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NON-TAX REVENUES IN THE DISTRICT OF COLUMBIA:
CURRENT PRACTICES AND FUTURE PROSPECTS Prepared for the D.C. Tax Revision Commission By and James O'Keefe April 1998 CONTENTS
Part II: Opportunities for Raising Additional Non-Tax Revenues in the District Part III: Recommendations INTRODUCTIONA recent catalogue of user fees in the District of Columbia listed 1,971 different fees. Yet, the common perception is that user fees account for a relatively small share of District revenues. The purpose of Part I of this paper is explore this apparent paradox by addressing the following questions:
Once we have a better understanding of the current situation, we explore whether, and to what extent, the District should increase its reliance on non-tax revenue sources and identify opportunities to accomplish that objective. This is the topic for Part II of this paper. PART INON-TAX REVENUES IN THE DISTRICT OF COLUMBIAThere is a common perception that the District generates about five or six percent of its own-source revenues from user fees and miscellaneous, non-tax, revenues. For example, in Figure 1-3 of her book, O'Cleireacain presents a pie-diagram which shows that the District generated $196.6 million from fees and miscellaneous revenues in Fiscal 1995 — six percent of total discretionary revenues.(1) Similarly, data in the District's Comprehensive Annual Financial Report indicate that licenses, permits, fines and forfeits, court fees, interest and other miscellaneous revenues typically account for between five and six percent of the District's General Fund revenues (see Table 1). This is thought to be a comparatively low reliance on such non-tax revenue sources relative to other state and local governments. Nevertheless, the District lists nearly 2,000 fees and charges. There may be several reasons why the District has so many fees and charges, but relatively low revenues. First, many of the items on the list may exist in legislation, but may not be collected. In fact, a large number of the fees listed indicate a zero fee rate. Second, even if a fee has a non-zero rate, it may not be collected. As a result, the number of user fees and the amount of revenue collected as reported in the District's Comprehensive Annual Financial Report
Examining up to 2,000 individual fees, how their rates are determined, analyzing collection rates and practices, and evaluating their general administration is beyond the scope of this study. The Department of Consumer and Regulatory Affairs (DCRA) is responsible for the bulk of individual fees and any fee by fee analysis would have to involve DCRA. Our goal is to provide a comprehensive perspective of the District's actual reliance on non-tax revenues, compare the relative importance of non-tax revenues in the District with other jurisdictions, identify differences that might exist between the District and other jurisdictions, and analyze why such differences might exist. This section examines, in a more systematic and comprehensive manner, the hypothesis that the District relies on user fees and other non-tax revenues to a lesser extent than other state and local governments. The next section discusses factors that influence the extent of the District's reliance on non-tax revenues. Making fiscal comparisons between the District and other jurisdictions, be they states or local governments, is very difficult. First, the District has all of the social and spatial characteristics of a municipal government, but it has the revenue raising and service delivery responsibility of a state. That makes interpreting fiscal comparisons with other municipal governments difficult. Second, the District, like most municipalities in the Northeast, has a high concentration of low income residents and a very skewed distribution of income. Again, fiscal comparisons between the District and states, which typically have a less skewed distribution of income and a more balanced composition of population, can be difficult to interpret. For example, the District may receive a smaller share of the costs of running its public hospitals from charges than Virginia, in part, because the population using the District's public hospitals may have a higher concentration of poor who cannot afford to pay for the services provided.(3) Another problem complicating comparisons between the District and other state and local governments, and even comparing state and local governments to each other, is that each government has its own budget definitions, classifications, and reporting requirements. Thus, data on actual revenues from annual budgets or financial reports for different jurisdictions cannot easily be compared in the aggregate and any such comparisons may lead to incorrect or misguided conclusions. Census Data and Interjurisdictional ComparisonsTo make comparisons between the District and other state and local governments, we need data on actual revenues collected that are comparable across jurisdictions — utilizing the same definitions and reporting conventions. The Governments Division of the U.S. Census Bureau constructs and reports such data in their annual report Government Finances. In the discussion below, we use data from Government Finance, 1994 — the most recent data available from the Census Bureau — to compare the District's reliance on non-tax revenues with other jurisdictions. Since we are reporting Census data, we must use their definitions. The Census Bureau starts by defining General Revenue as all revenue of state and local governments except revenues from liquor stores, utilities, or insurance trust funds. So a jurisdiction's Total Revenue equals General Revenue plus Liquor Store, Utility, and Insurance Trust revenues. A jurisdiction's General Revenues are divided into four major types of revenue:
