In most major American cities, the taxi industry is heavily regulated. City officials treat taxi companies effectively as public utilities, tightly controlling every aspect of their operations, from the licensing of drivers to the fares they may charge. Many cities, including New York, Boston, and Chicago, operate so-called medallion systems whereby cities set a maximum cap on the number of cabs that can operate in the city.
How Does a Medallion System Work?
The basic element of a medallion system is the taxi medallion itself, a small metal plaque that is affixed to a vehicle. Without one of these medallions, it is illegal to operate a taxi in cities with medallion systems. The number of medallions, and thus the number of taxis, is tightly controlled and determined by political rather than market forces. It usually changes only when regulatory bodies decide to issue new medallions.
A medallion is not a license to drive a taxi; it is a license to operate one, and this is a critical distinction. Few medallion holders actually drive taxis. Rather, holders may possess significant numbers of medallions and operate fleets of taxis by leasing those medallions to drivers by the shift. These leasing fees become the primary revenue stream for the medallion holder. Whether a driver has a good shift or a bad shift, he still owes the lease fee. Effectively, medallion holders are guaranteed profits while bearing little or almost none of the actual costs or risks (which can be considerable) that are associated with driving a taxi.
What’s Bad for Drivers… Under this leasing arrangement, each driver begins his or her shift owing money to the medallion owner. In San Francisco, New York, and Boston, for example, drivers must earn roughly $100 per day (not counting fuel and other incidental costs) just to cover the cost of the medallion rental and break even. These costs seldom decline, simply because there are considerably more taxi drivers than there are available taxis. In New York, more than 50,000 licensed drivers vie for the chance to lease one of the roughly 13,400 available medallions. In Boston, about 6,200 cabbies compete to lease 1,825 medallions. Any driver who balks at the high lease fees can easily be replaced by one that is willing to pay them.
Some cities have attempted to preserve the once-common driver-owner, who owns and drives his own taxi, by apportioning an allotment of their medallions for individual “owner operators.” The financial situation for these drivers is arguably worse. Because of their high cost, medallions typically are debt-financed. Driver-owners face a steep down payment and long-term medallion mortgages that effectively lock them into the taxi business. After factoring in the loan payments these drivers face, net earnings for owner-operators may fall considerably below minimum wage.
…Is Good for Medallion Holders. Medallion systems erect barriers to entry that protect existing taxi interests from competition. The only way in for a new company or operator (absent the government issuing new medallions) is if an existing medallion holder decides to sell his or her medallions. Even then, the total supply of cabs does not change much, if at all.
The supply of taxis is set by law to be below market equilibrium, or the point at which supply meets demand. There is always a shortage of taxis, so taxi owners are essentially guaranteed the right to charge above-market prices and earn above-market profits. Supply caps mean that firms have little prospect of growing their business to meet demand, so the rational new entrant has no economic incentive to lower prices in order to compete for market share. Doing so would only eat into profit margins. Therefore, at no point are existing taxi interests threatened by competition or subjected to market forces.
By making taxis an artificially scarce commodity, medallion systems enable holders of medallions and those who finance their purchase to reap significant economic rents (the supracompetitive profits earned because firms can charge prices above what a market would support). Medallion holders earn these rents at the expense of drivers and the public. Medallions themselves are thus highly valuable assets that historically have appreciated in value faster than the stock market. At their peak, medallions traded hands in New York City for more than $1 million apiece.
Birth of the Medallion System
Regulatory advocates claim that medallion systems were first enacted to protect the public safety and welfare, and at first glance, they appear to have history on their side. These systems rose to prominence in the Depression-era 1930s. As unemployment shot up, the out-of-work turned to taxi driving in the desperate hope of making a living. The number of drivers soared: By 1932, there were nearly 150,000 taxi drivers nationwide, very nearly double pre-Depression levels. Supply far outstripped demand, and fares collapsed as drivers competed, sometimes violently, for every last rider.
