Just as the New York cabbie is a stock character of stage and screen, so is the New York taxi-regulation system, with its $275,000 medallion just to put a taxi on the street, cast as the very model of destructive interference with the free market. The stuff of libertarian caricature, the system seems to symbolize perfectly the absurdity of New York's restrictive business climate. But contrary to conventional wisdom, there's a good case to be made that medallion costs that high make sense: they are part of a regulatory system that—believe it or not—makes Gotham the U.S. city best served by for-hire vehicles, including taxis.

The key to this counterintuitive assertion lies in what can be called New York's two-tier taxi system—a small, highly regulated first-tier system for the city's most congested areas, complemented by a minimally regulated second-tier system that has allowed thousands of driver—entrepreneurs to get into the business at a low cost and to provide service to the outlying lower and middle-income neighborhoods that in most big cities go unserved. It is this combination of great and small regulation that makes New York a model that other cities should not scorn but emulate—not least for the economic benefits it can offer the enterprising poor. To be sure, the New York taxi system has flaws that need fixing; but its essential triumph is largely unappreciated.

In order to grasp the virtues of the New York system, it's important to understand that big cities need some sort of taxi regulation, because of the sheer congestion of places like midtown Manhattan and the airports. Without some way to regulate the number of taxis operating in such busy areas—what economists call congestion-pricing—there is potential for chaos. Even a libertarian-leaning economist like Daniel Klein of Santa Clara University, acknowledging that congestion is a serious problem, has proposed a system to auction the right to operate a taxi in congested areas, rather than simply allowing open entry. Klein suggests that cities should auction off "curb rights"—the right to wait at the limited space at curbside—much as airports require airlines to bid for landing slots.

To be sure, New York didn't create its medallion system with such problems in mind: the 1937 Haas Act, which created the medallion system, was a move by taxi owners to stem competition at a time when the Depression-era unemployed were swelling the ranks of drivers. But over time, the medallion system proved to be a reasonable proxy for a full-fledged congestion-pricing and auction scheme. In places as crowded as midtown and lower Manhattan, it's quite possible that an auction for the right to operate a taxi would lead to prices as high as the current $275,000 medallion price. Because of its history, the medallion system may seem arbitrary and capricious—and, in terms of who actually owns medallions, it surely is—but that does not serve to make the case against taxi regulation.

It makes sense for big cities not only to regulate the number of taxis in heavily trafficked neighborhoods but also to regulate taxi fares. After all, it's hard to shop around for the best taxi deal. An out-of-towner might have no idea how much the fare to his destination should be and isn't in a position to do the on-the-spot research to find out. Someone in a hurry (one of the main reasons for taking taxis) has no time to comparison-shop and often would prefer to avoid souk-like bargaining with the driver. Because of this problem of "search cost" (as economists call it), cities are justified in regulating taxi fares—at least insofar as they protect passengers by setting a maximum fare. The same search-cost problem justifies other forms of taxi regulation, too, such as the requirement that taxis be regularly inspected and insured. No passenger wants to invest time in making sure that the cab can make it to the airport.

But to say that some forms of regulation make sense is not the same as saying that most cities do a good job of regulating. Many cities, for example, don't have severe enough congestion problems to justify their existing limitations on the number of cabs. In Indianapolis, for example, when Mayor Stephen Goldsmith replaced the ceiling on taxi licenses with an open-entry system, the number of cabs rose only slightly, from 392 to 435—meaning that the city is sufficiently spread out, and demand is sufficiently limited, that it needed no congestion-related regulation. Even Washington, D.C., has long allowed open entry without serious taxi congestion. It's probable, in those relatively uncongested cities that do limit the number of taxis, that existing license holders have used political influence to limit competition.

But most of the congested big American cities that really need a taxi limit—Boston, Chicago, Philadelphia, and San Francisco, for instance—make a crucial regulatory mistake that New York has managed to avoid. They combine the congested downtown and airport markets with the far less congested residential neighborhood markets. The result: drivers cluster downtown and at the airports, leaving the outlying areas unserved. After all, if all taxi drivers are paying for the high cost of the medallion—in New York, up to $2,000 a month in loan costs (if they've borrowed to buy their medallion) or over $100 a day to rent a cab with a medallion—they inevitably will cluster in the parts of town where potential fares are thickest on the ground. They will overlook the low- and middle-income outer areas that surround every downtown—Boston's Dorchester neighborhood, say, or Chicago's West Side—where there is simply not a steady enough stream of riders to justify a driver's time spent cruising.

