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?

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  1. fraac says:

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

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    • Daniel says:

      This also illustrates why mandatory/expected tipping is a terrible practice — the customer has the ability to greatly influence the worker’s compensation due to reasons that are arbitrary or outright at odds with the performance of the worker.

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    • doug says:

      He’s not trying to protect the driver, he’s trying to express his displeasure about the surcharge.

      Thumb up 3 Thumb down 0
    • David McKnight says:

      If the argument is economics, then the lesson is for the driver.

      If most of his fares “give his tip” to the cab company as a result of the surcharge, the driver needs to change his part of the equation. My immediate thought was the same conclusion that others have reached: driver needs to get a square or PayPal account to solve the problem — and ask the fare if he can include a tip, how much (or suggest an amount); an even easier way to tip. Then the driver substitutes his collected fares with cash. Simple.

      Now the reduction in collected surcharges demonstrates demand reduction to the cab company. And if they want to win the collections battle, they need to adjust their tactics so it is mutually beneficial for the driver and his fare. Or, just give up on the surcharge all together.

      On the other hand, if the driver only has one fare in 100 that stiffs him on the tip. He can get that off his chest by screaming at the fare, burning his image into his brain, and never letting him grace his cab again. It really is all about economics.

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  2. Jeff says:

    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.

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    • Mike B says:

      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.

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      • Jeff says:

        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.

        Hot debate. What do you think? Thumb up 15 Thumb down 11
    • Bryan Larsen says:

      That’s kind of the point. They don’t want your business. If you pay for a $2 bagel with a credit card, they’d lose money on the transaction.

      I really hope that more stores start offering a cash discount now that the DOJ has made that possible. It’s in both my interest and the store’s interest to offer a 3-5% cash discount for large purchases or a 50 cent discount for small ones.

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      • Jeff says:

        Fair enough. But when mom-and-pop stores complain about chains killing their business, they need to look at their own customer-unfriendly practices first.

        I doubt places are going to start offering a cash discount. It’s not in the store’s interest at all to offer a discount if cash payers are used to paying the same as everyone else.

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      • Abigail says:

        In the Netherlands, I can pay everywhere with my ATM card. The transaction costs for the seller are measured in cents, which makes that shops actually promote paying with ‘plastic’, even for tiny amounts, as that’s cheaper for them than handling the cash. This is a win-win situation: consumers need less cash, merchands have less costs for handling cash, and banks win as well, as they also have to deal less with cash.

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      • Mike B says:

        Ha, cash discount, what a cute kid. Nothing is ever a “discount”. It’s either an “I’m pocketing the sales tax discount” or some sort of bait and switch because they know that nobody would ever carry around the amount of cash needed for the purchase and the price* is just to get you in the store. Hey, handling cash costs money to in the form of time, security expenses and increased accounting controls. Of course because so few people use cash any more stores can use it as a loophole to jack up their prices on 95% of their customers.

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      • Jesse says:

        A cash discount, where you pay less than the advertised price if you use cash, has always been allowed. What the DOJ settlement made possible is a credit card surcharge, where you pay more than the advertised price if you use plastic.

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    • Des says:

      I disagree with your statement that you have a “right” to pay in any manner that is convenient for you. Paying with plastic offers you convenience and protections, and you should pay for those privileges. When there is no charge for card (or discount for cash) the cash-paying customers are effective subsidizing the card-paying ones. Merchants have to charge higher prices to account for the transactions fees they pay, and that additional cost should be borne by the people receiving the benefits of plastic, not by everyone.

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      • Paul M. says:

        I don’t know about you, but I certainly pay, explicitly and implicitly, to use my card. Annual card fees are obvious for non-bank connected cards, but even my bank requires a minimum balance to avoid card usage fees. I have paid to use my card and if anyone accepts my card, they have arranged to compensate the credit agency facilitating their transactions. Tacking on an absolutely exorbitant fee, from the company I am paying no less, is just a way of hiding the price from the consumer. The whole situation just boils down into the cab company deliberately abusing information asymmetry (Tourists aren’t familiar with Nevada law allowing a $3 charge on cab fares when you use a card instead of cash).

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  3. Mary says:

    pay cash – and tip the driver -

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    • Mike B says:

      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.

      Hot debate. What do you think? Thumb up 11 Thumb down 9
      • James says:

        Who carries cash any more? A whole lot of people, that’s who. Maybe some of you who’ve lived all your lives on the upper rungs of the economy can get away with not carrying cash. Maybe you’ve even come to think of it as normal, but that’s just a reflection of your own cultural isolation.

