My point is that Target gets its money for giftcards anyway, so why not give it a 5% discount too.
Because, like someone pointed out already, the GiftCard was probably purchased using a non-Red debit/credit card, which means Target had to pay a transaction fee based on however much the GiftCard was purchased for. One major reason for giving the discount on Red debit/credit is that Target does not pay a transaction fee on those transactions. The second major reason is that people with the RedCards spend so much more, per-trip and per-year, than people without them, so Target wants to try to shift as many people from the latter camp into the former as they possibly can.
And I guess what it really comes down to is this: if you can buy a GiftCard for its full face value (let's say using cash, so we put the transaction fees out of the equation altogether), then turn around and use it to get your merchandise at a 5% discount, why would you EVER not buy a GiftCard first? So now
everyone is buying a GiftCard first, because it's free money, so
everyone is always getting that 5% off--and at that point, why not just make everything 5% off regardless of payment type, period? That's effectively what you'd have done anyway.