend on the hardware and software

needed to implement the system.

ß Pay by Internet. Internet payment systems allow

government agencies to accept electronic pay-

ment via the web. An internet payment system

reduces the costs associated with traditional (andoften inefficient) paper-based payment methods,

and allows citizens to pay taxes and fees when and

where it is convenient for them. This significantly

improves access to government services and in-

creases the potential for on-time payments and

fewer delinquent payments. The many costs asso-

ciated with developing and maintaining an inter-

net payment system include software, hardware,

licenses, and maintenance costs.

Acceptance of electronic payments through the dif-

ferent payment channels offers a variety of benefits to

government agencies and citizens. The combinations of

electronic payments and payment channels have differ-

ent costs associated with them and some types of elec-

tronic payments are even limited to certain payment

channels. Table 3.1 provides a matrix of payment chan-

nels and payment types and describes the level of trans-

action fees that are faced by the government agency for

each combination of payment type and payment channel.

3.2 Credit Card Payments for Government Services

While credit and debit card acceptance as a payment

method has become virtually universal within the pri-

vate sector, credit card use for payment for government

services has lagged behind credit card usage in the con-

sumer market. To allow government agencies to benefit

from the cost advantages of electronic payments and topermit citizens to realize the benefits of credit card pay-

ments, government leaders and citizens have encour-

aged policy changes that permit greater acceptance of

credit card payments by government agencies and en-

courage greater use of credit cards by citizens to pay

their taxes and fees. The system or structure for credit

or debit card payment of government taxes and fees are

not very different from that of the private sector.

Government agencies have two primary options for

accepting credit card payments, as shown in Figure 3.1.

The primary difference between the two systems is the

use of a financial intermediary—a third party serviceprovider—that can perform multiple functions for the

government agency, including accepting and processing

the credit card transaction. In the first option (top panel

of Figure 3.1) the credit card transaction begins with

payment accepted directly by the government agency.

The bank issuing the credit card transfers funds to the

Transaction fees charged to

Type of payment government agency Point-of-sale Telephone Internet

Cash or check None ✓

Credit card High ✓ ✓ ✓

Signature debit card High to Moderate ✓

PINless debit card2 Moderate ✓ Varies

PIN-based debit card Low ✓

ACH Low ✓ ✓ ✓

Source: National Electronic Commerce Coordinating Council’s E-Payments Primer (NECCC 2005).

Payment Channels

Table 3.1

Transaction Fees by Payment Channels and Payment Types


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government agency’s processing bank. Subsequently,

funds are deposited into the government agency’s ac-

count. Note that the issuing bank must transfer payment

to the processing bank prior to collecting payment from

the taxpayer. In this first option, the government agency

is typically responsible for the fees associated with the

credit card transaction.

The same process is mirrored in the second option

(bottom panel of Figure 3.1). However, depending on

the functions undertaken by the third party service

provider, the payment for government services can be

made either to the government agency or to the third

party service provider. In addition to possibly accepting

the credit card payment, the third party service provider

also replaces the functions of the processing bank.

Government agencies have two primary options for

accepting credit card payments, as shown in Figure 3.1.

The primary difference between the two systems is the

use of a financial intermediary—a third party service

provider—that can perform multiple functions for the

government agency, including accepting and process-ing the credit card transaction. In the first option (top

panel of Figure 3.1) the credit card transaction begins

with payment accepted directly by the government

agency. The taxpayer transfers funds to the bank is-

suer of his/her credit card, which in turn transfers the

funds to the government agency’s processing bank.

Once the payment is settled, funds are deposited into

the government agency’s account. In this situation, the

government agency is typically responsible for the fees

associated with the credit card transaction. The same

process is mirrored in the second option (bottom panel

of Figure 3.1). However, depending on the functionsundertaken by the third party service provider, the pay-

ment for government services can be made either to the

government agency or to the third party service pro-

vider. In addition to possibly accepting the credit card

payment, the third party service provider also replaces

the functions of the processing bank.