As the quality of taxi drivers and their cars deteriorated, public safety concerns emerged. As taxis grew in number, they were blamed for worsening congestion. And as revenues fell, drivers went on strike to protest their worsening economic fortunes. Under pressure from all sides, city governments responded with a typical New Deal-era economic intervention. Taxis, it was concluded, were incapable of operating in a free market and needed public utility-like entry and price controls to remain viable in the face of “ruinous competition.”
However, this commonly accepted history ignores several critical details. A decade before New York adopted its medallion system and years before the 1929 crash triggered the circumstances of the 1930s taxi glut, pressures were already building in many cities to regulate taxi markets for nakedly protectionist, anti-competitive purposes. Low-priced automobiles were emerging in the American market for the first time in the 1920s, enabling not only personal vehicle ownership, but also the emergence of a new wave of low-price taxicab companies. The lower fares made taxi services affordable for a larger percentage of the population, but the fresh competition also threatened to undermine the business interests of established firms. The entire situation sounds eerily similar to today’s fight between ridesharing and taxi companies.
The response from the established cab companies, then as now, was an appeal to government to keep the new entrants out of existing markets. While forming a private cartel to manipulate prices or eliminate competition may be illegal under our antitrust laws, using governmental authority to establish the same barriers to entry is not, since government-created cartels are immune from antitrust liability under the so-called state-action doctrine. Backed by the legal and police power of the state, entrenched interests are able to achieve the same ends as an otherwise illegal cartel—shutting out competitors and sticking consumers with above-market prices—with the obvious advantage that there is no reason to fear antitrust action.
Medallion systems have always been about protectionism. The situation in Milwaukee in the late 1920s serves to illustrate how established cab companies succeeded in getting the local government in effect to make it illegal to compete with them. According to the Milwaukee Sentinel, local cab companies warned the Milwaukee Common Council that “certain interests have threatened to send a fleet of cars into Milwaukee and run those now operating out of business by cutting prices.” They then issued a veiled threat that the natural consequence would be a “taxicab war” in the literal sense. Acts of violence perpetrated against competitors were not uncommon at the time, and the horrifying recent demonstrations of mob violence in France against Uber drivers reveal that the brutal suppression of competition is a practice that is still alive and well among some entrenched interests today.
A wise and more courageous Milwaukee policymaker might have called the price-cutting new entrant an “innovator” or “disruptor,” to use the modern parlance, and reminded existing companies that public acts of violence would not be tolerated. Instead, the Common Council drafted an ordinance that required city officials to refuse to issue new taxi permits if it was found that “transportation facilities already available are adequate to meet the public need.”
The following year, a newcomer to the city, National Cab Company, applied for 75 permits and was rejected on the grounds that the needs of local residents were being met by existing firms. Any additional taxis would only result in needless congestion. Months later, Milwaukee’s native cabbies put in for fully twice that number of new permits. Their request was granted, exposing the taxi ordinance for what it really was: naked economic protectionism.
Though the city of Milwaukee did not implement a medallion system, those that did shared its protectionist sentiments. Numerous studies, including most recently, a report prepared for the Washington, D.C., City Council, have concluded that advocates of medallion systems saw their raison d’être as protecting public transportation utilities and existing taxi interests from competition.
Can Medallion Systems Be Justified?
Medallion advocates counter that entry restrictions are necessary evils because the taxi industry is prone to “ruinous competition” and cannot function as a market without significant government intervention. It is also argued that free entry into the market would significantly increase taxis’ negative externalities, such as congestion and pollution. Advocates also assert that medallions are a necessary component of taxi safety and welfare regulations generally and that supply caps make it significantly easier to enforce those regulations, leading to net improvements in consumer safety and welfare.
Ruinous Competition. The argument here is a simple one and largely the same as it was in the 1920s and ’30s: Allowing free entry into taxi markets leads to oversupply, which consequently drives prices and revenues below the cost to operate a taxi or taxi company. Businesses of necessity would fold, eventually leaving only a single monopoly firm in the market that could then raise prices and earn above-market profits at the expense of the riding public. Fears of monopoly control of the industry were one of the stated reasons why New York City adopted its medallion system in 1937.
