They charged you the PayPal fee? I'm pretty sure according to PayPal's TOS they can't ask you to cover the fees...always seems shady when someone wants me to cover one of their fees; it's the cost of doing business, same way businesses are charged by CC companies, etc. If you can't cover the PayPal costs, don't offer that as a payment option, or charge more for s/h...
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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).
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