Junk Fees or Junk Economics? (Part II)

Why is the President obsessed with hotel resort fees & airline seating charges?

Dear The War On Prices subscribers,

We recently wrote about Joe Biden’s fixation with what he calls “junk fees,” such as hotel resort fees, charges for sitting together on flights, and early termination fees for telecom services. It’s baffling that the President is spending so much time and focus on such a tiny economic issue.

Since then the President has backed the Junk Fee Prevention Act, which would:

1)    mandate that hotels, travel agencies, and online ticketing services display the total price of their good or service upfront (including any mandatory fees);

2)    prohibit companies from charging ill-defined “excessive or deceptive” mandatory fees;

3)    give the Federal Communications Commission and Department of Transportation authority to regulate “early termination fees” and family airline seating policies, respectively;

4)    allow the FTC broad authority to promulgate rules regarding any other fees they deem mandatory or deceptive, and to make “any other entity determined appropriate” subject to 1).

In the last post, we made three simple points about the economics of the narrative Biden is propagating:

• banning such fees would mainly just raise base prices (meaning households overall wouldn’t save significant amounts of money, as Biden implies);

• price unbundling is a totally normal business practice that can bring significant benefits to poorer customers;

• and, competitive markets provide strong incentives against deceptive or hidden fees, even if those services for price transparency are provided by third party platforms and intermediators.

The rest of this newsletter will present a more in-depth analysis of two pricing policies that Biden seemingly despises: airline family seating charges and hotel resort fees.

Airline seating charges

President Biden rails against “fees for things like sitting next to your child on an air flight.” No airline charges a “sitting with your kid” fee, of course, but airlines do have different methods for allocating seats after tickets are purchased that typically do not discriminate by age.

Families wanting to sit together when flying today have numerous options. They can buy tickets that include advanced seat selection, pay for seat selection before check-in, hope seats together will still be available during check-in, or take the chance of asking an airline staffer helping them on the day. For airlines with open seating, families with very young children (6 and under) usually already have the option to board early enough such that sitting together is near-guaranteed.

The cheapest airfares, however, do not usually include advanced seat selection, presenting uncertainties for families who are simply unwilling to pay more. This is what the Biden administration seemingly finds beyond the pale. It thinks those paying the cheapest basic fares should nevertheless have a right to guaranteed seats with all children under-13 for “free,” unlike other passengers.

Biden regularly talks as if airline ancillary fees—such as paying to check baggage—are purely extractive of consumers. Yet this large revenue source for carriers typically allows lower base fares - which survey after survey shows passengers care most about. The first order effect of banning or restricting such fees would be higher basic fares, potentially putting flying out of the financial reach of poorer families.

Seat selection is itself just a form of unbundling through an ancillary fee. People have strong seat preferences, with middle seats perceived worse than aisle or window seats. As Matt Yglesias has said, it is logical that those willing to risk random assignment should pay less than those with strong preferences. This is typically a key feature of the service differences between the cheapest and standard fares.

What the call to eliminate airlines “charging” for families sitting together really amounts to, then, is a demand for parents to obtain a privileged seating option at a price of zero. It’s a social policy mandate that compels other passengers to subsidize families with kids (whether through increased seat allocation charges for other passengers or higher fares).

To pressure airlines into providing this, the Department of Transportation is already running a dashboard showing which airlines have or haven't committed to make it "free" for families to sit together. The Junk Fee Prevention Act would make this an explicit regulation, with the threat of civil penalties.

Air carriers would have to confirm adjacent seats for children aged 13 and younger with an accompanying adult, if seats are available, within two days of booking. If not, they would have to offer a full refund or a week's wait to see if such seats materialize. If nothing crops up, then they must give passengers the option to rebook or to agree to waive their seating rights. For carriers without seat assignments, passengers must also be boarded in a manner that ensures each child under 13 is seated adjacent to an accompanying adult.

Even aside from the cross-subsidization inefficiency, this law would cause practical issues for airlines, particularly Southwest and its open seating policy. Currently, Southwest assigns boarding positions at check-in (you can pay extra to be near the front), allowing passengers to choose any seat still available when embarking. They currently allow families with young children (aged 6 or below) to board after group A, which usually allows affected families to find seats together. However, parents of children aged 7-13 must today either pay for EarlyBird Check-In or Upgraded Boarding for guaranteed seats together, as no special policies apply to them.