Benets of Accepting Credit and Debit Card Payments

for Government Taxes and Fees

Many of the benefits credit and debit cards offer

government agencies are the same as those offered by

other electronic payments. However, credit cards offeran additional benefit to citizens and taxpayers in the

form of short-term credit. This credit option offers ad-

ditional taxpayer relief by providing the opportunity

Credit Card Issuing Bank Processing Bank

Citizen/Taxpayer Government AgencyTransaction

Credit Card Issuing Bank Third-Party Service Provider

Citizen/Taxpayer Government AgencyTransaction

Figure 3.1

Two Primary Credit Card Payment Systems for Government Agencies

Source: Developed by the research team.


18/61


for payment spreading and cash flow management for

those who may otherwise face difficulties in paying

large tax or fee payments at a particular point of time

but who could otherwise manage payments spread over

time. Debit cards also offer further advantages over

credit cards. Because anyone with a checking account

can obtain a debit card, accepting debit cards as a pay-

ment option serves a larger pool of potential users. In

addition, canceling services or returning goods paid forwith a debit card is typically treated as if they were

made with cash or check, allowing for a less compli-

cated and less costly return or cancellation process.

Challenges to Accepting Credit and Debit Card Payments

for Government Taxes and Fees

However, accepting credit and debit card payments

also poses several challenges to government agencies.

These include legal and legislative challenges, cost

challenges and technology challenges. From a legal or

legislative perspective, issues that affect the acceptance

of credit and debit card payments include:ß Credit and debit card transactions impose certain

costs (transaction fees), which may conflict with

legislation requiring that government agencies

collect 100% of the amount due;

ß Credit card transactions may violate public funds

handling laws; and

ß Legislative issues regarding protection of financial

data from public records laws and technology is-

sues related to data and information security need

to be addressed.

The primary costs associated with credit and debit

card payments are the start-up costs (initial equipment,training, marketing and education) and the recurring

per transaction fees. The fees paid by government agen-

cies for credit card processing are determined by their

contractual relationship with their bank and/or service

provider, and are based on a number of factors, includ-

ing total and average volume, total and average dollar

amount, association fees, processor fees, card types,

and processing timeframe. States have used two princi-

pal ways to pay for such fees associated with credit and

debit card transactions including the use of surcharges

and convenience fees.

Transaction Surcharge. A transaction surcharge

is an additional charge that is added to the transaction

amount by the merchant if the customer chooses to pay

by card, either credit or debit. The surcharge tends to be

a fixed amount but varies with the transaction amount.

Use of surcharges is strictly prohibited by Visa, Master-

Card and Discover. However, a very small number of

merchants were grandfathered by the debit networks to

surcharge on PIN debit transactions (Webster 2005).

Convenience Fees. A convenience fee is an addi-tional charge that is added to the transaction amount

by the merchant if the customer chooses to pay the

merchant in a non-traditional environment, such as via

a website or an interactive voice response (IVR) tele-

phony system. The convenience fee amount can take

the form of a flat fee or a percentage-based fee, but the

type of fee varies widely across government entitiesand third party service providers. American Express

allows convenience fees if the transaction is related

to: (1) federal, state, provincial or municipal govern-

ment mandatory revenue payments; (2) public utility

payments; and/or (3) mandatory fees at public higher

education institutions. Furthermore, under the Ameri-

can Express convenience fee policy, convenience fees

(1) can only be charged when the payment is made

through a more convenient payment method; and (2)

cannot be higher than the fees imposed on other pay-

ment instruments. For Visa and MasterCard, the conve-

nience fee must be applied equally to all payment types

offered through the same environment. However, Visaalso states that the convenience fee cannot be charged

for over-the-counter or face-to-face transactions. The

merchant must also state up-front that a convenience

fee will be charged to the cardholder, specify the fee

amount, and allow the cardholder to either decline or

proceed with the transaction and the assessed fee.


