The User Fee Illusion

Charging the users of government services instead of the taxpayers sounds like a great reform, but it masks the fundamental issues.


One does not enlighten a government, and of all governments, the least susceptible of being enlightened is one that believes it sheds all the light.
—Balzac, The Country Doctor, 1833

Many of the goods and services supplied by the federal government could be sold directly to their consumers by charging "user fees." Revenues from these fees could then be used to finance the activities, rather than financing them with general tax revenues as is now customary. Several advantages accompany user-fee financing.

First, user fees link those who receive the benefits and those who pay for them. This is more equitable than financing in which the link is broken.

Second, user fees introduce incentives that reduce or eliminate wasteful utilization of public facilities; the use of prices ensures that output will go to those who value it most highly. Prices can also reduce congestion and the need for other, less efficient, ways of allocating output. As a result, the net benefits to the public are enhanced by charging user fees.

Third, user fees provide information about what users are willing to pay for goods and services. Therefore, analysts have an opportunity to actually measure the benefits from public projects, and the task of deciding whether to invest in projects can be less complicated and more reliable. At the same time, if users pay directly for what they consume, they have less incentive to exaggerate their "needs" for services.

Fourth, user fees reduce the need for financing from tax revenues. Hence, they can indirectly promote work effort, saving, and investment.

Fifth, user fees reduce the rewards associated with what economists call "rent seeking"—expending resources to obtain the "right" to receive free or underpriced goods and services from the government. Hence, these resources can be freed and directed toward productive activities.

Finally, user fees charged by government can increase the ability of private individuals and firms to compete effectively with the government for the provision of goods and services.

Recognizing these various advantages, the Reagan administration has proposed to increase government reliance on user fees to finance certain types of goods and services. For example, increases in fees were proposed for airports and airways, flood insurance, grain inspection, cotton and tobacco grading and inspection, and the construction and operation of inland waterways. In addition, new fees were proposed for Coast Guard services and for the construction and operation of deep-draft ports.

When proposed, these measures were estimated to generate revenues of $1.0 billion, $1.7 billion, and $2.1 billion in fiscal years 1982, 1983, and 1984, respectively. With the exception of flood insurance, the grading and inspection of agricultural products, and Coast Guard services, the administration recommended that fees or prices be set at levels that would approximate average operating and maintenance costs and that new methods for financing and amortizing capital costs be introduced. In addition to these proposals, the administration is reviewing other possible areas in which user fees could be either increased or introduced.

Although the introduction of user fees can improve the allocation of resources, there remain questions about the appropriate level and structure of the fees. Economic analysis provides some guidance in resolving these questions. For example, the following operational rules should be used as a guide to determine the level and structure of fees:

1. For existing facilities, user fees should be set equal to average operating and maintenance costs. If facilities are still congested, the fees should be raised to eliminate congestion.

2. For new facilities, these same guidelines should be followed, and in addition, annual license fees should be imposed on users or "up-front" financing should be paid by users to recover the capital costs of new facilities.

Even so, however, user fees could prove to be a mirage—a mirage that detracts from the attainment of a truly superior economic performance. Even when a public activity can be supported by user fees and charges that are set in accordance with such guidelines, the activity could be better carried out by the private sector. As a result of their differing incentives and regulating mechanisms, private firms tend to perform better than public enterprises.

A large body of empirical evidence supports this conclusion. By identifying the factors that determine costs, econometric studies allow us to identify the cost differentials that result exclusively from private versus public supply. Whether the public services be water supply, waste-water treatment, fire protection, police protection, refuse collection, ship repair, air transport, urban bus transport, electric supply, or ambulance service, we obtain the same result: for the same quantity and quality of service, the cost of public supply is approximately twice that of private supply.

Thus, if our objective is to efficiently provide "public services," we should eliminate public ownership and allow private enterprise to supply these goods and services. To accomplish this, we must not be attracted by the user-fee mirage. Rather, we must eliminate statutes and regulations that limit the ability of private individuals and firms to freely compete in the provision of public services, and we must actively pursue policies of denationalizing and privatizing these activities.

* * *

I presented this argument recently in New Orleans at the annual meeting of the National Waterways Conference. During the meetings, the spotlight was focused on Reagan administration proposals to increase the user charges and "up-front" financing requirements for inland waterways and deep-draft ports.

The proposal to instead privatize inland waterways and ports raised some eyebrows, particularly those of the many representatives from the US Army Corps of Engineers. Leaders from the barge and towing industry, however, were more receptive.

For example, Mr. Les Sutton, president of Dravo Mechling Corp. and a member of the panel on which I spoke, supported the privatization concept. Moreover, he reminded other industry members that J.W. Hershey, one of the industry's patriarchs and chairman of American Commercial Lines, Inc., as well as of the National Waterways Foundation, has argued in favor of privatization. The industry's privatization arguments are quite straightforward: if the industry is forced into a cost-plus arrangement with the Corps of Engineers, then, the industry argues, it should attempt to purchase water and port facilities, because private costs would be lower than public ones.

Steve Hanke is a senior fellow at the Heritage Foundation, on leave from Johns Hopkins University. He formerly served as a senior economist on President Reagan's Council of Economic Advisers and has contributed several times to REASON on the privatization of federally owned land.