Despite this, Southwest is known for being family-friendly, not least because of its generous baggage allowances and flexible cancellations. These benefits can significantly reduce flight costs for young families and incentivize passengers to bring less carry-on luggage, which makes boarding itself more efficient. A blanket regulation to guarantee adjacent seats for families with children under 13 would make this bundle of services marginally more difficult to maintain profitably on certain routes. With more families granted advantageous queueing positions, the value to others of revenue-raising services such as EarlyBird Check-In or Upgraded Boarding is diminished. It’s therefore likely some price elsewhere would have to give to compensate: whether higher basic fares or cuts to currently complimentary services.

Implementing a child seating guarantee would present challenges for all airlines' reservation systems too. Updating them for new assignment rules and managing the volume of notices for families will be burdensome, particularly if rebooking or refunds are involved. Additionally, last-minute bookings for families with children would create substantial uncertainties for all involved. Airlines would either need to rearrange the seating of fee-paying passengers, introduce a clear system for families to waive their seating rights, or simply deny bookings on flights that are near full, even though today sensible accommodations are usually found to get passengers where they want to be.

Is all this worth it? Customers can already book using multiple airlines on most routes that offer different policies and tariffs to better fit their seating needs. In the rare cases when the parent and young child are separated after check-in, flight staff and other passengers typically find other ways to allow them to sit together.

This sort of blanket cross-subsidy will reduce airlines’ abilities to tinker with boarding and seat allocation practices. In doing so, it’s likely to increase headline ticket prices marginally and somewhat reduce the revenue viability of certain other ancillary services. And for what? Can anyone tell me how many children under-13 are actually currently separated from their parents against the parent’s wishes per year on domestic U.S. flights?

Hotel resort fees

Hotel resort fees, sometimes called "destination" or "amenity" fees, are non-negotiable charges that hotels use to supplement advertised room rates, typically covering a bundle of services like Wi-Fi, pool access, or gym facilities. The White House considers them a deceptive or unjustified “junk fee.”

Partitioned pricing - separating these fees from the room rate for billing purposes - supposedly hinders cost comparison across hotels and leads to unexpected charges for some unaware customers at check-out. Following research critical of resort fees from the FTC, the Commission explored rules against them last year. Now, the Junk Fee Prevention Act would compel hotels to advertise only a"total price" for stays, inclusive of resort fees.

Are these resort fees economically significant and damaging enough to warrant such attention? As a fee you can’t refuse to pay, Matt Yglesias calls them a "total scam.” Yet various estimates suggest just 6-10 percent of hotels charge them, and usually in tourist regions such as Orlando, Las Vegas, and Hawaii, or major city centers. Hotels utilizing them typically offer significantly more amenities, such as pools, gyms, tour services, parking, water sport rentals, boarding pass printing and sometimes even unique extras, like a white noise machine or a cup of clam chowder. This suggests they by-and-large genuinely reflect the provision of additional services.

If hotels were banned from using resort fees, it seems obvious that basic room rates would rise near enough commensurately to maintain revenue, leaving the total cost of stays faced by consumers nearly unchanged. So why do hotels structure prices in this way?  Resorts could 1) only charge customers who use the facilities and amenities (unbundling the services), or else 2) incorporate the cost of amenities into the basic room rates for all guests. That hotels in certain locations shun these options suggests there’s some economic rationale for resort fees – that structuring prices like this improves the hotels’ bottom line.

It's clear why hotels might refrain from unbundling charges for all services. While some European hotels do unbundle, and many US hotels charge extra for, say, premium Wi-Fi or sports kit rental, monitoring access to facilities such as pools and gyms can be costly for hotels and bothersome for vacationers. When guests have varying preferences for amenities, it can also just be profit maximizing for hotels to bundle their amenities together at a lower total price, as not every guest will use every facility.

Why, though, not just chuck this charge into the basic room rate? The Biden administration sees the failure to do so as borderline fraud – akin to luring customers with misleadingly low advertised prices. Yet hotels in tourist-heavy areas typically face stiff competition. If they gained from deceptive practices, competitors would surely be motivated to expose this information or offer alternative pricing structures. There must then be some economic explanation for the prevalence of the behavior.

Consumer shrouding? Some behavioral economists theorize that in markets with short-sighted customers and near-identical hotel cost structures, it's just not in other hotels' interest to expose competitors' deception, so the practice becomes a sticky equilibrium. If two hotels (A&B) charge the same combined price, then B educating customers that A uses a lower room rate and later adds a resort fee (whereas B prices transparently) still provides no financial incentive for customers to give up on A for B. In fact, if the newly educated customers can negotiate away or use loyalty schemes to dodge some or all the resort fee (as some hotel chains allow), exposing this information might actually harm B’s profitability by driving more customers to A. Add to this that at least some customers will fail to notice resort fees anyway, and you can thus see why hotels might charge them.