This is a crucial problem with taxi regulation: a city has no justification for denying uncongested residential and commercial areas taxi service because they happen to be in the same municipal jurisdiction as congested downtown areas. If these outlying neighborhoods were independent suburbs, they would license their own taxis. But because they lie within the city limits, their residents, many of them often poor, must do without.

Cities with innovative governments around the world have addressed this problem. Hong Kong, for instance, has three types of taxi licenses, each for different districts of the city, and it holds auctions for each. The less densely populated the area, the less expensive the license. But though New York's system was not as elegantly designed, it has come to operate on the same theory, leading to the key aspect of New York's taxi success: the neighborhood car service, or livery car. The car service—a radio-dispatched vehicle linked to a cooperatively owned dispatch base that pre-arranges pickups by phone—provides exactly the kind of loosely licensed "taxi" service that lower-income neighborhoods in other cities desperately need.

Such vehicles, as often as not older cars owned by their drivers, first developed informally—and non-legally—in the 1950s, notes Bruce Schaller, former chief analyst for the city's Taxi and Limousine Commission. "The system was not planned," he observes. "It evolved." The licensing system that took shape, legalizing car services, permitted a slow-building boom in outer borough for-hire vehicles, so that today an estimated 30,000 to 33,000 of them ply the streets, complementing the 12,000-plus medallion taxis. Taxis and car services combine to provide New York with by far the largest number of "taxis" of all kinds per person of any U.S. city—and more per person than even Hong Kong and Singapore, always ranked among the world's leading bastions of free enterprise.

The key elements of New York's smart regulatory regime include, first, no limit on the number of for-hire vehicles. Demand, rather than an arbitrary figure, decides how many car-service cars are operating. Second, there's no official minimum fare: a car service can't charge more than a yellow medallion taxi—but it can charge less, allowing drivers to adjust to what lower-income passengers can afford and to vary their fares depending on the time of day or night. Third, there's no age limit for car-service vehicles, in contrast to medallion cabs, which must now be replaced at least every five years. A 1993 Taxi and Limousine Commission survey found that the average car-service vehicle was ten years old, suggesting that entry costs into the business, contrary to the New York stereotype, are relatively low. This policy marks New York as even more laissez-faire than Hong Kong, which imposes the same fare and vehicle requirements on its outer-neighborhood taxis as those in its central core. (That's why a taxi license for the outer ring New Territories is only slightly less expensive—$175,000—than an "urban taxi" license, currently selling for $250,000.) Finally, New York has low licensing charges for car services—only $60 a year for the driver and $275 annually for each vehicle. Dispatch bases pay but $500 a year to register.

The result of these low fees has been a proliferation of small car services. Taxi and Limousine Commission figures list nearly 500 car-service bases—49 percent of which have 19 cars or fewer. Three-quarters of all the cars are owned by their drivers, the rest by the base owners. Clearly, this is where the taxi entrepreneur can easily start out.

This relatively hands-off city policy is official and explicit. In its literature, the Taxi and Limousine Commission asserts that "the TLC wants to encourage, not discourage, operators to become and remain licensed. Burdensome regulation would thus be counterproductive, especially in light of the competition from unlicensed operators who do not pay insurance, workers compensation and other costs." This is an insight that transcends the taxi and car-service worlds. The TLC has mastered a regulatory paradox: less regulation means more compliance. Limited regulation protects the public, because it keeps the entrepreneur out of the illegal economy, where cars would be less likely to be insured or inspected. Greater London offers a notable counterexample: an estimated 50,000 so-called minicabs, the illegal counterparts of New York's car-service vehicles, complement the city's 24,000 licensed cabs. With so big an industry operating outside the law, the city has had a recent problem with minicab driver assaults on passengers.

In addition to protecting the public, limited regulation assists entrepreneurs by making it easy to be legal—and upwardly mobile. How can one get a bank loan for a new small business—such as an expanded car service—if one's income is off the books? Not only would other cities do well to adopt Gotham's loose-tight approach as part of a two-tiered taxi system, but New York would do well to extend its enlightened policy of limited regulation to other entry-level service occupations. Many in-home child-care centers, for instance, remain in the underground economy because they cannot meet difficult-to-afford housing-code and teacher-training standards. No one wants to consign children to unsafe conditions—but neither does one want the best to be the enemy of the good.

