Public Sector Economics
Lecture Fourteen: Fees and Charges As Revenue Sources for Government
The terms "user charges," "fees," "current charges," and "user fees" are used interchangeably by most economists.
Fee vs. Tax: Remember, a tax is involuntary, whereas a fee is paid as a result of a voluntary purchase of services by the payer. More like the market.
A tax normally produces general revenue that can be used for any public purpose, whereas revenue from a fee is supposed to be used to cover the cost of providing a specific service.
There is a continuum from a pure tax, not linked to a particular service and just providing general revenue, to a pure fee in which payment is made for services rendered.
Legal Distinction Between Taxes and Fees/Charges
In some instances, there is very little practical difference between a tax and a fee.
Legal distinctions between taxes and fees are very important, however, because many states have constitutional or statutory restrictions on the ability of local governments to levy taxes--restrictions that usually do not apply to fees.
Also, tax limitations on state and local governments sometimes require extraordinary majorities or otherwise restrict taxes, but may not impose similar restrictions on fees.
Franchise Fees: are payment for the privilege of being the exclusive provider of a service for a given area. Used heavily by local governments, these fees determine which cable service or electricity supplier will serve a given area. More later on this.
These are being eroded by deregulation and increased competition in formerly monopolistic industries (due to legal barriers) such as electricity distribution and telecommunications.
These fees can be highly general (equivalent to a business license fee) to the highly specific (franchises for service providers or concessions at state parks).
User Charges (or fees): Charges imposed for providing current services or for the sale of products in connection with general government activities.
Common examples include tuition at state colleges and universities, athletic and other extracurricular activity fees at public elementary and secondary schools, highway tolls, public transportation charges, and parks and recreation charges.
User charges are the equivalent of the operating portion of the state budget, not the capital portion of the budget. In other words, user charges pay for current consumption of goods and services and do not include fees for capital costs.
Types of Fees and Charges
Three Categories:
1. Licenses and permits
Business licenses (primarily local)
Drivers' licenses
Marriage licenses
Hunting, fishing, camping and dog licenses
Building permits
Auto license/registration
Franchise fees (cable, electric, gas, etc.)
2. Fees for Service
Grazing fees
Landing fees (airports)
Park entry fees
Highway tolls
Solid waste collection and disposal fees
3. Government Enterprises
Postal service
Water and sewer
State liquor stores
Transit services (bus, subway, etc.)
Electric and gas utilities operated by state or local governments
Then there's the difficult to classify:
Law enforcement and fines
Impact fees
Equity Issues in Fees and Charges
What is equitable?
Equity might call for users of services to pay for them.
OR
But it can also imply that citizens should have access to public services regardless of ability to pay.
Fees and Charges More Popular Now: Budgetary pressures in the 1980s at all levels, changing philosophies about the role of government, and recognition of some efficiency values in requiring at least partial payment by at least some users have changed the way policy makers and citizens think about fees and charges for a wide range of public services.
Some equity issues might include:
1. Protecting the Poor With a Blanket Policy: One of the risks of using access for low-income households as a justification for any kind of blanket policy (eliminating sales tax on food or free tuition at public colleges) is that the revenue loss or expenditure demand can be excessive relative to the amount of the goods or services that actually get to the target low-income population.
2. Vouchers: A middle ground between free and unlimited access to protect the poor and ensure that users pay. Consist of some kind of coupon redeemable for goods and services. Education vouchers for example.
The drawback of using such a system, which provides subsidies for the poor but not the non-poor -- is the need to verify eligibility based on family income, size, assets, etc. However, once a system is in place for one service, it can easily be extended to others (if the system is a good one?)
3. Price Discrimination: Charging different prices to different people for the exact same good - taking cost into consideration (coupons, discounts); or charging the same price to everyone, but costs of providing the good or service is different to different people (salad bar).
Many goods and services are made available at reduced prices for senior citizens and students, for example. Businesses do this and so does the government. In the private sector, the rationale is obvious - there are different groups with different elasticities of demand - so different prices will broaden the markets and bring in more revenue.
In the public sector, the rationale for special treatment of elderly citizens, for example, in assessing fees for services is not as clear. Historically senior citizens have, on average, had lower incomes than the rest of the population, but poverty among the elderly has dropped dramatically in the last 30 years, and they are now less likely to be poor than younger families.
Perhaps then there is a public choice explanation: senior citizens have a greater tendency to vote and participate in public affairs.
Cross-Subsides (another form of price discrimination): Often used in public enterprises such as water, sewer, waste collection, and public transit. Different users are charged different prices per unit, or different flat rates, based on easily identified categories such as residential or commercial/industrial. Households are ensured access to public services at a subsidized rate, while higher charges for business users reduce the amount of tax financing that needs to be devoted to providing these basic services.
Or - everyone charged the same rate but it costs the government more or less to serve certain people.