This so-called "shrouding" could explain why resort fees are common in highly competitive areas, where more touristy guests may be less knowledgeable or sensitive to hotel chain practices. Yet it’s not clear this is a realistic model of competition. And it also overlooks the role of online travel agents and third-party booking sites, which maintain strong incentives to provide comprehensive information on charges. Expedia, Kayak, and Booking.com have all already introduced innovative ways to improve transparency on resort fees, catering to consumer demands to see the full cost of stays – exactly what Biden is trying to replicate through legislation.

An Information Role? A less persuasive theory suggests resort fees offer informational value to customers, who appreciate seeing their money spent on amenities. Under this hypothesis, resort fees in tourist-heavy areas prompt discerning customers to examine amenities lists to find a better fit for their travels, provided the total cost of these charges are still clear and not hidden. The issue with this theory, however, is that resort fees are often found in smaller print on hotel websites, rather than being advertised proudly .

Cat And Mouse with Online Travel Agents? The hotel industry itself says that online travel agents' commission rates are often based on basic room rates, so hotels would suffer financially if resort fees were banned, and the hotel forced to increase basic room rates in response.

Add to this that many third-party websites list hotels by price using room rates, and there’s a clear incentive for hotels to try to eke out an advantage by using resort fees rather than reporting a higher basic price. If this lowers the hotel’s commissions, at least part of this saving would surely benefit customers – directly, through lower prices, or indirectly, through higher profits generating more entry into the sector.

Eventually, as more hotels adopt this strategy, travel agents of course adapt, and any additional profits from using resort fees will surely be short-lived. For example, Booking.com started charging commissions on resort fees in 2019, eliminating potential benefits for hotels. Given the fundamental bargaining power between hotels and online travel agents is independent of resort fees, banning them shouldn’t change the amount hotels must pay in the long-run. What we may see here, however, is a cat-and-mouse game where hotels adjust pricing structures to improve listing positions or exploit commission systems on certain websites over time, with modest benefits for customers.

Tax arbitrage? A final theory is tax arbitrage. Analysis from the University of Hawaii in 2018 indeed found that “amenities offered in conjunction with the room and charged separately” were exempt from Hawaii’s “transient accommodations tax.” Therefore, partitioning pricing meant a lower tax charge for the business, a windfall likely again shared between hoteliers and consumers.

While Orlando and Las Vegas explicitly include resort fees in their tax bases, both New York City and Los Angeles exempt resort fees from their hotel occupancy tax, perhaps providing a financial explanation for why some hotels might be more likely to structure prices in this way.

This tax avoidance isn't illegal, of course, and concerned policymakers can always follow Hawaii's example by clarifying the law to broaden the tax base if they are really concerned about it. This, though, will make some combination of the hotels and customers affected worse off. You cannot argue tax arbitrage is the issue driving resort fees and easily argue that it will be good for consumers too.

So what of more drastic measures? Outlawing resort fees would have a limited economic impact overall. Base room rates would likely rise to compensate for resort fees’ elimination. Some ill-informed customers would avoid making bookings they’d regret. Other guests might suffer: some hotel chains exempt those booking with loyalty points from having to pay resort fees and late cancellations often only incur a one-night room rate charge, for example. A rebalancing from resort fees towards higher room rates could therefore hurt various types of customers if, for simplicity, hotels maintain the same policies as today.

To the extent that hotels profit from lower commissions to online travel agents or reduced tax bills, abolishing resort fees could hurt them financially. A full ban may negatively affect some consumers by raising prices directly or by reducing choices indirectly due to lower profits and deterred sector entry.

The same would be true, albeit to a lesser extent, in regards to the provisions of the Junk Fee Prevention Act, which requires that hotels display a “total price” when advertising for the cost of a stay. Yes, this could simplify price comparisons for customers, but it might raise consumer prices if transparency alters the balance of power with online travel agents temporarily or prompts legislatures to expand the tax base to cover resort fees. In some cases, it might lead to confusion or less investment in amenities, as consumers are less likely to click through to see what extras their resort fee is covering.

Hotels really should be transparent about their resort fees, yes. Consumers should not be misled by surprise charges. Yet the benefits of banning them or forcing a bundled price are very likely to be small, especially given third party websites increasingly do this transparency job for customers where hotels are unwilling. And there are some downsides that could result for certain types of customers. While many customers have a visceral reaction to this type of pricing, as a matter of economics, it’s not clear why the President is expending so much energy on resort fees.