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While some studies have examined the acceptance

and management of electronic tax and fee payments,there have been limited empirical studies that focused

on the broader issues relevant to state governments ac-

cepting electronic payments for state taxes and fees.

Combined, however, information from existing studies

can be used to develop preliminary answers to the fol-

lowing research questions:

1. How extensive is the acceptance of credit card

payment for taxes and fees?

2. What taxes or fees can be (and are) paid by credit

card?

3. Why should government agencies allow payment

of taxes and fees by credit card?

4. Who pays the transaction fees associated with

credit card payments? How are they paid?

5. What is required for state agencies to accept credit

card payments?

4.1 Overview of Previous Studies

The analysis included in this chapter is based on five

major studies and research efforts. These other studies

include an assessment of the acceptance of credit card

payment by a federal agency,

a survey of state and localgovernment agencies, a sur-

vey by the Federation of Tax

Administrators (FTA), and

a public opinion survey re-

garding internet-based gov-

ernment services. These are

discussed below.

Credit Card Survey of

State and Local Government

Acceptance by the District

of Columbia Treasurer’s

Office and the Office of theCity Administrator. In 1991,

staff from the District of Columbia Treasurer’s Office

and the Office of the City Administrator contacted trea-

sury and finance officials in the 20 largest U.S. cities,

the 17 jurisdictions making up the Washington met-

ropolitan area, and the seven states known to accept

credit cards. Altogether, 45 state and local governments

were surveyed, along with 23 federal-level government

agencies (Kuhn 1992). The purpose of this survey was

to determine the prevalence of credit card payment ac-

ceptance among state and local governments.

Chapter 4

Findings of Previous Studies on Government Tax

and Fee Electronic Payments

One reason driving gover

acceptance of tax and fee pay

by credit card is citizen pref

for credit card pa

The analysis included in this chapter is based on ve major

studies and research efforts. These other studies include an as-sessment of the acceptance of credit card payment by a federal

agency, a survey of state and local government agencies, a sur-

vey by the Federation of Tax Administrators (FTA), and a public

opinion survey regarding internet-based government services.


20/61


Case Study of the U.S. Postal Service (USPS) Ac-

ceptance of Credit and Debit Cards for Payment ofPostal Services (GAO 1994, Green 1997, Beyer 1999).The USPS first began accepting credit card payments

at some post offices in 1981. In 1991, then Postmaster

General Anthony Frank established a task force to make

recommendations on the future direction of credit card

acceptance. The task force arranged for Arthur D. Little

to undertake a feasibility study in 1991 of the extent of

market demand for credit and debit cards at postal re-

tail windows and vending machines. Postmaster Gen-

eral Marvin Runyon then decided in 1992 that USPS

should begin accepting credit and debit cards and soon

as possible. Implementation of the credit card accep-

tance program, to be launched in three phases, began inJune 1993 with 550 pilot test sites. The only restriction

on credit card acceptance was that money orders and

collect-on-delivery services could not be paid for via

credit card. Later, the USPS added the policy that credit

cards could not be used for payment of bulk mailings.

Texas Electronic Government Survey (Strover &Straubhaar 2000a, 2000b). The Texas Electronic Gov-

ernment Survey is a public opinion survey to assess a

variety of issues related to public access necessary to

use e-government service. Research addressed specific

questions: (1) Would people use government services if

they were available on the internet? How much would

they pay? (2) What are the privacy and security con-

cerns of Texans with respect to e-government appli-

cation? (3) What are citizen opinions with respect to

financially supporting e-government services?

Federation of Tax Administrators (FTA) CreditCard Survey (FTA 2003). A survey conducted by theFTA in 2003 on how states use credit cards to facilitate

the payment of taxes or fees. Thirty-three states (in-

cluding the District of Columbia and New York City)

responded to the survey. The survey also focused on

the use of debit card and e-check for payment of taxes

or fees. The survey examined issues such as: (1) ac-

ceptance of credit card, debit card or e-check for tax or

fee payment, (2) types of taxes or fees that can be paid

by credit card, debit card or e-check, (3) transaction

volume, (4) payment of the merchant discount fee, (5)

satisfaction with electronic payment processing pro-

grams, and (6) proposed changes to these programs.