With public transit and first class mail delivery - easy to serve areas are subsidizing others living in places that are more remote, less dense, or in come other way. more costly to serve.
Peak-Load Pricing: often practiced in the private sector (movie theatre), a related use of fees by the government in order to influence demand. Examples are congestion on government toll roads, where the toll is higher during certain times of the day.
Sometimes called "Congestion Pricing" -
Graph (subway):
Off-peak demand = Da, Peak or Rush Hour demand = Db.
The MC of serving an additional user during off peak hours is essentially zero - but once capacity is reached, MC increases sharply (for example - might have to add another subway car, or another run).
Assume: the subway is free. Then demand would be at Qo. The marginal benefit (MB) is not equal to marginal cost. Marginal benefit is below the MC of the government to provide the subway.
So - charge a positive price for the subway at peak hours - where marginal cost (of the government) = marginal benefit. Therefore, quantity demanded goes to Q1.
But some of these customers will switch to off-peak hours - so Da moves to Da2 - which makes better use of equipment.
Only when demand for a service by one user begins to limit the amount available to another or to create additional costs of provision is there any reason to charge a fee - so the theory goes.
Continuing with the congestion issue:
What about not just individual demand for a government provided good (use of the good) but also demand for it in the political process.
Example - a public or municipal park (from James Buchanan - "Individual Demand for Public Goods," in Public Finance in Democratic Process
Exclusion applies, at least to a degree, for most publicly supplied goods and services. After all -- goods are scarce!! Your use will effect my use.
This causes us to introduce two distinct demand elements:
1) the private demand for the good (in markets)
2) the private demand for the good (in political choice processes)
Example: a municipal park.
Will it matter if there is a user fee? Yes
Assume the park is built with collective taxes. Then a user fee of 25 cents is assessed for each visit to the park.
Assume:
The user fee is not a partial substitute for the tax price. It is in addition to it.
Graph: Individual Demand with and without a User Fee
D1 is the demand for the park services, as a collective good, on the assumption that these services are to be made available at zero user prices.
D2 is the same person’s demand with the 25 cent user fee.
But – this may not be universal. If the user fee decreases congestion, the demand might actually shift to the right with the user fee.
So the amount of the good demanded could move either way with the additional user fee (or stay the same).
Graph: Individual Demand when the decrease in congestion is of greater value than the user fee.
So a user fee may generate more total investment in public facilities with the charging of direct user fees than without. Public parks may be larger in municipalities that charge user prices than in those that do not.
Even if congestion is not an issue -- a user fee might change the perception of the quality of the park -- and more people would demand it.
What about if the size of the park is fixed. Would demand then come in the form of more use?
Could a user fee increase the use and congestion of a park? Would it depend on how much the user fee is and how much people disliked congestion?
If the user fee was very high, there might be less use. On the other hand, the high fee would keep people out, increasing the demand for the park by others.
So a user fee might end up shifting the use of the park -- especially a high user fee - based upon income levels.
The outcome really can’t be determined theoretically – must do an empirical experiment!! And, the experiment would have different outcomes with different individuals making the decisions.
4. Collecting From Nonresidents: A museum, park, or library fee will ensure that even people who do not pay local taxes but use the service will contribute to its cost. Fees are generally a better way to internalize these kinds of positive externalities, especially at the local level.
Sometimes the users live in the county while the service is provided by the city. County residents enjoy lower taxes while obtaining the benefits of the nearby city.
Tourism taxes are one mechanism for shifting the burden, but so are admission fees to state parks, tolls on state roads, and various kinds of local fees for tourism-related services.
Elasticity and Fees
Fees both reduce quantity demanded (in most cases) and generate public revenue. The mix of quantity change and revenue outcomes depends on the height of the fee and the price elasticity of demand.
If a fee is charged for a service with highly elastic demand, it will accomplish the goal of restricting the amount of people, but it will raise little revenue as people shift to substitutes.
What would you think are examples of each - elastic/inelastic:
parking?
recreation?
Efficiency Issues in Fees and Charges
Distorting Decisions: With taxation, there is a concern about taxes distorting decisions, which is not the case with fees.
In fact, fees are often intended to influence people's decisions about how much to use a particular service such as public parking, public transit, public recreation, or waste collection.
Taxation is concerned with burden; while fees are designed to ensure that the burden falls on the user who can rely on the usual decision-making rules; for instance, is the service worth the price? Much more like the market.
Fees and charges have five major purposes:
measuring and controlling demand
to implement the benefit principle (user pays)
to reduce negative externalities or increase positive externalities (fee to use the park to decrease externality of over-crowding, pollution fee or fee to use the library by an outsider to provide revenue for the library for locals)
to reduce the pressure on taxes where feasible
to capture monopoly profits (in the case of franchise fees or government enterprises)
With respect to the first four: Examples include street maintenance, waste collection, fire and police protection, recreation and parks, and, of course, education.
