Resurrecting User Fees in Public Finance: A Prescription for Lowering the Cost and Improving the Fairness of Public Services
By Randall Pozdena, Ph.D.
The share of personal income collected as revenue by state and local governments has doubled since 1945. Oregon and other US state governments obtain approximately 75 percent of this revenue through broad-based taxation and 25 percent from fees levied on the beneficiary of the service.
This report first details the theoretical and practical advantages of reducing reliance on broad-based taxation in favor of user charges. It reviews the economic philosophy of reliance on user charges versus broad-based finance and the findings of the public finance literature. These key findings are:
- The total cost of public services would decline. By making users of services and facilities aware of the costs associated with their use, spending would be limited only to those services for which consumers get benefits commensurate with their user costs.
- Because user fees, unlike broad-based taxes, are only paid if one uses a service, the public or private providers of the services are incentivized to provide a service of value and at the minimum cost. This effect is particularly pronounced if users also enjoy choice of the provider of the service.
- User fees link the generation of revenue intimately to the specific service or facility used. This avoids the “trust fund” or “trough” financing model that allows political lobbies to direct the allocation of revenues and provision of services to those with political power, rather than what is beneficial to consumers overall.
- The result is more efficient and equitable provision of services because of the closer nexus of financing burden and receipt of benefits from the services.
The report goes on to examine historical and current patterns of state and local spending and revenue collection. The review of these practices reveals that there are at least five areas where increased reliance on user charges is both practical and desirable.
- K-12 education
- Higher education
- Health services
- Public safety, including police, fire, and corrections
- Transportation infrastructure, especially highway and transit services
Together, these services constitute approximately 50 percent of state and local public spending in Oregon and other states in the aggregate, but in total have less than 5 percent reliance on properly designed user fees at present. The report then offers an analysis of each public service area and offers:
- A description of the rationale for the current mode of finance.
- A presentation of the rationale for the use of user fees.
- Conclusions regarding the utility and feasibility of converting from tax-based finance to user fees.
The analyses reveal that user fees can completely, or near-completely, replace broad-based taxation, and consistently yield better outcomes and lower costs. The report identifies and cites the available literature reviewed, and concludes with a bibliography of the relevant literature.
Randall Pozdena is President of QuantEcon, Inc., an Oregon-based consultancy. He received his BA in Economics, with Honors, from Dartmouth College and his Ph.D. in economics from the University of California, Berkeley. Former positions held by the author include professor of economics and finance, senior economist at the Stanford Research Institute (SRI International), and research vice president of the Federal Reserve Bank of San Francisco. He also served on numerous public, non-profit, and private boards and investment committees. He is a member of the CFA Institute and a member and former officer of the Portland Society of Financial Analysts. He has authored over 50 refereed articles and books and has been cited in the Wall Street Journal, USA Today, and numerous other national and regional publications. He has served for over a decade on the Oregon Governor’s Council of Economic Advisors.
Randall J. Pozdena, Ph.D.
PO Box 280
Manzanita, Oregon 97130
About Cascade Policy Institute: Founded in 1991, Cascade Policy Institute is Oregon’s premier policy research center. Cascade’s mission is to explore and promote public policy alternatives that foster individual liberty, personal responsibility, and economic opportunity. To that end, the Institute publishes policy studies, provides public speakers, organizes community forums, and sponsors educational programs. Cascade Policy Institute is a tax-exempt educational organization as defined under IRS code 501(c)(3). Cascade neither solicits nor accepts government funding and is supported by individual, foundation, and business contributions. Nothing appearing in this document is to be construed as necessarily representing the views of Cascade or its donors. The views expressed herein are the author’s own. Copyright 2014 by Cascade Policy Institute and Randall Pozdena. All rights reserved.