The results of the city's relatively minimal car-service regulation are impressive by many measures. TLC figures show that for-hire vehicles serve up to 275,000 riders per day, or 7 percent of trips in New York City by taxi, bus, or subway. Car-service industry revenue rivals that of the yellow medallion-cab industry, yet fares are cheap. And 30,000 vehicles on the street could mean full or part-time employment for twice that many drivers, since many work part-time and each car can be driven for two or even three eight-hour shifts. As a result, too, customers of modest means can do all sorts of things that they might not otherwise be able to do, including getting to work, especially at times or places when other transportation is limited. As the TLC For-Hire Vehicle Fact Book puts it: "For-hire vehicle service is a vital part of the transportation network in New York City. They take patrons to doctors, hospitals, stores, places of employment and entertainment, business appointments, the airports, and such special events such as weddings and proms."

Such a picture of economic and social activity is about more than local color. It is an implicit rebuke to those who have imagined that only massive investments in expensive public transit can link the poor, who don't own cars, to employment. (More than half of all New Yorkers do not own cars.) This flourishing industry is part and parcel of the kind of spontaneous economic activity that signals real urban renewal. It's worth noting that neighborhoods like Washington Heights, Crown Heights, Flatbush, and Sunset Park, where immigration has led to renaissance, are also the neighborhoods where car services are most abundant.

All this is not to say that the city's car-service regulation can't be improved. An old Koch administration suggestion that car-service cars be allowed not just to respond to telephone calls, but also to respond to street hails outside the prime medallion-cab district—above 96th Street in Manhattan and throughout the outer boroughs—should at long last become law, regularizing the de facto toleration that prevails today. There is no reason to deny an elderly resident of Harlem or Brooklyn the right to hail a taxi in the rain.

At the same time that it encouraged the boom in neighborhood car services to supplement the medallion taxis and provide service to outlying areas, New York filled another hole in the system. It permitted the growth of the nation's largest upscale limousine service—the fleet of so-called black cars, late-model luxury vehicles that serve midtown and financial-district corporate clients and others willing to pay premium prices for higher-quality service than medallion cabs provide. The black-car phenomenon was, even more than the neighborhood car services, conceived as an explicit way to increase the supply of "taxis" in 1982, despite the fixed number of taxi medallions.

Up to that point, taxi owners were equipping more and more medallion taxis with radios, giving them the option to pre-arrange pickups rather than relying solely on street hails. Increasingly, corporate customers were calling "radio cabs," to the point that up to a quarter of medallion cabs were "on radio call" and not available to be hailed. By requiring the transfer of the radios to a newly licensed limousine trade, at the same time that the number of medallion cabs remained the same—though now available only by street hail—the TLC effectively increased the supply of cabs in the highest-demand parts of Manhattan by two-thirds, or 8,000 vehicles, the number of black cars operated today by 45 firms.

Not only has the advent of the black car increased the "taxi" options available to New Yorkers, but it has allowed people to purchase taxi service with greater amenities: the price cap on metered yellow medallion cabs may protect out-of-town customers from price gouging, but it also eliminates any incentive to provide higher-end service. Moreover, the higher prices and pre-arranged nature of their service allow black-car owners to be profitable without ceaselessly driving around, adding to the city's congestion. Black cars have proven to be a way to increase the number of "taxis," in other words, without creating midtown gridlock.

One clear area remains where New York ought to make its already good taxi system even better: it should improve the quality of service provided by many of the drivers of medallion cabs. The service problem stems from the lease system that covers some 60 percent (6,818) of New York's yellow cabs, which are corporate-owned and are hired out to drivers for 12-hour shifts at a time.

The economics of leasing are tough on drivers. Owner-drivers, who operate roughly 40 percent (5,369) of Gotham's yellow cabs, make decent livings, averaging $35,000 a year way back in 1993, according to the latest, if obsolete, TLC figures. Those who bought their medallions for $30,000 or $50,000 long ago and own them free and clear do best; they earn a decent income from driving and, at retirement, can sell the medallion and live off the vast appreciation. Those buying $275,000 medallions today, primarily South Asians, can still do okay, if two partners share the cost of financing the medallion together, and each drives a 12-hour shift daily. The 1993 TLC survey, when medallions still cost only $137,000, found that new owner-drivers then averaged $27,000 a year.

