Taxi Tipping and the Principal-Agent Problem

(Photo: Spider.Dog)

A reader named Matt Hasten writes in to say:

While in Las Vegas last week for a convention, I took a taxi between casinos (might as well see a few while making my contribution). When it came time to pay and I pulled out a credit card, the cab driver informed me that using a credit card would mean paying a $3 fee in addition to the fare ($11.50). This struck me as a ridiculously high surcharge and when it came time to tip the cab driver (all of this using the back seat electronic card reader), I did not add anything extra. My logic was that while I usually tip 20% on cab fare, that would have only been $2.30 and I already was paying $3 above the fare.

I explained to the cab driver that the money I would usually spend tipping him was instead paying for the $3 fee the cab company imposed on me. The cab driver, understandably, saw things differently and had some colorful wishes for the remainder of my evening. At the time, I felt justified not tipping because I felt the only way to make my displeasure known about the fee was to stiff the cab driver and hope his (and other cab drivers’) anger of missing out on tips might put pressure on the cab company to change the policy. In hindsight, I do feel bad about stiffing the driver! I’m the kind of guy where you have to really mess up to earn less than a 20% tip at a restaurant.

I know the driver didn’t set the $3 credit card fee, but taking it out on him by not tipping was the only way I saw to make my displeasure known or, better yet, impact a greedy policy.

Was I right to not tip?

Interesting question. But, Matt, you’re asking us if you were “right”? By now you should know that Freakonomics is not very strong in the right-vs.-wrong department 🙂

Anyway: I can see Matt’s point of view. I can also see the driver’s point of view. As Matt further noted, the $3 surcharge has been controversial for a while in that it seems to be a back-door profit center for the cab companies, with much of the money not going to the credit-card companies (or the drivers) but rather to the cab companies themselves. From a 2011 Sun article:

Credit card companies said they were unaware of the surcharge until recently, when the politically active taxicab companies began pushing for the bill’s passage.

The Assembly approved the bill earlier this session with minimal opposition. But it is beginning to draw some resistance.

“It’s exorbitant,” said Michael Hillerby, a lobbyist hired by MasterCard. “Nothing we’ve seen justifies that charge.”

William Uffelman, president and CEO of the Nevada Bankers Association, said: “There’s good public policy, then there’s self-serving efforts. This is a self-serving effort.”

The average Las Vegas cab fare last year was $13.52, according to the authority. The $3 fee works out to an average 22 percent surcharge.

But let’s get back to Matt’s situation. Indeed it is tricky. Why? Because he has encountered what economists call the “principal-agent problem.” This means that two parties who seemingly have aligned incentives in fact do not. In this case, the cab company (the principal) would like the driver (the agent) to carry out a strategy that works well for the company, but the driver finds that such a strategy goes against his own interests.

We offered an example of this problem in SuperFreakonomics: city officials and police bosses would like street cops to crack down on prostitution but in fact the cops themselves didn’t have a very strong incentive to do so — which is why, as a Levitt-Venkatesh study showed, “a prostitute [in Chicago] is more likely to have sex with a police officer than to get officially arrested by one.”

While Matt’s reasoning makes sense — “I know the driver didn’t set the $3 credit card fee, but taking it out on him by not tipping was the only way I saw to make my displeasure known or, better yet, impact a greedy policy” — from his point of view, of course it doesn’t help the driver, who’s getting squeezed between the customer and the company.

What would you do if you were Matt?

One thought: suggest to the driver that he set up his smartphone to take credit-card payments, cutting out the cab-company middleman.

Better ideas?


Tip him what you think is fair. You aren't his mother, it isn't your job to protect him in the world.


This is against the vendor's agreement with most (all?) of the credit card companies; they can offer a discount for paying cash but not a penalty (or minimum charge) for using a card. I'm surprised Visa/MC didn't rescind the companies' ability to accept their cards.

Minimum charges or issues with credit cards are common in New York. Whenever I encounter minimum charges at places where the average purchase is likely to be low, like a bodega or bagel shop, I usually respond by not giving them my business anymore. Either don't take cards at all or take them for any purchase. As a customer, I should have the right to pay in a manner convenient to me.

The problem is that every cab company in Vegas sees they can get away with this, so they all do it, so there's no way for their customers to escape it. Even if one or two companies decided to not charge, you can't really set up a ride with one of them if you're just in the taxi line at a casino. Maybe they need to go NYC-style and centralize and control fares to avoid this kind of gouging.