The Census Bureau defines taxes to be ". . . compulsory contributions exacted by a government for public purposes."(4) The important features of this definition are that taxes are compulsory and that they are for public purposes. Therefore, the Census Bureau classifies as License Taxes
Revenues from all these sources are included under tax revenues by the Census Bureau because of the compulsory nature and public purpose of the payment. These revenues generally can be thought of as regulating fees with the primary purpose of protecting the public from fraud, deception, and incompetence. Because the benefits of licensing and regulation accrue primarily to citizens in their roles as consumers, it is more useful analytically to view such license fees as taxes, not user charges.(5) Such revenues are not included in this paper as non-tax revenues. Using this definition of taxes, the District's non-tax revenues are simply its total revenues minus its tax revenues. In 1994, the District relied on taxes for 39 percent of its total revenue and non-tax sources for 61 percent (see Table 2). The District's reliance on non-tax revenues is high, higher than combined state and local governments in Maryland (45 percent), Virginia (48 percent), and the U.S. (53 percent) (see Table 3).(6) Such a broad definition of non-tax revenues, however, may not be useful for District policy makers. For example, 40 percent of the District's total revenue, and two-thirds of its non-tax revenues, are intergovernmental revenues. These are revenues transferred from the federal government to the District for specific purposes. Excluding intergovernmental revenues, the District receives a smaller share of its total revenues from non-tax revenues (35 percent) than combined state and local governments in Maryland (37 percent), Virginia (41 percent), and the U.S. (44 percent). One final adjustment is required. Census defines Insurance Trust Revenues as
Thus, for the purposes of this paper, we omit revenues from insurance trusts. For policy purposes, we are left with examining the relative importance of utility/liquor store revenues, miscellaneous general revenues and charges. This is a much broader definition of charges and miscellaneous revenues than reported in Table 1 which refers only to a limited number of General Fund revenues. The data in Table 3 indicate that the District's reliance on these three sources of non-tax revenue (14 percent of total revenue) is less than combined state and local governments in Maryland (19 percent of total revenue), Virginia (27 percent of total revenue), and the U.S. (24 percent of total revenue). The next three sections look at each of these sources of non-tax revenue in more detail. Utility and Liquor Store RevenuesThe Census Bureau defines Utility Revenues to include
According to the data in Table 3, the District actually generates a larger share of its total revenue from utility and liquor store revenue (6 percent) than combined state and local governments in Maryland (2 percent), Virginia (4 percent), or the U.S. (5 percent) — in spite of the fact that the District is the only jurisdiction among this group that does not generate any revenue from liquor store operations. Table 4 presents information on the various components of utility revenue. These data indicate that 86 percent of the District's utility revenue comes from the public transit category. This category includes all revenues for the regional transit authority, thereby overstating the District's utility revenue significantly. The Census Bureau does not have the capacity to allocate these total among the jurisdictions served by the regional transit authority — Maryland, Virginia, and the District. The only other category where the District generates any utility revenue is in the water supply category. However, this category accounts for only about 14 percent of the District's utility revenue compared with nearly 35 for combined state and local governments nationally, and nearly 60 percent and 70 percent for combined state and local governments in Virginia and Maryland, respectively. Water services in the District have been provided by the Washington Aqueduct that has been in existence for over 100 years. The Washington Aqueduct, which is financed by the Council of the District of Columbia, currently bills Falls Church, Arlington, the federal government and the District Water and Sewer Authority for water consumed based on fixed and variable costs as well as debt service. Rates charged to District residents are set in tandem with sewerage rates by the Sewer and Water Authority, and like sewerage charges, were not increased from 1986 to 1997. Miscellaneous General RevenuesThe Census Bureau defines Miscellaneous General Revenues to include
The major components of miscellaneous general revenues include
Based on the data in Table 3, the District receives a smaller share of its total revenue from miscellaneous general revenue sources (4 percent) than combined state and local governments in Maryland (7 percent), Virginia (8 percent), or the U.S. (7 percent). Based on the data in Table 5, nearly three-fourths of the District's miscellaneous general revenue is classified as "other general revenue" which primarily represents lottery revenues. The only other feature of miscellaneous revenues that stands out is the fact that combined state and local governments in Maryland, Virginia and the U.S. generate between 43 and 50 percent of their miscellaneous general revenues from interest earnings while the comparable figure for the District is just 23 percent. Current ChargesThe Census Bureau defines Current Charges to include