While these studies may be somewhat dated—most-

ly from the mid-1990s and early 2000s—the informa-

tion they provide remain useful as starting points for

the current investigation into policies and practices re-

garding state government acceptance of electronic pay-

ments for taxes and fees. The studies’ findings may no

longer be current or relevant in today’s environment,

but they do provide interesting insights into how gov-

ernment agencies have dealt with the issues and chal-

lenges of accepting electronic payments.

4.2 How Extensive is the Acceptance and Use of Credit

Card Payment for Taxes and Fees?

Acceptance of Credit Card Payment for Taxesand Fees. There is evidence, as far back as the early

1990s, that federal, state, and local government agen-

cies have been accepting credit card payments for taxes

and fees. In the 1991 survey by the District of Colum-

bia government, 65% of the government organizations

surveyed accepted credit card payments, with another

20% having recently issued RFPs for credit card pro-

grams or conducting feasibility studies (Kuhn 1992).

In addition, a Public Investor survey conducted in 1993

found that 30% of state and local governments in the

U.S. accepted credit card payment for user fees, parking

tickets, utility bills and taxes (Michel & Carter 1996).Mitchell (2004) cites a 2003 survey of 419 counties

by the National Association of Counties which found

that 28% and 29% of respondents indicated that their

agencies had enabled residents to pay taxes and fees

with credit cards on-line and over the telephone, re-

spectively. This represented an increase from 18% and

26% of respondents the previous year. A 2003 survey

by the National Center for State Courts (NCSC) of 84

courts in 30 states found that 77% of the responding

courts accepted credit card payments. Most of these

courts had begun accepting credit card payments with-

in the previous five years.Of the state revenue agencies responding to the 2003

FTA survey, all but one had the necessary legal author-

ity to accept credit cards for payment of taxes or other

fees. Results of this survey showed that 91% (30 out of

33) of the responding states had programs in place to

accept credit card payments. They further found that

most states were planning to expand their electronic

payment programs. These included adding more pay-

ment types via the Internet, expanding the program to

include more types of taxes or fees, and adding direct

debit or e-check capabilities.

Dollar volume of

Number of payment transactions Average

Year payment transactions ($ in million) transaction value ($)

999 53,300 $184 $3,445

000 216,500 659 3,044

001 284,800 891 3,130

002 313,400 781 2,494

003 559,600 878 1,569

ource: Mitchell (2004) from IRS data.

able 4.1

rends in Credit Card Payments of Federal Income Taxes


21/61


Citizen Use of Credit Cards to Pay Taxes or Fees .

In 1997, the first year the credit and debit card program

was fully implemented, the USPS had more than $1.2

billion in credit and debit card transactions alone. More

than 18 months after the complete rollout, transaction

numbers and volume had more than doubled (Beyer

1999). In 1998, the Postal Service had 5.5 million debit

card transactions totaling $332 million and 42.6 mil-

lion credit card transactions totaling $1.4 billion.

A similar growth was experienced by the Internal

Revenue Service (IRS) when it began accepting credit

cards for payment of federal income taxes in 1999. Ta-

ble 4.1 summarizes the growth in both number of trans-

actions and dollar volume of transactions between 1999

and 2003. The number of transactions increased ten-

fold over this period and the dollar volume increased

more than four-fold. In the early years of the credit

card acceptance program, the most avid users of the

program were those with large tax balances (average

transaction value of $3,445) but over time the program

became more widely used and the average transactionvalue dropped to $1,569.

In the FTA survey, almost $700 million was collect-

ed from credit card, debit card and e-check payments

in FY 2003. This was a significant increase compared

to the $190 million collected by the states just two

years earlier (FY 2001). Credit card payments alone

amounted to almost half of these transactions, com-

prising slightly over 40% of the transaction amounts.

