USER CHARGING IN THE FEDERAL GOVERNMENT –
A Background Document
Treasury Board of Canada, Secretariat
Government of Canada
TABLE OF CONTENTS
Page
LIST OF BOXES AND FIGURES......
Acknowledgement......
1. Introduction......
Organization of the Paper......
The Changing Environment......
2. Why Charge for Public Services?......
Economic rationale......
Political and managerial rationale......
What Services Should be Charged for?......
- Characteristics of publicly provided goods and services......
- Market structure......
- Taxonomy......
Managerial and Administrative Implications......
- Moving to a more market-oriented approach......
- Should specific revenues and expenditures be linked?......
The importance of fairness......
3. Designing User Charges......
Cost-based Charges......
Pricing "Rents" — A Market-value Approach......
Pricing Externalities......
The Costs and Process of Pricing......
4. Conclusion......
Political Realities......
Concluding Remarks......
Appendix A......
Guidelines for User Charging in the Public Sector......
Appendix B......
A Special Note on Earmarking......
Selected References......
LIST OF BOXES AND FIGURES
Page
Boxes:
1.Examples of Federal User Charges......
2.The "Publicness" of Federal Services......
3.Estimating Demand: Contingent Valuation......
Figure:
A1.Guidelines for Public Sector Managers on Setting Prices......
Acknowledgement
Richard M. Bird and Thomas Tsiopoulos of the International Centre for Tax Studies at the University of Toronto prepared this paper, in consultation with staff of Treasury Board of Canada, Secretariat. This paper sets out the views of prominent practitioners in the fields of economics and public finance on issues such as when user fees are appropriate; what features distinguish public and private goods; and what approaches departments should follow in establishing user fees. In addition, this paper should contribute to a better understanding of user fees and foster better communication between departments and their paying clients.
User Charging in the Federal Government
1.Introduction
This paper has two principal purposes. The first is to present the rationale, from an economic and managerial perspective, for user charges. The second is to set out general guidelines on how to determine where charges should be imposed, and what those charges should be. The primary aim of the paper is to improve understanding of the rationale for this policy, among the public and government officials.
Organization of the Paper
Following the Introduction, Section 2 sets out the economic, policy, and management rationales for introducing user charges to the federal public sector. This section indicates when charges are appropriate and when they are not, and it outlines the principal benefits of imposing correctly designed user charges. A variety of possibilities for financing public sector activity, from general taxation to user charges, are examined, and the circumstances under which each method of financing is most appropriate are described. The characteristics of the goods or services provided are stressed — for example, a service's inherent "publicness" or its mandatory nature. Finally, the managerial and administrative implications of adopting user charges are discussed.
Section 3 sets out the key principles for determining appropriate charges for different public sector activities, taking into account the factors mentioned in Section 2. It also covers "cost" (in terms of resource use and distribution) of implementing user charges. Attention is paid to the potential benefits of an appropriate charging policy, and to difficulties that may be encountered in determining and implementing appropriate charges for various types of activities. A range of approaches for determining charges, from strict marginal-cost pricing to more market value-oriented strategies, are discussed.
Finally, the importance of establishing an adequate process for determining and reviewing charges is stressed. Charging policies must be appropriate to be accepted by principal stakeholders and the public at large.
Section 4 offers some concluding remarks. Appendix A provides a brief set of "guidelines" for establishing user charges. Appendix B provides additional information on earmarking.
The Changing Environment
Over the last 50 years, the scale and scope of government activity in Canada has increased. Until the mid-1970s, the growth in expenditure at the federal level was financed relatively painlessly by an increasing stream of tax revenues produced by economic expansion. As economic growth slowed, expenditure growth was financed partly by deficits. More recently, federal expenditure growth has not only halted but has been reversed. In the current economic and fiscal environment there is little chance that any significant new expenditures can be financed out of general tax revenues. Indeed, there is, and will likely continue to be, increasing pressure to reduce not only deficits and expenditures but also taxation. In these circumstances, it is important to carefully examine the rationale and structure of all federal expenditures and revenues, including user charge policy.
There is nothing new about user charges at the federal level. They have existed for many years; see Box 1. What is new, however, is the need to ensure--more than ever before--that the right prices are charged for the right activity. This paper is intended to contribute to this goal by making the principles underlying user charges more transparent, more clearly articulated, and better understood. To accomplish this task, three challenges must be met.