The important characteristics of current charges are that payments are made for a service or benefit received and are usually made by the person or group consuming the service or realizing the benefit. The District generates a smaller share of its total revenues from current charges (4 percent) than combined state and local governments in Maryland (10 percent), Virginia (15 percent), or the U.S. (12 percent) (see Table 3). Similarly, current charges account for a smaller share of District own-source revenues (9 percent) than combined state and local governments in Maryland (14 percent), Virginia (20 percent), or the U.S. (18 percent). Table 6 lists the major components of current charges and their relative importance in the District and for combined state and local governments in Maryland, Virginia, and the U.S. The District receives
Similar patterns are found when the District is compared to other municipal governments.(12) For example, data in Table 7 indicate that the District's reliance on current charges for own-source revenues (9 percent) is lower than all of the comparison cities which range from 11 percent in Baltimore to 32 percent in San Francisco and 31 percent in Seattle. When looking at the composition of current charges across municipalities it is clear that the responsibilities of a municipality dictate the level of current charges. For example, those municipalities that provide access to public hospital services (the District, Boston, Indianapolis, and San Francisco) receive between one-fourth and one-third of their current charges revenue from those public hospitals. Similarly, those municipalities with airports receive between 15 and 31 percent of their current charges revenue from those airport activities; while those municipalities with ports receive between 5 and 14 percent of their current charges from their port activity. Like the District, no municipalities received revenue from toll roads or natural resources (see Table 8). Thus, it appears that the composition of municipal activities influences to a significant degree the relative importance of current charges as a source of total and own-source revenues. SummaryBased on the Census data reviewed here, the District relies on non-tax revenues to a lesser extent than combined state and local governments in Maryland, Virginia and the U.S. Utility revenues in the District are lower than the comparison jurisdictions. The District relies on miscellaneous general revenues to a lesser extent than combined state and local governments in Maryland, Virginia, and the U.S. Nearly three-fourths of the District's miscellaneous general revenues are classified as "other general revenues" and are primarily accounted for by lottery revenues. Finally, the District relies less on current charges than combined state and local governments in Maryland, Virginia, and the U.S. In part, this reduced reliance reflects the composition of such charges since the District does not have toll roads, an airport, a port or natural resources. These data show that the District receives a smaller share of its total revenue from non-tax revenues (current charges, specifically). The District's reliance on non-tax revenues, especially current charges, appears low because of the composition of current charges (the District has no revenues from toll roads, airport, port, or natural resources), and because the District has a state-like revenue structure which generates more revenues from taxes. FACTORS INFLUENCING THE DISTRICT'S RELIANCE ON NON-TAX REVENUESThe previous section documented the District's more limited reliance on non-tax revenues than combined state and local governments in Maryland, Virginia, and the U.S. and selected municipalities. In part, the more limited reliance of the District on such non-tax revenues reflects the composition of the services provided, or not provided, by the District. Alternatively, the District's reliance on current charges may be relatively low because rates in the District are low. One means of gauging whether rates in the District may be low relative to rates in other jurisdictions is to calculate revenue from current charges as a percent of expenditures for selected services (see Table 9). Current charges as a percent of expenditures for 11 expenditure categories indicate that current charges accounted for 12.4 percent of expenditures on higher education in the District, compared with 42 percent in Maryland, 51 percent in Virginia, and 41 percent for state and local governments in the U.S. These numbers are difficult to interpret, however, because we are comparing the University of the District of Columbia with systems of higher education in the other states which include junior colleges, state colleges, and universities — each of which has a different mix of funding mechanisms (tuition, general funds, research grants, charitable contributions, etc.). Another example may be hospitals. The data in Table 9 indicate that current charges revenue from hospitals accounted for only 21 percent of hospital expenditures in the District, compared with 38 percent in Maryland, 84 percent in Virginia, and 68 percent for combined state and local governments in the U.S. A similar pattern emerges when looking at municipalities that provide public hospital services. Current charges accounted for 36 percent of hospital expenditures in Boston, 29 percent in Indianapolis and 43 percent in San Francisco. The District funds a much smaller share of its hospital expenditures from user charges then other jurisdictions (see Table 10). A similar