As shown in Table 4.2, credit card payments for state

taxes and fees show a trend similar to that of the IRS.

Between 2001 and 2003 both the number and dollar

volume increased while the average transaction value

decreased.

4.3 What Taxes or Fees Can be (and are) Paid by Credit Card?

Early research has shown that federal, state, and lo-

cal governments accepted credit card payments for a

variety of taxes and fees. For example, Kuhn (1992)

mentioned parking fines, motor vehicle service fees,

recreation and leisure services, taxes, court fines and

airport parking as the most frequently cited applications

of credit card acceptance at the state and local levels.

She further noted that at the state level, all seven states

surveyed (California, Indiana, Maryland, Montana,

Missouri, Oregon, and Vermont) accepted credit cardsfor payment of taxes, motor vehicle licenses, registra-

tions, recreation fees or parking violations. For taxes,

five states accepted credit card payments for delinquent

taxes only, while two of the states accepted credit cards

for both current and delinquent taxes.

The FTA survey of state revenue agencies found

that an overwhelming majority (90%) of the respond-

ing states accepted credit card payments for individual

income taxes. Slightly over half of the states accepted

credit card payments for corporate income tax and sales

and use tax.

4.4 Why Should Government Agencies Allow Payment

of Taxes and Fees by Credit Card?

One reason driving government acceptance of tax

and fee payments by credit card is citizen preference

for credit card payment. The literature suggests that

citizen preferences for credit and debit card usage are

driven by factors such as convenience, flexibility, speed

of transaction, security and ability to reduce the volumeof cash carried. Credit cards provide citizens with a se-

cure, reliable and convenient means of payment. They

are also a flexible payment method that allows citizens

to avoid late payment fees while stretching their pay-

ments out as a means of managing their cash flows.

Frequent-use awards and access to credit at the point-

of-sale further encourages credit card use.

Benefits to government agencies for allowing pay-

ment of taxes and fees by credit card can be divided

into three categories: (1) collections, (2) processing,

and (3) administrative. From a collections perspective,

acceptance and use of credit cards may result in moretimely payments, in addition to an increased certainty

of tax and fee payments and the potential for increased

collections. The increased certainty of collection is pri-

marily due to immediate, real-time fund verification that

ensures the credit card payment is valid. Greater use of

credit cards to replace checks, therefore, is expected to

reduce the occurrences of returned or defective funds.

Credit card acceptance may also yield greater collec-

tions by improving collections of delinquent payments

and increasing the consumption of government goods

and services by citizens as credit cards allow illiquid

consumers or those paying with future income to con-

sume and pay for goods and services (Chakravorti 2003).Payment processing is also affected by the accep-

tance and use of credit cards. The most commonly cited

reason for government to accept credit card payments

is the accelerated fund availability associated with

credit card payments. Credit card transactions provide

the government agency with good funds typically with-

in 48 hours of the government agency submitting the

transaction. This reduction in float improves fund avail-

ability and allows government agencies to get money

into interest-bearing accounts sooner. Credit card pay-

ments also result in staffing efficiencies, as they require

less extensive physical handling (in terms of paper- and

personnel-intensive activities) compared to checks and

cash.

From a transactions perspective, credit card use im-

proves the transaction efficiency, such as by increasing

the speed of check-out (reducing transaction time) and

reducing cashiering and other transaction costs. Be-

yond the actual tax or fee payment transaction, credit

card payments can simplify administrative recordkeep-

ing and improve the paper trail and accountability.

There is some anecdotal and empirical evidence sup-

porting these claims of credit card benefits. For example,


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the Washington, DC survey found that allowing citizens

to use credit cards to pay by mail or by telephone was

a major factor in reducing delinquent tax payments for

some local and state governments. Among the benefits

of credit card use cited by the cities, counties, states,

and the federal government included increased sales of

merchandise, more timely payments than conventional

methods, reduced interest and penalties for some tax-

payers, reduced mail and processing float, improvedfund availability, lower administrative costs, and less

risk associated with defective checks (Kuhn 1992).