Mike B

Due to a recent DOJ anti-trust settlement neither Visa or Mastercard can ban merchants from setting minimums or charging a higher price for credit card use. Some states like NY prohibit such practices, but most do not. Hopefully states will catch on because when customers are encouraged to use cash the state will usually never see a dime of tax from those invisible transactions.


Ah! That explains it. It's seriously irritating, because who carries cash anymore? Then I have to deal with change, etc. Much easier (and faster!) to swipe a card, especially when it's under $25 and I don't even have to sign. If I have to stand behind one more person digging through a coin purse...

And yes, I'm aware this is a prime example of a First World Problem.


pay cash - and tip the driver -

Mike B

Who carries cash any more? The sad part is that before recent legislation and a DOJ anti-trust settlements you could complain about this sort of thing to the credit card company and the credit card company would suspend the merchant's account as use fees and minimum charges used to violate the vendor agreement.

Mike B

There are all sorts of better reasons not to tip the driver than just an unfair surcharge. The whole American concept of "mandatory" tipping is bizarre. What was probably originally meant as either a reward for good service or straight payment for service has morphed into a cross between a mechanism for extortion and a mechanism for revenge. In this case it was being used as the latter, striking back against an unfair system and rightly so I might add, but why are people every day expected to pay above and beyond the listed price of a service when that service is anything but "bad"? I know workers who get tips often needs those tips to get either a living wage or even minimum wage, but why can't the fair cost of labor be factored into the cost of the service like it is in the majority of retail establishments? I went to Europe recently and it was so refreshing not to be required to tip, even if at the end of the day the bill was the same with a service charge. I would love to do the same in this country, but here such an action is likely to be met with some sort of reprisal.


RJ Roy

I would argue that your experience in Europe was truely mandatory tipping, as you are charged automatically a set percentage, with no choice in the matter. While North American society pushes one to tip all the time, it is not required.

The North American setup for tipping ostensibly provides an incentive to provide high quality service, as your income is directly related to how the customer felt about the service. Conversely, the European setup offers no such incentive; you get your X% regardless of whether you provided service fit for a king, or whether you tossed the food all over the customer.

That said, I never had bad service the few times I was in a European restaurant, so I don't know how well the incentive (or lack thereof) really works.


I suspect the incentive lies on the back end in European restaurants - if you get too many complaints (and that's probably not very many) you are fired and good luck finding your next job.


At the risk of sounding glib, I would carry cash.

You can get discounts by paying cab fares in cash. For example, for a $20 metered fare, drivers will often accept $17 in cash rather than $20+tip on a credit card.

A cab company (not in Vegas) tried to hit me with a surcharge one time. I had the receipt for the fare, they added $5 or so because of a "minimum" that was not advertised. I disputed and won.

But why are people surprised when LV finds another way to screw them out of their money?


In my experience most cab drivers will take you past a cash machine / ATM and wait free of charge if you explain it's to get cash for a tip. They know the CC system doesn't work out well for them or the customer better than anyone.


...where I have to pay an ATM fee and, depending on how sketchy the ATM is, risk compromised banking data.

They did some surveying in NYC after credit card readers were implemented, and actually drivers reported that people tipped significantly *more* on credit cards. Enough to offset the extra fees, even. By offering 15-25% amounts onscreen, and taking cards, I don't have to round and make it an even dollar (in which case I'm never going to round in favor of the cabbie). It's a nudge to tip more. It also means cabbies have to carry less cash, which is safer for them.

Cor Aquilonis

Rule for Living: If you can't afford to tip, than you can't have the service. The tip is part of the cost of doing business.

Also, it's not cool to stiff the driver so you can have the "convenience" of paying by credit card. Not cool at all.

Mike B

No, a tip is OPTIONAL, else it would be called a service charge. Someone cannot be charged with theft or sent a bill for not paying a tip. If a tip is in fact mandatory then it should be added to the official cost of a service.

Cor Aquilonis


Is this also how you operate at restaurants?

Eric M. Jones.

You should have tipped the driver if he gave you good service otherwise. He didn't make up the rule.

BTW: In my business, I see more and more businesses NOT taking credit cards at all (and my credit score is 795). They want bank transfers or cash--which is worrisome because the last guy who insisted on cash only was selling things out of the trunk of his car in a parking lot.


The only time I pay for a taxi/car service with a CC (and pay the add-on card fee) is when I travel for work and get reimbursed. So long as the charge is within bounds of my company's reimbursement policy, I don't spend too much time analyzing the cost/benefit of a couple dollars here or there. I opine this is typical business traveler behavior. The existence and possible prevalence of this type consumer would make the CC fee a smart market segregation mechanism. Charge more for those willing to pay it.


How about carrying a $20 in case you need cash?