Revisiting User Fees in Challenging Fiscal Times

The findings of the International City/County Management Associations 2009 State of the Profession Survey (covering 2,214 cities and counties) demonstrate widespread user fee interest. Among various fiscal strategies, 46 percent of local agencies surveyed reported an increase in user fees, while 23 percent added new fees. With such broad-based activity, the advantages and disadvantages of user fees warrant reexamination as public managers wrestle with wavering revenues.

Appropriate user fees may assist in shaping a more sustainable fiscal future. While certainly no panacea, they facilitate economic, equity, accountability, public interest, choice, and informational objectives. However, they also may introduce inequities and present a host of troublesome hurdles.

User Fees and Equity

Governmental entities require revenues, including equitable user fees, to provide services. User fees assess costs on voluntarily purchased, specific services. Such services are beyond those enjoyed by the general public. They reflect individual preferences and relative affordability compared to the services available to the general public and paid for through general revenues. The equity intent is that the special service beneficiary pays in proportion to the benefit received.

User fees, according to John Mikesells book Fiscal Administration: Analysis and Applications for the Public Sector, require two necessary conditions: benefits separability and chargeability. Separability refers to an efficient method to segregate or deny services to nonpayers. Chargeability means there is an effective way to establish and collect an appropriate user cost.

These conditions guard from the subsidization of a benefit identified with a particular individual rather than the general publica key issue being whether individual beneficial use can be distinguished from general use. Unsurprisingly, because of the prevalence of economic self-interest, all levels of government struggle with distinguishing which services are individually specific and call for an equitable user fee.

User fees may have inequitable effects and should not be deployed merely to cover other faltering revenues in tumultuous times. They do not provide simple solutions to financial difficulties or easy bandages to help heal wounds. They must engage elected officials, practitioners, and the public in fiscal soul searching regarding strategies to sustain accessible services.

Federal User Fees

The U.S. Office of Management and Budget (OMB) Circular A-25 specifies a general national user fee policy. It covers activities subject to user fees, as well as how to set and implement fees. It also addresses transactions that result in specific benefits above those received by the general public where no other federal legislation is controlling. General objectives are threefold:

1. guarantee that federal services to specific recipients are self-sustaining
2. ensure full-cost recovery through user fees for special benefits
3. permit private enterprise to compete with the federal government for comparable services where appropriate.

Federal policy restricts user fees, prohibiting fees when a specific beneficiary is unclear and the benefit accrues broadly to the general public. User fees must recover the full service cost. However, exceptions are made:

• courtesy exemptions to foreign governments and international organizations
• collection exemptions where recovery cost imposes extraordinary expenses
• exceptions based on special conditions formally reviewed by OMB.

OMB Circular A-25 promotes user fees encourages the removal of restraints on user fees, and makes federal agencies accountable for establishing them. It requires biennial reviews for fee adjustments and new fees. Further, it mandates that federal legislative proposals with special benefits must consider imposition of user fees.

Beyond general user fee policy, Congress often specifies user fee provisions statutorily. This may be in terms of agency authorizing or appropriations legislation. Sometimes the government uses policy discretion to underprice a fee or exempt a fee altogether to encourage publicly beneficial behavior. Examples include

• setting a U.S. Food and Drug Administration prescription drug review fee to encourage new development
• exempting low-income taxpayers from an application fee under the U.S. Internal Revenue Services Offer in Compromise Program to promote accessibility and participation.

Fees may recognize that service costs may vary among diverse users. A fee may be user-specific or reflect a system-wide average. The U.S. Governmental Accountability Office reports that the federal government manages the trade-offs between advantages and disadvantages. Legislators may consider the purpose, the fee level in comparison to other user costs, and the cost variance between users. Occasionally, Congress provides fee exemptions, waivers, and caps to advance policy interests.

State and Local Government User Fees

State laws provide discretion to state and local governments in establishing user fees. Such fees are collected for engagement in certain activities and for regulatory purposes. The fee amount is linked to the service cost. Sometimes, the payment may not relate directly to the costs connected with a specific beneficiary, but is more loosely associated with a discrete group of beneficiaries.

The fee signals that the individual beneficiary or group beneficiaries receive something beyond those services normally available to the general public and covered by taxes. Using California as an example, the state provides discretion to cities and counties to impose fees under conditions fairly similar to the federal governments policy guidelines:

• fees must not exceed the service cost
• fees must offset the service cost and not be used for general revenue purposes
• fees may include overhead and indirect costs proportionate to the services share of these costs.

Specific service beneficiaries are not always clear, however. Some services have a combination of mixed general and specific service characteristics. Consequently, government officials wrangle over who benefits, how much they benefit, and how to finance the service. To simplify, general and specific services may be portrayed on a public financing continuum with four gradations. Figure 1 illustrates such a continuum, with the character of the service associated with financing vehicles.