The experiences of the U.S. Postal Service also evi-

denced some of the benefits of credit card acceptance

previously discussed. The Arthur D. Little consultants

contracted by the USPS found that 27% of households

and 15% of small businesses surveyed expressed an

interest in using credit and debit cards at post offices.

MasterCard, in cooperation with the USPS, conducted a

survey of customers buying characteristics and opinions

regarding credit card payments at pilot test sites. Survey

responses from 4,000 respondents showed that 64% feltthat the USPS acceptance of credit and debit cards made

it more like a retail establishment; 30% said credit card

acceptance added convenience; and 5% said it provid-

ed for better customer service. Results of both surveys

suggested support for the citizen preferences argument.

Time and motion studies at USPS pilot test sites dur-

ing the early stage of credit and debit card acceptance

showed that credit or debit card transactions were pro-

cessed more quickly than cash or check transactions,

thus saving customers and postal workers time. At post

office windows, a credit card transaction was processed

in an average time of 52 seconds and a debit card trans-

action was processed in an average 32 seconds. In com-

parison, average processing times were 80 seconds forcheck and 43 seconds for cash. The credit/debit card

program allowed postal clerks to complete transactions

more quickly and made them feel safer and more se-

cure as they no longer had to carry as much cash in

their drawers (Green 1997). A follow-up study by Coo-

pers and Lybrand found that the card program produced

significant financial benefits. The average handling and

processing cost for a debit card transaction was deter-

mined to be 1.5 cents per dollar spent by the consumer

and for a credit card transaction this cost was 4.0 cents

per dollar. In comparison, the handling and processing

cost for cash and check transactions were 4.8 cents and

2.7 cents per dollar, respectively.

As a result of the debit and credit card program, the

USPS has also been able to consolidate its cash man-

agement banking arrangements from more than 5,000

accounts down to 30 accounts. As Terrell Carter, as-

■ Fee paid by state

■ Fee paid by taxpayer

■ Combination of state and taxpayer

Figure 4.1

Responsible Party for Paying Fees Associated with Tax Payments

Source: FTA (2003) Credit Card Survey.


23/61


sistant treasurer of payment technologies for the USPS

states, “We have been able to significantly reduce our

cash-handling time, costs, and the risk associated with

it. Customers using credit cards also tend to buy up. Our

average transactions have increased” (Beyer 1999).

The 2003 NCSC survey found that state courts’ ex-

periences with credit card acceptance has been that al-

lowing credit card payments (1) increased the amount

of fines actually collected, (2) accelerated payment re-

ceipt, and (3) simplified recordkeeping.

4.5 Who Pays the Transaction Fees Associated

with Credit Card Payments? How are they Paid?

One of the most significant obstacles to accepting

credit card payments for government taxes is the per

transaction cost of credit card use. Most public agen-

cies are required by law to collect 100% of the tax or

fee amount owed by the taxpayer. As a result, public

agencies cannot pay the merchant discount fee that

acquirers charge merchants for processing credit cardpayments. For example, the 2003 NCSC survey found

that the most commonly cited reason for state courts

for not accepting credit card payments was the trans-

action fees charged by the banks for processing credit

cards. The fee charged by banks to process credit card

payments has typically been based on a formula that

includes the interchange rates, anticipated sales vol-

umes, average transaction amounts, and the method of

authorization and settlement. In the 1991 Washington

DC survey, most government agencies (69%) were

charged a discount rate (a percent based on the dollar

volume of credit card transactions) ranging from 1.4%

to 5% (Kuhn 1992). Other agencies, using a third party

processor, paid a sliding scale of fees ranging fro $3 to

$60, depending on the amount of the payment being

processed.

Private sector merchants can typically hide or bury

the fees associated with accepting credit card payments

into the price of the goods and services. Some govern-

ment agencies have taken an approach similar to the

private sector in absorbing the credit card transaction

fees as part of the cost of doing business, but without an

across-the-board rise in tax rates or fee structures.