The first challenge arises from the perception that, no matter how rationally they are designed, they are "just another tax." Overcoming this can be difficult when: (1) client groups are strongly organized; (2) they can use such general "public policy" arguments as the alleged adverse effects of charges on income distribution; or (3) there appear to be no compensating benefits to offset the new charges. A critical problem in user charge policy is thus how to introduce and communicate such charges to the public at large and especially to those most directly affected. This question is discussed further in sections 3 and 4 of this paper.
The second challenge to user charges is managerial interest and attitude. At first glance, it may not seem to be in the managerial interest of those responsible for providing a particular public sector service to impose economically efficient charges. If by doing so, they arouse opposition in their clients, this makes their own lives more difficult. If charges also discourage some users of the service, managers will lose clients and have their budgets reduced. At a deeper level, however, proper user charging can and should form part of a new managerial approach, delivering public services efficiently and effectively in today's changed economic and fiscal environment.
Client responses to user charges can provide vital information to public sector managers as to what they should be doing and how. A new dynamic of "client responsive" management may thus be created, particularly where agency budgets are made revenue dependent in some way. This point is discussed further in Section 2.
The third challenge, and the main subject of the paper, is the technical task of determining what user charges should be imposed. Section 2 discusses in broad terms the public sector activities that should be financed in whole or in part by user charges. Section 3 discusses how to determine user charges for different types of services, and Appendix A provides general guidelines for setting the user charges suggested in this paper. It should be noted that each specific public sector activity requires careful and detailed analysis to determine whether charges should be imposed and, if so, what those charges should be.
BOX 1
Examples of Federal User Charges
National park entrance
Race track supervision
Grain inspection
Citizenship registration
Fishing licenses
Broadcasting licenses
Specific statistical services
Aircraft landing
Terminal rentals and concessions
Contract policing
Passports
Scientific services (mapping, remote sensing)
Small business loan administration
Import/export permits
Publications
2.Why Charge for Public Services?
To some Canadians, the idea of charging for public services seems ridiculous. When an activity is carried out by the public sector, presumably Canadians have indicated through the political system that they are not willing to rely on the market for this service. If something could and should be priced as if it were provided by the private sector, presumably it would be so provided. If it is not, there must be a good reason for the public sector to be providing it. In the absence of persuasive argument to the contrary, attempts to impose charges or to raise prices for services provided below cost are likely to be viewed as little more than "revenue grabs."
Such views may be widespread, but they are also misconceived. The federal government is engaged in a vast array of programs. Some of these programs cannot and should not be "priced." But "prices" are already charged for many federal services — see Box 1 for examples. For many others there are good reasons why they should be priced. Moreover, there are equally good reasons why some charges already in place should be significantly changed.
The basic principle underlying this paper is the precise opposite of the common view cited above. It is that, whenever possible and desirable, public services should be charged for rather than given away. Section 3 sets out how public prices may be determined. The balance of the present section discusses why and when such prices should be charged.
Economic rationale
The primary economic reason for user charges being levied on the direct recipients of public services is to improve the efficiency with which Canadians in general and federal public agencies in particular make use of the resources they have available. Making efficient use of scarce public resources is especially important now, when general fund financing is decreasingly available.
But while user charges may be advocated — or attacked — as a potential additional source of revenue, their main economic rationale is not to produce revenue. Rather, it is to promote economic efficiency by providing information to public sector suppliers on how much clients are actually willing to pay for particular services and by ensuring that the public sector supply is valued at least at (marginal) cost by citizens. In this important sense, the objective of effective public pricing policy is not so much recovering costs as it is improving the efficiency with which government uses its resources.
Efficient does not necessarily mean “unfair”. User charges may, however, be perceived as having unfair effects on lower income Canadians. The truth of this perception can only be determined by a case-by-case review, but there is some evidence that it is incorrect. The reality and perception of fairness will contribute to the public’s appreciation of the equity and efficiency effects of the government’s user charges
Political and managerial rationale
Accountability is the key to improved public sector performance, and information is the key to accountability. Efficiency requires that scarce resources be put to their best possible use. One of the most important sources of information for determining efficiency comes from prices. Proper user charges can significantly improve accountability by making clients aware of the costs of the services they receive and managers aware of the benefits and costs of the services they provide.
To gain their support for efficient government, the various user groups need to know what is done, how well it is done, how much it costs, and who pays for it. If users are asked to pay, they should have a say in what programs are delivered, and how. If they are dissatisfied, they will press for greater efficiency and cost effectiveness, explicitly through protests and public actions and implicitly by reducing their use of the services in question. Ideally, imposing user charges will show the real value of public sector services. It will create a new dynamic — a "market test" — which forces managers to respond more directly to clients and to allocate their resources as efficiently as possible.
