I attended a meeting today on proposed reforms for the Victorian taxi industry prepared by former ACCC guru Allen Fels with a major input by David Cousins. Opening the PDF version of the Fels Draft Report (here) at least gives you a helpful contents page to what is a long document. There is an executive summary, but it is avoids some core issues.
The taxi industry is a key part of our transport system. With environmental problems of congestion and pollution we should be encouraging less use of privately-owned vehicles, more use of public transport and, when the occasion demands it, increased use of taxis which provide a convenient point-to-point means of transport that avoids the fixed costs of car ownership.
The taxi industry in Victoria is in a bit of a mess and I fear this report, by avoiding a core difficult issue that has inhibited reform in the past, might not improve things. My view, moreover, is that, as a consequence, its recommendations at least as stated in the Draft Report are unlikely to be implemented.
There are several report recommendations that should be accepted by regulators and the industry alike – for example, increasing the maximum flagfall to encourage drivers to accept short trips and setting charges so that drivers do not have incentives to wait for hours at Melbourne airport while the rest of Melbourne is short of taxis. These are sensible reforms . So too are proposals to strengthen the peak-load pricing component of the fare regime by providing higher fares to drivers during peak travel times. With these reforms there are reduced prices for long-distance commutes and for off-peak travel.
Reforming the operations of the network providers – particularly CabCharge – is another efficiency-based reform that few could argue with although some type of regulatory solution, in addition to promoting competition, will be necessary in this sector. There are network externalities here that will reward size and provide the inevitable opportunity for exercising monopoly power but network providers should also charge competitively and strengthen the consumer service incentives of the industry. Services in this sector need to be rewarded for arranging matches that reduce the time taxis spend being underutilized and which promote ‘punishments’ (such as actually enforcing temporary bans from networks) for drivers who do not deliver an agreed to service. When you make a taxi booking you should be assured of service in some pre-defined time horizon.
Generally taxi fares should reflect costs not monopoly rents and these are obvious reforms. Short trips, with possible ‘no shows’, are expensive for drivers to provide and need to be remunerated appropriately.
But reforming the Victorian taxi industry, more generally, is just that. It is a reform. It is not establishing a new taxi industry on a new settlement on an island in the middle of an ocean somewhere. The taxi industry in Victoria exists and has a history. Attempts to reform its operations must account for this central fact.
And central to this central fact is that there are several thousand taxi licences out there in Victoria. The proposal is to make an unlimited supply of these licences available at $20,000 per annum and to sustain this nominal $20,000 charge indefinitely. This effectively pegs the value of a taxi licence at the present value of a stream of such costs in perpetuity that is $20,000/r where r is the interest cost of capital or the cost of borrowing to pay the recurring costs.
For r=5% the value of an existing licence is pegged at $400,000 which is 14% less than the current market value of $467,000 in April 2012. For r=7.5% (a more reasonable discount rate which just exceeds current home mortgage rates) an existing licence is valued at $266,000 implying a capital loss to current licence holders of $201,000. The Fel’s report itself sees the reforms it proposes as halving the value of a licence so he must have in mind a discount rate of about 20,000/233,500 = 8.6% which, in fact, seems a little high. It is noteworthy that these core issues of the effects of the reports proposals on the central issue of licence value receive so little explicit attention in the report. The final report on this industry should include a chapter that sets out all the effects of proposed reforms on licence values – it is an inconvenient issue but one which is pointless to attempt to duck.
My best guess is that the suggested reforms will come close to wiping out half the asset values of Victorian plate owners at reasonable interest rates and rates of inflation.
Not mincing words this is an expropriation of legitimately-held asset values that would be somewhat analogous to confiscating about half of the accumulated superannuation holdings of civil servants or politicians. The difference of course is that confiscating ‘owned’ assets generally does not leave the owner with a large debt. Those owner-drivers who have recently purchased a taxi licence could be left with a substantial debt on an asset whose value has been halved. It is interesting to imagine the response of banks and other creditors to this development since they would now presumably have less security for any loan they have advanced.
Another way of looking at the same issue is to recognize that a fee of $20,000 annually is effectively replacing the current assignment fee to drivers of about $30,000. This discount lies at the core of licence-owner complaints.
