Straight from the PayPal user agreement:
http://www.paypal.com/cgi-bin/webscr?
cmd=p/gen/terms-outside

"No Surcharges. Under Visa, MasterCard, Discover 
and American Express regulations and the laws of 
several states, including California, merchants 
may not charge a fee to the buyer for accepting 
credit card payments (often called 
a "surcharge"). You agree that you will not 
impose a surcharge or any other fee for accepting 
PayPal as payment. This restriction does not 
prevent you from imposing a handling fee in 
connection with the sale of goods or services, as 
long as the handling fee does not operate as a 
surcharge (in other words, the handling fee for 
transactions paid through PayPal may not be 
higher than the handling fee for transactions 
paid through other payment methods). "

Here's a reference to the federal law:

http://www.fdic.gov/regulations/laws/rules/6500-
2100.html

It is illegal to charge the consumer a credit 
card surcharge.  

The workaround for this is to simply price your 
goods at a higher price and then offer a cash 
discount.