But advocates ignore that their doomsday scenario is the present reality created by medallion systems. Under these systems, existing firms are allowed to form what amounts to state-sanctioned cartels that otherwise would clearly be illegal. As noted, medallions grant exclusive rights to operate a taxicab. By effectively handing control of the industry over to incumbent firms, they allow these firms to achieve all the advantages of monopoly power—the ability to charge higher prices and earn supracompetitive profits—without the risk of government trust-busting. Additionally, the resulting highly concentrated group of taxicab owners becomes a politically powerful advocacy group with a tremendous incentive to engage in rent-seeking behavior. The risk of regulatory capture—which occurs when an agency created to police an industry ends up co-opted by that industry, advancing rules and regulations designed to benefit it—is extreme.
Negative Externalities of Taxis. Removing the limitations imposed by medallion systems would almost certainly lead to at least a temporary increase in taxis. The rise of for-hire ridesharing, which already employs more drivers and operates more vehicles than taxi companies in many medallion markets, demonstrates that there is a significant unmet demand for such transportation. It would be natural for a new wave of taxi drivers to want to capture some of that demand for themselves. Medallion advocates argue that this will naturally lead to significant negative externalities, primarily revolving around congestion and pollution.
Entry and supply restrictions, however, are neither the most effective nor the least costly means of dealing with these externalities. Taxis account for an exceedingly small portion of vehicular traffic in most cities, and while it is true that the number of taxis would likely increase following the abolition of medallions, they still would likely account for no more than a minor fraction of vehicles on the road at any given time. Therefore, the benefits gained in terms of addressing the congestion or pollution caused by increased taxi supply would probably be significantly outweighed by the cost to the public in terms of lost access to ground transportation.
To the extent that taxis and rideshares do contribute to pollution or congestion, it would be more efficient to factor in the social cost of these externalities through congestion pricing than through supply caps. Access to transportation could thus be preserved for those who value and need it without the attendant supply shortages imposed by medallion system caps. Moreover, expanded access to cheap and convenient taxis and other similar forms of ground transportation might actually decrease congestion by solving the “last mile” problem inherent in public transit systems, encouraging their use. Additionally, widespread and inexpensive for-hire transit options might discourage personal vehicle ownership. Paradoxically, increasing the number of available for-hire cars could reduce the traffic load into and out of cities, freeing lanes, alleviating parking troubles, and reducing overall vehicle emissions.
Health, Safety, and Welfare Regulations. Cities have a long history of imposing other forms of regulation on the taxi industry beyond supply caps. For example, vehicle maintenance requirements, drivers’ licensure and training requirements, liability and insurance requirements, price caps, “no refusal” policies, and vehicle cleanliness standards are common to most jurisdictions in the United States. These regulations are promulgated under states’ “police power”—the authority to regulate private activity in order to promote public health, safety, and welfare.
While these forms of taxi regulation are fairly ubiquitous, medallion systems are not. Entry controls can therefore be divorced from the broader body of health and safety regulations in the taxi industry without undue deleterious effects. For example, cities can easily impose vehicle insurance requirements or even drivers’ licensure requirements without needing to impose draconian supply caps. Medallion cities already license far more drivers than they do taxis, undercutting the argument that caps are critical to enforcement. Further, the expansion of ridesharing has been accompanied by a variety of specialized safety regulations, including requirements that drivers be adequately insured, without also imposing supply caps.
It may behoove cities to revisit some of their existing taxi regulatory schemes to determine whether these schemes, like medallion systems, have outlived their usefulness. It is clear, however, that entry barriers play no critical role in those regulations that cities deem essential to public health and safety. Governments seeking to end medallion systems can do so without fearing that they will undermine the remaining body of occupational taxi regulations.
