Colorado’s state House just passed a bill to regulate various aspects of card transactions in the state. Proponents claim these regulations will save merchants millions of dollars to pass on to consumers. The evidence suggests the opposite is far more likely. The bill also likely violates federal law.

HB-1282 prohibits issuing banks from retaining interchange fees on the sales tax and tips portions of a card transaction. In that respect it is similar to an act passed by the Illinois legislature subject to a preliminary injunction for violating federal legislation. But the Colorado bill also caps interchange fees for charitable contributions and changes the rules for disputing transactions.

Proponents of HB-1282 make two broad arguments: First, merchants should not bear the cost of collecting tax and tips on behalf of the state. Second, savings from the removal of interchange on those items will pass on to consumers. Neither argument holds water.

Merchants in Colorado with sales of up to $1 million can deduct a vendor fee of up to $1,000 per filing period (typically per month). Since much of the cost of collecting and remitting sales tax is fixed, the vendor fee helps small and medium retailers who’d otherwise be at a greater disadvantage from their bigger competitors.

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By contrast, excluding sales tax and tips from interchange fees would have high fixed costs, so it would be disadvantageous for smaller retailers. This is because interchange fees, which are retained by card issuing banks as part of each transaction, are currently calculated on the entire transaction amount. POS machines generally don’t need to collect separate information about sales tax — and most don’t. Merchants would either have to upgrade their equipment or implement new systems for recording the sales tax on transactions.

So, HB-1282 effectively discriminates against smaller merchants. No wonder the big-box merchants push for this change!

But the idea cutting interchange on sales tax and gratuities would help consumers misconstrues what interchange does. Essentially, card issuers use interchange fees to subsidize consumer benefits — such as fraud protection, zero liability and rewards programs. By incentivizing consumers to use cards, these benefits have driven near-ubiquitous adoption and use of electronic payments But merchants benefit too: from more rapid throughput (card sales are quicker than cash, especially when using contactless tap-to-pay) and larger purchases (because consumers can spend more than the amount of cash in the pocket).

When issuers lose even a fraction of this interchange revenue, they recoup the shortfall by reducing cardholder benefits or imposing higher fees on other aspects of their service. We know this because it is what has happened everywhere interchange fees have been capped, including in the U.S.

Meanwhile, merchants rarely pass on savings from interchange fee price controls. If HB-1282 is signed into law, consumers would lose card benefits and/or face higher fees, while experiencing little if anything in the way of reduced costs of goods and services.

The bill also raises legal red flags. If the preliminary injunction in Illinois striking down much of that state’s similar law is made permanent, HB-1282 would surely suffer the same fate.

Supporters of HB-1282 claim it helps merchants and consumers. In practice, it has the opposite effect. Smaller merchants, especially, face disproportionate costs, while consumers face higher fees and/or fewer benefits from payment cards that would not be offset by any reductions in cost.

Julian Morris is a senior scholar at the International Center for Law and Economics and the author of State Regulation of Interchange Fees