I really like that you were able to make the twist at the end. The system is messed up, but if you can’t beat ‘em, join ‘em. I also lament the way it works, but the prices will be the same no matter how I pay, so we might as well get a little bit back in the process.

I use Chase’s Freedom and the BP Visa (5% on gas, 2% on travel/dining).

(Disclosure: I used to work for Chase [as a teller], and I do not own any JPM stock.)

Plus many people spend with money they don’t have (ie credit cards) and then don’t pay of the balance. Not only has this, as other comments have suggested, caused an increase in spending (the merchants get paid their money) but credit card companies are making a killing off of interest and fees. With an average rewards credit card APR hovering around 19.4 percent thats a whole lot of money to throw around by the company. Take 1 percent out (as that is the most popular reward back amount) and hand that to the rewards program and those that pay off their balances in full get the rewards free and those who don’t simply put the ‘rewards’ right back into the system through interest plus the other 18 or so percent their still paying.

Rewards programs really pay for themselves and the most likely scenario is that companies take a fraction of different incomes they earn (say 0.2 % of merchant fees and 0.8% from interest payments and late fees) to ‘pay out’ 1% back rewards.

Say a merchant has $1,000,000 in sales of which $500,000 is paid w/ CC. The merchant pays 2% of $500,000 ($10,000) to the CC companies. This $10,000 is 1% of their sales so they raise prices by 1% to pay this cost.

A person with a 1% cash rewards card would therefore about break even in this scenario, as the reward offsets the rise in prices. A person paying in cash on the other hand would be 1% poorer, in order to subsidize the use of CCs by other patrons.

It then follows that a CC user only comes out ahead with a reward if sales volume is less than half CC and lose money if its more. Of course, people that pay in cash lose money in all scenarios but lose more as CC volume goes up.

You really have to hand it to the CC companies, they have applied game theory principles masterfully. If no consumer used credit cards then prices would be lower. CC companies provide an incentive through “rewards” to use them. But the “reward” is only a reward if a few people use CCs. And once CC use becomes dominant people still have an incentive to use them because they will lose less by getting a “reward” than if they paid in cash.