Since these examples induce positive externalities (if your neighbor has his waste removed, you benefit) -- if there is no fee and the marginal cost is zero, demand would be too high. With a fee that is too high though, demand would be too low. Would want to find the point where MC = MB (both private and social). Ideally, the fee would cover the private benefits and a tax (general funding) would cover the social benefits -- again, ideally!! How to measure???
With respect to franchise fees: All levels of government derive revenue from franchise fees, which are payments in exchange for a grant of exclusive privilege.
This comes from the old theory of natural monopoly. The idea is that "we" know that one large firm (due to economies of scale) is most efficient. What's the assumption here (derived from the model of perfect competition - which, of course, has no competition in it)!! Competition defined by the structure of the industry, no change, no process, no behavior in the model - no human action. Pretense of knowledge argument is a good criticism of this theory.
GRAPH - Natural Monopoly
Examples: cable TV, electricity, phone, public owned airports, etc.
Cable TV companies, for example, generally pay a negotiable franchise fee to counties or cities in exchange for the exclusive right to serve customers in a given area.
Franchise fees are an effort to capture some of the monopoly profits that result from the grant of an exclusive privilege to provide commercial services in a given area.
Pricing for Public Enterprises: Public enterprises are operations that are run separately from the general fund, with the accounts kept in an enterprise fund, which receives revenues and pays the costs of providing the service.
It would be nice if they attempted to set the price equal to where MR = MC (at least attempted!! - although even in the private sector this is often a very difficult thing to do) - but these are generally government granted monopolies, so they don't. This is why many are subsidized.
One strategy in pricing public enterprises is to charge a flat rate rather than a fee based on usage, or a combination of a flat fee and a per-unit fee.
Students on college campuses often find a transportation fee on their tuition bill, which covers part of the cost of shuttle buses. Students pay this fee regardless of whether they never use the shuttle bus or not. The marginal cost is zero -- which encourages students to ride it, thereby decreasing congestion and demand for on-campus parking, and saves the college the cost of collecting from each rider.
Fees and Charges as Growth Management Tools - Impact Fees
Local governments have increasingly begun to use fees to influence the pattern of growth in order to minimize the cost of servicing a growing population.
Established residents and local public officials often think that growth will tend to reduce their tax burdens through sharing the cost of public services. But this isn't necessarily the case.
Therefore, the impact fee (paid by the developer and often passed on to the final resident) is designed to:
decrease growth
make those who will use the additional public services pay for them
reduce the burden of additional taxes on current residents
Pros and Cons of Impact Fees
Proponents argue:
1. requires new development to pay its own way - existing residents should not have to pay
2. the fees actually allow development to occur that local government bodies and voters otherwise would not permit
3. impact fees are an important growth management tool that allows localities to direct growth to where infrastructure is underutilized and away from areas where infrastructure is inadequate to accommodate growth
4. impact fees allow localities to use a "pay as you go" financing arrangement for new projects that avoids using general obligation debt.
5. impact fees add certainty and specificity to the planning process because, unlike exactions negotiated with each individual project, impact fees are known in advance.
Opponents argue:
1. impact fees subsidize existing residents by paying for improvements that benefit all property owners. In the case of schools, for example, education provides statewide benefits that do not accrue only to specific property owners in a development.
2. impact fees provide a windfall gain to existing residents because by increasing the price of new homes they also increase the value of existing homes.
3. impact fees make housing more expensive and put homeownership out of the reach of lower- and moderate-income households (since developers pass the fees on to new homeowners in the price of new houses).
So Who Bears the Burden of Impact Fees?
An important consideration in state and local debates about the imposition of impact fees is the incidence of such fees--that is, who ultimately pays them?
1. Homebuyer -
2. Home Builder -
3. Landowner -
4. Combination of two or three -
Some Principles for the "Appropriate" Use of User Fees in State and Local Finance (You can agree or disagree):
Principles one through five address user fees and principles six and seven relate to property-related assessments and impact fees.
User charges may be appropriate when government is performing a service that narrowly benefits an individual taxpayer, or for certain government activities that compete directly with private sector provider (fee for health and fitness facilities).
User charges may be appropriate to provide market-based incentives to encourage or discourage the use of public resources (volume-based fees for water usage or solid waste disposal may encourage recycling and process changes that reduce solid waste volume).
Policymakers need to consider the impact on low- and moderate- income citizens of shifting reliance from broad-based taxes to user fees.
User charges may not be appropriate to fund services when states have a constitutional or statutory obligation to provide those services to all citizens.
User charges should cover the cost of the services provided. They should not be used to generate excess revenues that are diverted to unrelated programs or services.
Property-related assessments and impact fees may be appropriate to finance services tied to new development, but should not be used to subsidize new services for existing residents. In states where impact fees are deemed appropriate, state legislatures should adopt enabling legislation that governs the imposition of such charges.
Policymakers should be mindful of how property-related assessments and impact fees for new school construction are integrated within the state and local school construction program.