A further feature of this reform is the proposal that the value of licence rentals be set fixed in nominal terms at $20,000. Thus a burst of inflation of 20% over a few years would further erode licence values permanently by 20%. Longer-term licence values will inevitably converge towards zero. Moreover, the Fels report itself identifies the cost of running a taxi is around $20,000 per year at present and part of its reform package will make licence owners responsible for extra costs of ensuring driver safety and so on. Giving licence holders responsibility for meeting such costs further reduces licence values. If the amount a licence holder can retrieve is less than anticipated costs then, of course, its value is zero.
Currently licence owners and taxi drivers share revenues 50:50 from operating a taxi with the licence owner paying the operating and capital costs of the taxi. Under the Fel’s proposal this will drop to 60:40 in favor of the driver. This reform, in itself, will slice 20% of the value of the future income stream from owning a licence plate and, in itself, should reduce the value of a licence by 20% or by about $93,000.
Indeed this change in the revenue-sharing arrangement will mean that the proposed annual rental fee of $20,000 will have its net additional impact on the capital value of a taxi licence reduced by nearly half for discount rates of less than about 7.6%. Thus even without the licence reform this shift to a 60:40 split will cut the value of a licence by 20%. It is again, at core, an expropriation.
My own view is that drivers should not be levied with a fixed charge for using a taxi or some fixed share arrangement. It makes more sense to give them a reward that motivates economies in utilization and petrol consumption – the latter costs around $12,000 annually. Currently drivers have incentives to maximize sales and to engage in high levels of cruising because they do not pay petrol and other variable costs. There is the potential to restructure contracts here in a simple way that saves money for licence holders and which does not make drivers worse off. (The divergence in incentives here is presumably why drivers favour low farers for sales-maximization reasons and why licence owners seek higher prices that maximise the bottom-line).
This reduction in capital values consequent on the Fels reforms will be the thorn that limits their political acceptability. The natural policy response to reform the taxi industry is to accept culpability for past policy mistakes and to respect the integrity of investments in taxi licence plates that have been done legally and in good faith. This could be accommodated by the government buying back licences at their market value as governments around the country have done in other areas of the economy where efficiency-based reforms are sought: For example, with respect to fishing licences and water usage entitlements by irrigators. The distinction between the taxi issue and these other concerns is only that the inefficiencies that have been formerly addressed relate to excessive use of natural resources and an excessive number of usage rights rather than a perceived shortage as is the case with taxis.
A taxi licence buyback would be an excessively expensive operation given public sector obsessions with budget deficits but one that would facilitate the achievement of taxi industry efficiency objectives and leave current stakeholders in the industry not unfairly disadvantaged.
Has the Fel’s review considered the following possible reform package that involves reduced immediate public sector costs? If governments seek efficiency without a huge payout to current taxi licence holders they could compensate each owner for the immediate capital loss occurring as a consequence of not a $20,000 fixed price scheme forever (this is too low to avoid the need for drastic compensations) but rather a $30,000 fixed price scheme. It would then issue each plate owner with a security that would deliver to them a proportionate share of all of the revenues that would eventuate from licence sales. The plate owners would retain their licences but be compensated for the reduction in asset values that resulted from any additional licence sales. This supports the ownership rights of current plate owners and compensates them for at least some of the loss in value of these rights.
For example if licence values fell by $50,000 per plate this would be paid to existing licence holders immediately. In addition, these licence holders would receive a claim on a proportionate share of the future revenues received from licence sales at a fixed annual fee of $30,000 not $20,000. Because the fee is fixed in nominal terms it would asymptotically decline towards zero in real terms so that eventually free competition without effective licence charges would result. The difficulty is that, for real efficiency, the optimal value of a licence will be zero immediately so there will be pressure to cut licensing costs – this again would effectively expropriate existing licence holders. This proposal sacrifices some short-term efficiency gains but does deliver long-term efficiency and a much greater chance of being politically acceptable.
This scheme would mean that government would get no revenue at all from licence sales – it would all go to current plate holders – but the cost of the buyback would drop by 1-150,000/467,000 or by about 68%. It isn’t an ideal solution but provides increased fairness as well as some measure of efficiency. One additional advantage of committing to giving the money back to current licence holders – apart from fairness – is that a greedy State Treasury would have no incentives to jack up licence charges medium term to maximize revenue potential.
In the interests of objectivity I should state that in the past I have worked for the Victorian Taxi Association (VTA). I am not currently doing so. I had an earlier shot at these issues here.