Policing the Industry. One of the most strained arguments in favor of medallions is that by restricting the number of taxis, regulators cut enforcement costs and have an easier time policing the industry. The result, it is claimed, is fewer violations of city health and safety regulations, to the benefit of the public.
It makes intuitive sense that having to inspect less of a given thing is less costly in terms of time and money than is inspecting a greater number of the same thing. However, looking solely at the benefit to taxpayers of cheaper enforcement of a regulatory regime to justify supply caps ignores the very real costs to consumers that those caps impose.
Supply caps and price controls in medallion markets have driven fares considerably above prices in deregulated markets, to the detriment of riders. Supply caps also lead to significant unmet demand due to continual shortages of taxis—again, a real harm to the public. One particularly pernicious consequence of the medallion system is that drivers, indebted from the moment they get behind the wheel, are highly likely to engage in aggressive driving that puts passengers and other motorists at risk. Another is that they are likely to refuse to service outlying or low-income areas because they may not earn enough in fare revenue to offset the cost of the medallion lease. The D.C. report, prepared when the city council was considering whether to impose a medallion system on the nation’s capital, included this ominous warning:
By restricting supply and creating high barriers to entry, there is an unmet demand for taxi service, longer wait times for taxis, more non-responses to phone requests, less clean vehicles, poorer quality of service, and higher fares. Taxicab drivers would refuse service to certain types of customers (for example, based on race) or to certain parts of the city.
New York City is the perfect example of taxi concentration. In 2014, only 6 percent of all yellow cab pickups originated outside either the core of Manhattan or the city’s airports, compared with 22 percent of UberX pickups. Historically, taxi concentration has left residents of the outer boroughs, particularly those in low-income communities, with few transit options—a reality that it appears is being remedied at least partially by rideshares.
Moreover, so-called gypsy cabs—black market, illegal cabs—tend to flourish in cities with tight entry controls. Answerable neither to a reputation-conscious private company nor to a regulatory body, these cabs are significantly more likely to engage in the sort of corner-cutting, price-gouging activity that regulators cite as justifying their close supervision of the industry. It can therefore be argued that supply caps can actually reduce public safety and welfare by encouraging such black market operations.
Time to Move Beyond Medallions
Medallion systems have endured and have been endured for more than 80 years. Ridesharing companies like Uber and Lyft represent the first genuine challenge to their supremacy in some of the nation’s largest cities. They offer rides that are cheaper, in vehicles that are generally nicer, through smartphone apps that are more convenient and reliable than any dispatch or street-hail system. Rideshares are expanding service options for residents in historically underserved neighborhoods, particularly those in low-income and minority neighborhoods.[35 ]Drivers are also jumping ship, switching to app-driven services that promise healthy revenues free of the burden of medallion leasing fees.
Regulators, under pressure from powerful taxi lobbying groups to preserve the status quo, have tried in many cities to ban or heavily regulate the startups. These efforts have largely failed, and absent a few setbacks, rideshares have expanded to virtually every major market in the United States. As a consequence, medallion prices are falling, reflecting the prevailing wisdom that once-certain economic rents are no longer guaranteed.
In response, some medallion owners have demanded government bailouts to safeguard them against defaulting on their medallion loans. Other medallion interests have taken to the courts. The medallion system is faltering; eventually, absent government intervention to restrict the growth of ridesharing companies, the existing medallion system will likely fail.
Policymakers in medallion cities thus have two options:
- Act to preserve a system that clearly benefits the few at the expense of the many or
- Begin to unwind and dismantle that system in favor of a free market that enhances the public welfare.
The growth of the ridesharing industry demonstrates one fundamental fact: For-hire transit options like taxis and rideshares are fully capable of functioning in a free market without supply and price controls, no matter what self-interested medallion owners claim. Medallion systems are dying, and policymakers should let them die.
—Jason Snead is a Policy Analyst in the Edwin Meese III Center for Legal and Judicial Studies at The Heritage Foundation.