Many other agencies, however, are constrained by

statute to collect 100% of what is owed. Most govern-ment agencies have passed on the transaction fee to

those taxpayers paying by credit card. Visa and Master

Card, however, had bylaws prohibiting merchants from

directly passing along the transaction fees to credit card

users. In 1993, they began enforcing these bylaws, or-

dering member banks to cut off service to those govern-

ment agencies passing along the transaction fee. Despite

extensive discussions with representatives of state and

local governments, Visa and MasterCard were reluctant

to change their position prohibiting passing along the

transaction fees. As a result, government agencies have

adopted various means for addressing the problem of

passing on credit card fees to taxpayers.

We examine two issues relevant to credit card trans-

action fees. The first is ‘who pays the fee—the govern-

ment agency or the credit card payor?’ and the second

is ‘how are these fees paid?’ Both issues will be ad-

dressed in the following subsections.

Who Pays the Fee? The NCSC survey found thatstate courts have dealt with credit card fees in three

ways: (1) absorb the fee as a cost of doing business; (2)

pass the fee through to the party paying the fee or fine;

and (3) negotiate with the bank to waive the fee. Ab-

sorbing the transaction fee as part of the cost of doing

business was the most common approach, but required

that the courts obtain statutory authorization to do so.

California and Michigan were two states whose courts

absorbed the credit card fees. The NCSC cited a three-

fold argument for doing so: (1) the increase in collec-

tions will offset credit card costs; (2) the cost of collect-

ing court fines and fees via credit is no more than, and

may actually be less than the combined fees, staffingcosts, security expenses, and costs for handling, hold-

ing, and transferring cash and checks; and (3) the pub-

lic prefers paying via credit card without any additional

fees attached.

The second option, adopted by Georgia and Louisi-

ana, involved passing on the fee to the party paying the

fee or fine by imposing a surcharge, transaction fee, or

convenience fee (justified such that they meet Visa and

MasterCard restrictions) to parties who wish to pay by

credit card. This charge may either be a fixed amount

or a small percentage of the amount being paid. The

advantage of this option is that it allows the state courtto collect the full amount of the fine or fee.

The final option involved the state court negotiat-

ing with its bank to waive credit card fees. Florida and

Massachusetts, for example, had gone this route, and

negotiated with their banks to waive credit card fees

in exchange for having the court, local government, or

state government deposit some of its funds in that bank.

The 1991 Washington DC survey uncovered two

methods for addressing credit card fees. The first was

for the government agency to directly bill the payor for

the credit card fees in the form of a surcharge which was

added to the transaction amount at the time the payment

was made. Thirty-eight percent of responding agencies

reported using this surcharge approach. However, since

this survey was undertaken before the crackdown by

VISA and MasterCard on credit card surcharges, it

is unlikely that this practice continued much beyond

1993. The second approach was for the government to

absorb the cost of credit card fees and paying this cost

by allowing the processing bank interest-free use of a

pre-specified balance for a pre-specified duration. This

practice, called compensating balances, was used by

62% of the state and local governments responding to

the survey.


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In the 2003 FTA survey, states were asked to identify

the party responsible for paying the transaction fees as-

sociated with tax payments made by credit cards. Re-

sponses to this question are presented in Figure 4.1.

Slightly fewer than 20% of the states actually absorbed

at least some of the credit card fees directly. The cost to

the state for merchant discount fees in FY 2003 ranged

from $70,000 to $1.4 million, and totaled close to $2

million. In the remaining states credit card fees were

paid by the taxpayer, either as an extra fee added tothe transaction amount (10% of the states) or through a

third party processor that then charged a service fee to

cover the credit card fees (74% of the states).