        Indeed, even on my own current fairly high rung, the only reason I don’t pay cash for a lot of in-person transactions is that I have a cash-back rewards card.

        Hot debate. What do you think? Thumb up 13 Thumb down 10
      • John Didier says:

        LOL @ “who carries cash any more”

        The story took place in Las Vegas. Vegas, baby, Vegas! EVERYBODY CARRYS CASH.

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  4. Mike B says:

    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.

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    • RJ Roy says:

      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.

      Hot debate. What do you think? Thumb up 12 Thumb down 8
      • Norcross says:

        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.

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      • Mike B says:

        The problem is that with optional yet expected tipping in North America, tipping is no longer a reward for good service, but simply a mechanism to punish bad service. Now ask yourself, what is the better way to motivate someone, positive or negative reinforcement? I am fairly certain that in the majority of situations positive reinforcement will get better results, ie it is better to provide extra rewards for good service than punishments for bad service.

        When exercising your ability to punish under the current system, the server is less likely fault their own actions, due to the Lake Wobegon effect among others, and instead blame you for being “cheap” or “unreasonable”. This can frequently result in retaliation, if not at the current interaction, then at subsequent ones. When the conditions for retaliation are easy (adding extra ingredients to a prepared food item) and detection is hard (can you really tell when someone has sneezed in your soup?) then such retaliation becomes likely. Moreover you could simply be refused service the next time or given intentionally bad service if you are going to be assumed to not tip in the future. The result is that a decision to punish via withholding a tip will have to be in conjunction with a decision to never partake in that particular service again or in any way rely on the persons providing it to assist you.

        Moreover when the social convention is to tip by default, it becomes psychologically difficult to punish through withholding a tip. However when a tip is seen as an optional extra only to be given in exceptional circumstances, the decision to tip can make both the tipper and tipee feel good about themselves.

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      • Fitty Stim says:

        Incorrect. In western Europe, employees are paid “living wages” – in other words, they make $20 /hour.

        Any tip (and people do tip) is usually just rounding up the bill to the nearest even amount. In any event, the tip goes directly into the pocket of the person in question an no tax is ever applied to this amount.

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    • CMITCH says:

      Exactly. Another downside to mandatory tipping is that it provides incentive for drivers, waiters, etc. to provide faster and/or better service to those who appear wealthy. This undoubtedly leads to some sort of discrimination.

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  5. JohnnyPeps says:

    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?

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  6. Clare says:

    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.

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    • Jeff says:

      …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.

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      • Dave says:

        It would be interesting to see whether the card itself encourages larger tips, or whether people who carry cash generally tip less. I could see both being true….

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  7. Cor Aquilonis says:

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    • Mike B says:

      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.

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      • Dave says:

        I think there could be good reasons for having a system with an expected tip. People might be comparing to mandatory tips in Europe, but after living in Europe for 6 years I can definitely say that the average server in America treats me better than the average server in England, France, and Germany. There are DEFINITELY confounding variables here, but I don’t see anything wrong with the tip system. I like being able to tip higher/lower based on my experience.

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  8. Eric M. Jones. says:

    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.

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    • Mike B says:

      What constitutes “good service”? In North America the threshold for giving a tip is almost always “not bad service”. Giving someone a tip for simply doing their job defeats the whole purpose behind a tip. If I on the other hand need to get to the airport to catch my flight and the driver goes above and beyond to get me there, then that driver is worthy of a tip. My experience in cabs is that most drivers will do whatever they can to milk the meter including taking round about routes or drawling to get stuck at lights to build up the “stopped or slow moving traffic” charges.

      Thanks, but no thanks. I’d rather walk.

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    • Jim says:

      To play devil’s advocate here why should I tip someone for doing their job? This can devolve into an argument about living wages and businesses no paying their employees enough but when you get right down to it when I have a pizza delivered there is typically a delivery charge and I’m supposed to tip a driver who is already being paid to deliver that pizza. There is an odd expectation that I should provide additional payment above the negotiated price for the good/service that was provided.

      I just think that it is plain odd that tipping is not a way of recognizing exceptional service and you can catch serious flak for leaving a low tip even with terrible service (the argument usually being that the establishment forces pooled tips so you’re not just hurting the one person). I know every former waiter on here will thumbs down me and tell me that if I don’t want to tip then don’t eat out and to that I say you should try and unionize for a real living wage.

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