scenario emerges for solid waste management. The District generates very little current charges revenue from solid waste management and, as result, recoups a very small share of solid waste expenditures from such revenues — just 7 percent. This compares with 41 percent for Maryland, 63 percent for Virginia, and 58 percent for state and local governments nationally. Similarly, all of the comparison cities recoup a larger share of solid waste expenditures from current charges then the District ranging from 17 percent in San Francisco to 95 percent in Seattle. Again, these comparisons are difficult to interpret for several reasons. First, institutional arrangements for delivering and financing services varies across jurisdictions. For example, the District is restricted by law to collecting solid waste only from buildings with three or fewer units. All residential buildings with more than three units, commercial properties and the federal government use private sector providers. Thus, the District government is responsible for solid waste management for a small minority of District properties and a smaller share of total solid waste. In addition, the District does not charge an explicit fee for the solid waste services it does actually provide. The vast majority of funding for solid waste services in the District comes from the general fund rather than a separate, earmarked portion of residents' taxes or more direct user charges. Of the user charges collected for solid waste management services, the vast majority come from the tipping fee charged to private haulers and a recycling surcharge tacked on the tipping fee. The tipping fee is recognized to be extraordinarily high within the region, largely due to the surcharge. This noncompetitive tipping fee reduces total revenue because private haulers avoid payment of the tipping fee by dumping in landfills outside of the District. It also results in the drastically lower percentage of expenditures funded by current charges versus the comparison group. Second, the District may collect a smaller share of funds expended from user charges because of the relatively high concentration of low income residents who may not be able to pay the full cost of services received. Third, the share of expenditures attributable to user charges may be relatively low in the District because of the collection and reporting problems described by O'Cleireacain. Overall, it appears the District does not generally recoup a significant share of its expenditures from user charges relative to other jurisdictions examined here. Downing used 1984 Census data to compute the variation in user charge reliance for 943 cities with populations of 5,000 or more for selected services.(13) The data he used is 10 years old and it is likely that user charge reliance for these services, across these local governments, has increased significantly during that period. In 1984, 747 of the local governments examined provided sewerage services and two-thirds of them recouped a greater share of expenditures from current charges than the District did in 1994. Similarly, 527 of the local governments examined provided solid waste services and three-fourths of them recouped a greater share of expenditures from current charges than the District in 1994. Finally, only 56 of the local governments examined provided public hospital services, but 95 percent of them recouped a greater percentage of expenditures from current charges then the District did in 1994. SUMMARYThe purpose of Part I of this report is to determine the extent to which the District relies on non-tax revenues, compare that reliance with other jurisdictions, and explain why any discrepancies might arise. Based on our review of Census data, we found that
From a policy perspective, should we care that the District relies on non-tax revenues to a lesser extent then neighboring state and local governments or other municipalities? To the degree that the reduced reliance is a result of the composition of services provided, or not provided, by the District, probably not. For example, no one would argue the District should build a port or another airport just to increase non-tax revenues. To the degree that the reduced reliance is a result of not charging for certain services, or charging too little (or in some cases too much) for some services, the answer is probably yes. Current charges have some very important advantages for local governments to consider. For example, Osborne and Gaebler argue that the safest way to raise non-tax revenue is simply to charge fees to those who use public services. What is fairer, they ask, than a system in which those who benefit from a service and can afford to pay for it do so, while those who do not benefit do not have to pay? They argue that current charges have two advantages: they raise money, and they lower demand for public services.(14) Such charges establish a direct link between the expenditure and revenue sides of the local budget for specific governmental services. As a result, such charges contribute to an efficient allocation of public resources by providing valuable information on consumer preferences and by constraining demand for government goods and services. Ultimately, such charges strengthen political accountability at the local level and lead to a more efficient mix and level of public spending.