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Taxinomics: How Not to Run an Industry | I like koalas.
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Taxinomics: How Not to Run an Industry

Posted by on September 25, 2009

[This post was originally written for my employer’s blog, Show-Me Daily.]

There’s an article in the Chicago Sun-Times about the state of the taxi industry in the Windy City, and how cab drivers are presently working to change it. Rates are capped there by the city, and any rate hike requires prior approval by the City Council. The last such hike happened in 2005, when rates rose by 11.7 percent. Drivers are currently petitioning for a hike of 22 percent, as well as requesting a $1 fee for each additional passenger, $1 for trips dispatched over the phone, a $1.50 credit card “convenience” fee, and a $50 fee for “clean-up” in case a cavorter gets sick in the back of a car.

The additional passenger fee is an industry standard; I’m surprised they don’t charge this already. The other fees seem like ways to internalize the cost of doing business. That is, the cabbies will have to pay for these things anyway, in the form of cell phones, fees to a credit card company for having access to credit card billing machines, and professional cleaning services. They either take a hit when these types of situations arise, and are thus marginally less likely to provide service to those sorts of customers (credit card users, people who order by phone, and the inebriated), or else they lobby to raise their rates even higher, thereby dispersing the costs onto customers who don’t force the cabbies to bear them (those who pay in cash and hold their liquor). The legislators who are voting on the cabbies’ petition profess to have a sympathetic ear for the working drivers, but aren’t sure if cab riders can face the increased costs, especially what with “this recession that we’re in.”

Perhaps it is the case that taxicabs should be licensed by someone — I would argue that this should be a private, professional agency like the AICPA (which certifies accountants) rather than a local or state government board — but even if we grant the necessity of things like a criminal background check and a driving competency rating (perhaps this is what a driver’s license is for), why regulate the amounts that can be charged? The “moral” and “social” arguments for limiting what drivers can charge are endless, as well as baseless. What would happen in the total absence of taxi rate regulation in a large city?

First, let’s see what happens when prices are regulated. Economics 101 tells us that if regulators set the prices too low, there will be a shortage of cabs; more people will want a ride at that price than there will be drivers willing to take them. Similarly, if regulators set the price too high, there is a possibility that the market will approach equilibrium, but the restriction on supply brought about by the presence of limited “taxi licenses” will likely result in increased revenue for cab drivers above market levels, and fewer people riding in taxis than would do so in the absence of such a limited number of licenses. In addition, there are other adverse effects that such restrictions have on the market, similar to the negative effects of rent control, such as a decreased incentive to improve product quality, or to distinguish your company or cab as having better quality, through branding or other similar behavior.

In the absence of price controls, some cabs would charge more, but there is every reason to believe that many — or even most — would charge less. Competition drives down prices and improves quality, because customers demand low prices and high quality. Sufficiently competitive circumstances allow the best to rise to the top. Restrictive licensing and legislating the rates that taxis can charge are both bad ideas for Chicago, and they’re also bad ideas right here in Missouri.

2 Responses to Taxinomics: How Not to Run an Industry

  1. Christine Harbin

    Have the cabbies considered the consumers’ response to this rate hike? It could have an opposite-than-desired effect. It’s probable that a rate hike would decrease ridership and consequently reduce their revenues. Chicagoans will increasingly choose to take substitute forms of transportation (e.g., the subway, the bus, walking) as they become relatively cheaper. And, according to one taxi driver who is quoted the article, ridership is already down by forty percent.

  2. Josh Smith

    It is certainly the case that some number of people will shift from taxis to any one of many substitute services, such as buses, The L, calling a friend, etc. The cabbies are not necessarily performing the economic calculus of supply and demand necessary to determine what effect this change will have on their total revenue. However, there is reason to believe that people who take taxis do it because it is often quite a bit more convenient than the options listed above in a number of scenarios, and thus it may be that demand is sufficiently inelastic that a rise in price will cause a rise in revenue.

    And given that some number of customers prefer taxis for whatever reason, and the city has set up barriers to entry, until those barriers are reduced, it may be possible for taxi drivers to earn monopoly profits.

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