But the drivers who lease their cars—either from large fleet owners (2,620 cabs in 28 garages) or from management companies—are the true drones of the taxi world. Prior to 1979, non-owner-drivers simply shared the revenue ("split the meter") with medallion owners, and they received modest fringe benefits. With leasing, however, medallion owners get their payment before the driver goes out onto the street; drivers must pay $100 or more to lease and may clear as little as $20 or $30 per shift after paying for gas. As industry consultant Schaller puts it: "Drivers loathe the leasing system, . . . [which] shifts to [them] all the financial risks created by weather, traffic conditions, variations in taxi demand and in the type of trips garnered in a day." Slack demand or heavy traffic can vaporize a day's profit, creating, says Schaller, "a pressure and strain that drivers feel all day."

Under that pressure, lease drivers are disproportionately involved in accidents; they have a powerful economic incentive to drive aggressively. TLC data have shown that lease drivers incurred 25 rules violations per million miles driven, while new owner-drivers incurred only eight. Given these realities, current TLC head Diane McGrath-McKechnie's crackdown on taxi-driver moving violations—which includes the threat of license revocation—makes good sense, as it does in the case of livery-car drivers, who are also involved in more accidents than the owner-drivers of medallion cabs.

By making it difficult to make much money, leasing makes a large percentage of New York taxi driving into a port-of-entry and quick-departure occupation for new immigrants, who make up 89 percent of new taxi drivers. Turnover, of course, means new drivers not familiar with city geography and the best shortcuts—despite the TLC's training requirements, among the nation's stiffest. No amount of training compensates for experience. As consultant Schaller points out, "experienced drivers violated Taxi and Limousine Commission rules four to five times less often than drivers in their first year." This is no small matter for New Yorkers; Manhattan residents—78 percent of whom do not own cars—hail a cab an average of 100 times annually.

The odds against changing the lease system are long, however. Cab fleet owners, especially the 13 firms with 100 or more taxis, are powerful players in this billion-dollar industry. Government, particularly the City Council (which oversees the TLC),  looks out for these mighty economic interests: the New York Times reported in July 1998 that Noach Dear, chairman of the Council's Transportation Committee, received some $170,000 in contributions from "taxi and livery interests" over the previous five years, while Council President Peter Vallone received more than $55,000 from them. The fact that medallion prices have gone up 87 percent in real terms since 1979, when the leasing system began, probably reflects not just the growing strength of the local economy but also the profitability of leasing out cabs to an endless stream of new immigrants, who may or may not be safe drivers but who will work for low wages. Fleet owners have even protected themselves from the insurance liabilities such drivers pose: they own their cabs through hundreds of legally separate corporate entities, so a liability judgment against any one of them leaves the assets of the others untouched.

One way to help lease drivers and, indirectly, to protect the public would be to follow San Francisco's lead in imposing a price cap on taxi lease rates, in order to ensure that drivers desperate to pay off medallion owners did not take foolish chances. (The San Francisco lease cap is $83, significantly below the going rate in New York, despite the Bay Area's comparably high cost of living.) In exchange for such a price cap, the city could insist on even more extensive driver training—which, with better-paid, longer-serving drivers at work, could well lead to better-quality drivers providing better service. This is hardly a free-market solution, but arguably it is appropriate in dealing with a government-protected monopoly.

Better still, the city could look for ways to transfer, over time, all medallions into the hands of owner-drivers. This might mean prohibiting resale to anyone but owner-drivers, and requiring that any new owner—even one who inherits a medallion—either drive the cab or sell the medallion to someone who will. Even more radically, the city could consider buying all existing medallions for the price paid by their owners plus some reasonable rate of interest, then offering them anew at auction on terms favoring owner-drivers, in recognition of the better service they provide. Given the political power of current medallion owners, however, such transition schemes are long shots.

But who would have imagined 20 years ago that by the turn of the century, despite the political power of their owners, yellow medallion taxis would make up less than a third of New York's total taxi industry? Even in the most adverse circumstances, if you give free-market forces the slightest opening, they can work wonders.


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