Charging Taxpayers a Convenience Fee for Cred-

it Card Use. In order to address credit card fees, somestates passed permanent or temporary legislation man-

dating credit card surcharges (e.g. Virginia, California,

Montana and Florida). Absent legislation, some state

and local governments have made policy decisions to

pass all or some credit card processing costs trough to

users in the form of a surcharge. For example, in the

early 1990s, the state of Massachusetts ruled that, inthe case of recreational fees or services, an expenditure

of public funds for the private benefit of an individual

paying with a credit card is unlawful, and therefore a

charge, however nominal, should be assessed to the

credit card user to cover the cost of providing this ser-

vice (Kuhn 1992).

Michel and Carter (1996) proposed charging conve-

nience fees for different payment options as a means

for covering the cost of credit card fees. This involves

presenting citizens with a menu of payment options in

which credit card users are not singled out and penal-

ized. The agency can then assign fees to different pay-

ment methods (phone, mail, walk-in service), instead

of assigning fees to different payment means (cash,

check, credit card). This allows the government agency

to associate the convenience fee with a benefit beyond

paying by credit card, such as paying by telephone to

avoid long waits in line. They cited the example of the

Wisconsin Department of Transportation (WisDOT),

which offers residents three ways to pay for vehicle li-censes—payment by mail via a bank lockbox (no fee),

payment in person at a customer service center ($3

fee), or payment using an automated telephone system

($2.50 fee). In return for the $2.50 telephone payment

fee, residents received fast service from the comfort of

their own home by dialing a toll-free number. A com-

puterized system asks for an identification number and

a credit card number to be used to pay the licensing fee.

In the 1990s, several state agencies adopted this con-

venience fee for different payment options approach,

while others have adopted a third-party convenience

fee approach.

As the more recent FTA survey indicates, the latter

has gained overwhelming popularity among the states.

A large majority of the states use a third party service

provider to process payments, with the taxpayer paying

a convenience fee directly to the third party for using

the credit card payment service (FTA 2003).

Kuhn (1992) found that officials in jurisdictions

where surcharges were in place noted that credit card

users were satisfied with the convenience and float af-

forded them, and did not consider surcharges a deter-

rent. However, convenience fees did not always resolve

the issue of government agencies collecting 100% of

what is owed, as is often required by law. Glen B. Gain-er III, State Auditor General for West Virginia, pointed

out that “a posted flat fee assessed to the consumer

may not entirely cover the agency’s cost if the agency

has a percentage-based acceptance pricing plan with

its acquirer” (Mitchell 2004, p. 22). In addition, while

taxpayer complaints regarding convenience fees is still

the most common among all complaints regarding the

credit card payment program, Iowa’s revenue officials

found that the percentage-based convenience fee was

much more acceptable to the public than the flat-rate

convenience fee (FTA 2003).

Survey evidence from the Texas e-Government proj-ect (Strover & Straubhaar 2000a, 2000b) also suggests

that citizens are willing to pay for the convenience of

paying by credit card. In this survey, citizens indicated

their willingness to pay for on-line access to different

types of government services (see Figure 4.2). It is rea-

sonable to expect that this same willingness to pay is

exhibited when it comes to paying for the convenience

of on-line credit card payments for taxes and fees.

How do States Pay Credit Card Fees? Kuhn’s1991 survey determined that in situations where the

state was responsible for paying the credit card fees,

■ Over $10

■ Up to $10

■ Under $3

■ Nothing at all

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

File and pay taxes

Renewdriver’s license

Pay traffic orvehicle tickets

Obtain shing orhunting license

Building or othersorts of permits

Figure 4.2

Citizen Willingness to Pay for Online Government Services

Source: Strover & Straubhaar (2000a, 2000b).


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the most dominant way of doing so was by using a

compensating balance. This involves the government

agency paying credit card fees using the value derived

from interest-free use of specified balances by the fi-

nancial institution. In 1991, 68% of respondents in the

Washington DC survey of state and local governments

had adopted this approach. A similar approach, identi-

fied by the NCSC survey, involved government agen-

cies (in the NCSC case, state courts) negotiating withtheir fi

Documents

Acceptance and Use of Electronic Payments for State Taxes and Fees