Categorizing and Relating Services to Financing

Public agencies must categorize services and relate them to a means of financing. Understanding the extremes of the financing continuum (Figure 1) comes most readily. On the one side, general services require general revenue support (mandated governmental levies not associated with individual services). A public agency does not deny anyone from a general service. Moreover, one persons service consumption does not compete with another persons consumption.

For instance, police service covers law enforcement for a jurisdiction. The entire community demands and receives ongoing protection even though a particular crime may result in only one victim in the community. Similarly, general public safety for the community does not compete with public safety provided for a particular individual.

On the other side, the term specific services apply to those that exhibit a market character. For example, local government utilities and waste disposal represent services provided by some public agencies to individuals. These services fall to user fees because of the specific personal benefit link. Additionally, the individual beneficiaries have the ability to influence their specific service consumption. They can decrease use to lower their fees or increase use if they are willing to pay for more.

Mixed services comprise the most controversial area of the financing continuum. Typically, public agencies supply many services that are not pure from a general versus specific services viewpoint. This reflects other values competing with efficiency, like social equity. This often results in some mix of taxes and user fees to cover the cost of particular services. General revenue subsidies run the gamut from heavy to light subsidies. This is especially common with the local governments in which elected officials thrash out public financing policy judgments through contentious hearings. Often, this results in certain services being partially subsidized through public policy rationales.

User fees are modeled after private-sector pricing in which consumers pay for their specific service preferences. They are not intended for general services because it would be either undesirable or too difficult to exclude nonpayers. Author D.G. Duff observes in his article Benefit Taxes and User Fees in Theory and Practice that user fees may be unsuitable for services distributed according to right, need or merit. For example, activities involving public education, public safety, social services, and indigent health issues are considered unsuitable for user fees.

User fees require analysis from multiple viewpoints and ongoing management. From an economic theory perspective, resource efficiency occurs to the extent that the price of a public service reflects the associated costs. The Public Finance Quarterly article The Revenue Potential of User Charges in Municipal Finance reports that user fees that do not fully capture associated costs lead to inefficiencies, cross-subsidization, and over expenditure.

Elected officials and practitioners, ideally with citizen input, seek to assign where various services fall on the financing continuum. Once assigned, elected officials retain accountability to ensure that user fees are thoughtfully constructed, equitably enforced, and respond to operational changes made in the public interest. They must make modifications as needed to facilitate the many benefits of user fees while minimizing any disadvantages.

For example, many local governments find that community swimming pool fees have difficulty covering operational costs. Moreover, such fees may effectively exclude poor families or seniors on fixed incomes. This could preclude the most likely users and deny segments of the community an attractive recreational outlet.

In the public interest, the city council may choose to subsidize the program heavily, waive fees for certain user groupssuch as children under the age of 16 and seniors over 65 years of ageor make pools available for free. Through monitoring, the council may find some families treat a free pool as free child care, leaving children unattended (except by the lifeguard) for several hours. This may result in distracting or unruly safety conditions and deter other community residents from enjoying the pool. The public interest may call for enactment of rules requiring adult supervision, limiting hours, or offering a fee-based or free child care service for extended pool visits.

Advantages of User Fees

User fees contribute several advantages to public financing.

Payments directly register the service demand of those who benefit.

Measuring service demand while collecting offsetting revenue to cover those provided addresses basic economic production questions. This improves allocative efficiency in as much as citizens express their service preferences. In turn, the public agency may increase efficiency by shifting correspondingly to meet service demands by allocating the necessary resources.

Conversely, Edward J. Bierhanzl and Paul B. Downing advise in an Atlantic Economic Journal article that disengaging the consumption of specific services from the direct payment for them provides incentives for over-consumption as well as for overproduction. For example, because the general taxes that citizens pay lack a direct linkage to the use of services, the price to obtain additional units becomes inconsequential. This may result in increased demand from citizens not required to cover the marginal costs of additional benefits.

User fees may improve finance equity for certain services.

This possibility exists where they replace a general tax subsidy for benefits received only by specific individuals. This enhances fairness by saddling the specific service beneficiaries with their proportionate cost through user fees. For instance, general taxes may support street lighting throughout a community. Establishing several street lighting districts may replace the need for general taxes. Instead, the districts could have customized rates tailored to street lighting service by district. These districts, over time, may chose to increase or to decrease street lighting with a corresponding change to their respective rates structures. This correlates direct benefits with proportionate charges.

Linking the supply of certain public services with production costs facilitates more rational political decisions and accountability.

User fees provide service price information and capture service cost recovery. This neutralizes the net impact of the specific service from the aggregate cost of government. In other words, if there is no service request, no user fee is collected. With a service request, an appropriate full-cost user fee negates the incremental, marginal cost impact to the public. This linkage promotes accountability when such revenue must offset only the service from which the revenue resulted.