What Services Should be Charged for?
Determining the proper domain and design for user charges is a challenging task. Certain important public sector activities cannot and should not be financed in this manner. Others may be. Still others should be. The characteristics of the activities in question and the nature of the "market" for the service will help determine the appropriate domain. To some extent, the continuum between purely "public" goods and purely "private" goods is matched by a similar one between general fund financing by taxes on one hand and user charges on the other. These two aspects — the nature of services and the choice of financing method — are discussed next. In addition, other dimensions of the pricing question that do not fit neatly into this framework are also considered.
- Characteristics of publicly provided goods and services
The federal government provides an enormous variety of goods and services to Canadians. Some of these services should be priced, some should not, and many fall between the two extremes. Where on this continuum particular federal activities fall depends on the characteristics of the services (or goods) provided. At least six distinct characteristics may be relevant in this respect:
[1]“Rivalness.” Purely public goods and services are "non-rival" in consumption. That is, one person can consume a particular service without affecting anyone else’s level of consumption. Furthermore, the marginal cost of allowing additional persons to consume non-rival goods and services is zero. (For example, an additional spectator at a fireworks display does not reduce the enjoyment of others watching the show.) A purely private good or service is rival in consumption. (For example, if one person eats an apple, no one else can eat that apple.) Broadly, the more "rival" an activity, the more desirable (in efficiency terms) it is to charge for it.
One of the main economic rationales for government is to provide citizens with the public goods that they wish, and it is not surprising that many federal activities demonstrate marked "non-rival" characteristics. Box 2 shows federal activities at many points along a continuum that includes goods and services that are purely public at one end and purely private at the other.
[2]Excludability. Purely public goods and services are non-excludable. That is, a person cannot easily be prevented from using the good or service without paying for it. Excludability determines whether pricing is feasible.
[3]Economies of scale and [4] Lumpiness/sunkenness of costs. These two characteristics refer to the production process. They are particularly relevant to federal programs that require significant capital investment in infrastructure.
A traditional argument for public provision of certain services in Canada has been the sheer size of the initial investment required. With unit costs decreasing as scale increases, efficient private sector provision of such services can be difficult to achieve, because efficient pricing in decreasing-cost industries will not recover full costs.
Technology may alter some of these historical arguments. For example, it is now technically possible to impose efficient road pricing through "smart cards" and similar electronic means.
BOX 2
The "Publicness" of Federal Services
This list illustrates some federal government activities on a continuum from "purely" public goods to essentially private goods, arranged roughly in decreasing order of "publicness":
Defence of the nation
International assistance
Transfers to persons
Income redistribution
Tax collection
Disease control
Citizenship and immigration
Control over the electromagnetic spectrum
Customs services
Weights and measures
Food inspection
Bank inspection
Loan guarantees
Fishing licenses
Entrance to national parks
Applied research activities
Specialized publications
Computer services
Housing rentals
Generally speaking, items towards the bottom of the list should be priced and those towards the top shouldnot be priced.
The picture thus painted is far too simple, however, for at least three reasons. First, even the simplest case can be viewed from different perspectives that lead to different answers. Second, almost all of the items listed encompass a variety of more specific services that may have very different characteristics. Third, the "publicness" (rivalness and excludability) of a service is only one of many relevant characteristics for determining the appropriate domain for pricing.
[5]Externalities. Another important argument for public sector provision of certain services is that they give rise to important public or non-excludable "externalities," meaning benefits (or costs) that are not priced and hence may not be fully taken into account by private producers.
Education offers an important example of a positive externality, but a better case in the federal sphere concerns telecommunications and transport systems. As each new user is linked to a network, all users presumably benefit as the range of potential interchange is expanded. This is a positive externality. User charges may be appropriate here, but they must be designed with such externalities in mind. How this may be done is set out in Section 3 below.
Negative externalities may also be associated with certain federal programs or private sector activities — for example, noise, congestion, and pollution in the case of transport. Sometimes public provision of certain activities is justified in part as a controlling or regulating force. In other instances, taxes, prices, or some other form of regulating private activities may be appropriate. Environmental pollution provides a perfect example. Pricing and "user" charges may play an important role in regulating pollution and similar negative externalities.
[6]Social and Political Objectives. Presumably, everything the federal government does satisfies a socio-political objective in some way. Such objectives are more apparent with respect to certain activities. Perhaps the clearest case is with transfers to individuals. When the sole objective of a particular program is redistribution, it makes no sense to charge beneficiaries in accordance with the benefits they receive.