Governmental authority to set a fee does not limit the fee to only offsetting service costs.

With a finding of a public interest rationale, agencies lower or cancel existing fees to influence citizen behavior. Economically struggling inner city retailers may persuade a city council to replace metered parking with free parking to entice shoppers. Public financed museums may enrich a community culturally and cultivate long-term aficionados by waiving admission fees for children and offering free days.

Mass transit fares may be heavily subsidized or suspended to promote ridership. In turn, parking pressure may be alleviated, congested eased, and air quality improved. User fees may ration services to those most willing to pay as well as induce citizens to sample or to make greater use of public services through waivers and reductions.

User fees motivate citizens and public agencies to explore service choices.

For instance, a citizen can choose to do without a service to avoid costs. User fees raise resistance regarding service appetites. Given disposable income limitations and economic choice, is an individual ready to exchange resources for the desired service? Is the benefit worth it?

From a governance perspective, these questions activate the equity functions of a user fee. They protect the public from the subsidization expense of the specific benefits accruing only to an individual. They self-regulate, or deter, some from making a demand for a government service that benefits only the requestor.

This curtails governmental costs. Indeed, Bierhanzl and Downing, found that greater reliance on user fees results in lower government expenditures. Concurrently, resistance to user fees sometimes motivates policymakers to choose to drive costs down by reevaluating public service delivery modes, including outsourcing, privatization, and public-private partnerships. Hence, user fees represent a self-regulating, moderating device that motivates choices and curbs the total volume of governmental services and related expenditures.

Accurate user fees inform the public about the value of a governmental service.

They clarify what public services cost. This reduces demand by connecting service consumption knowledge and payment. Without the connection between service consumption and user fees, little motivation exists for citizens to consume efficiently. User fees remedy this gap by

• answering economic production questions while improving allocative efficiency
• enhancing finance equity for some services
• facilitating rational political decisions and accountability
• providing a means to influence public interest citizen behavior
• motivating exploration of choices by citizens and public agencies
• informing citizens about the value of governmental services.

Disadvantages of User Fees

User fees generate disadvantages also. Regardless of their benefits, user fees face substantive hurdles. Some of the more troublesome include

• determining which public services seem sensible to finance through user fees
• calculating the correct user fees
• countering the inequitable effects of user fees vigilantly wherever they occur
• establishing the net benefit resulting from changing financing modes
• evaluating the political feasibility of executing a change.

On the one hand, non-existent and under-priced user fees subsidize individual beneficiaries at the expense of the general taxpayers. On the other hand, inaccurate overpriced user fees subsidize the general taxpayers at the expense of individual beneficiaries.

Despite limitations, effective fee structures enhance the efficiency effects and other advantages of user fees. However, Bierhanzl and Downing stress that the information provided by even an incorrectly set user fee restores the consumption-payment link and restrains individual service demand.

User Fees Are No Panacea

In reexamining user fees, public agencies should not view them as a panacea. Indeed, Mikesell lists several limitations to user fees. First, they do not substitute general taxes since many public services are shared by the general public. Second, some services may exclude low income and disadvantaged individuals if they are only provided through user fees. In this instance, a user fee may deny an essential service or create an inequitable effect. Next, some user fees pose expensive collection costs. For example, mixed goods (those exhibiting a combination of general and specific characteristics) may lend themselves to some level of user fees.

However, the development of the charging mechanism and the costs for operating and monitoring it may exceed the projected return. In addition, political and equity issues may arise when benefit recipients feel they have already paid for certain services through general taxes. Finally, denying services to those not paying the fee can be politically unpopular. The import of these disadvantages lies in informing and sharpening the analysis in constructing and applying prudent user fees.

Revisiting User Fees

Public managers have been encouraged to leverage change through market-oriented mechanisms. Such encouragement foresees that government will never outrun demand if it only focuses on supplying services. Public agencies must determine what market mechanisms contribute to managing service demand.

User-fee design involves trade-offs among the advantages and disadvantages arising from establishing and fine-tuning these instruments. Appropriately targeted and accurately designed user fees offer compelling advantages. They facilitate economic, equity, accountability, public interest, choice, and informational objectives. Duff contends that these advantages, when conveyed to voters, can be made politically acceptable.

At the same time, public managers should not hastily pursue user fees without carefully considering their problematic nature. It is tough to determine which services call for user fees and calculate them. Inequitable effects may be introduced, the net benefit may be uncertain, and citizen resistance may stymie deployment politically. Certainly, the arguments here catapult user fees to the front trenches in carefully considering options for coping with challenging fiscal times. A more comprehensive understanding of user fees aids public managers in analyzing when, where, and how to employ or not to employ them.