(15) In addition, it should be noted that focusing solely on the revenue potential of current charges tends to give too narrow a view of their potential net impact on local budgets. One of the primary arguments favoring current charges, over general tax financing, is that wasteful consumption will be eliminated and the costs of production reduced to more efficient levels. These adjustments lead to lower expenditures at the same time that revenues increase. Both adjustments reduce the need for local tax revenues. In fact, the reduction in current and future expenditures may be more important, from a budgetary perspective, than the increase in revenues from a greater reliance on current charges for own-source revenues. Downing argues that there is great potential for almost all jurisdictions to increase non-tax revenues.(16) This is especially true for the District, since it places a lower reliance on non-tax revenues than all of our comparison jurisdictions. This situation offers the opportunity to explore possibilities for increasing the District's reliance on user charges, while keeping its fees and charges competitive within the region and compared to the rest of the nation. Part II of this paper discusses the potential advantages of user charges as a means of funding locally provided services, identifies some caveats that must be kept in mind when designing and implementing specific user charges, and outlines a number of opportunities for raising additional non-tax revenues in the District. PART II: OPPORTUNITIES FOR RAISING ADDITIONAL NON-TAX REVENUES IN THE DISTRICTPart I of this paper documented the reliance of the District on non-tax revenues and compared it with other jurisdictions. There is evidence that the District relies on such revenues to a lesser extent then other jurisdictions. In part, it is because the District has a different mix of services then other jurisdictions, e.g. no airport, natural resources, or port; in part, it is because the District recoups a smaller share of certain expenditures from user fees then other jurisdictions; and in part, it is because the District does not utilize user fees in some circumstances that other jurisdictions might. The purpose of Part II of this paper is to construct a framework for designing and implementing user fees and provide some illustrative examples of how such fees might be utilized in the District. A Framework for Designing User ChargesUser charges are most appropriate when the benefits of the good or service accrue principally to identifiable consumers and their demand for the good or service is sensitive to price changes. In such situations, the user charge should be set equal to the marginal cost of providing an additional unit of the good or service. There are other efficiency advantages of funding public goods and services with user charges. For example, it contributes to increased political accountability in the local budget process. Similarly, increased reliance on user charges may reduce other economic distortions caused by high marginal tax rates on income, sales, or property values. Finally, if consumers are willing to pay for what they get, increased reliance on user charges may lead to different levels of service being provided in some neighborhoods. The recent explosion of Special Benefits Districts in urban areas is one manifestation of this benefit. One caveat is in order, however. In order to achieve the efficiency gains attributed to user fees, there must be a market for the good or service being produced. That means potential consumers must have the income to translate their needs and/or desires into market transactions. If there is a high percentage of the population with very low incomes they do not have many votes in the market place. Their market activity, therefore, may not be an accurate reflection of their actual preferences. For example, Martha might like 17th century Dutch painting and although there is a market for Rembrandt paintings, she cannot translate her preferences into market activity because she does not have the income to participate in that market. Care must be taken in designing user fees to be sensitive to the needs of the less fortunate in society. Increased reliance on user charges has several important equity benefits as well. First, by providing a direct and visible link between consumption benefits and payments, the extent of unintentional subsidies provided to specific, identifiable groups of citizens may be reduced. User charges also provide a mechanism for charging nonresidents and those occupying tax-exempt properties for public services received. The Advisory Commission on Intergovernmental Relations summarizes guidelines provided by John Due and Ann Friedlaender for determining when it is appropriate (or in appropriate) to consider expanding the role of user charges in financing public goods and services.(17) In summary, they argue that the use of pricing mechanisms for funding the provision of public goods and services is justifiable when:
Use of charges is more questionable when:
There are real and significant potential benefits from increasing the relative importance of user fee revenues in the District. The next section discusses some illustrative examples of potential user charges for the District. Opportunities for User Charges in the DistrictThis District is undergoing significant changes in how local government operates and is financed. These changes include major restructuring in several areas funded by user fees. For example, new institutions have recently been created for water and sewer services and for the municipal hospital. Similarly, the University of the District of Columbia has been engaged in a process of reinventing itself. Given the difficult dynamics of these transitions, we do not attempt to prescribe how these new institutions should set fees. Our only observation would be that they should follow the general guidelines set out in the framework described above and in the Appendix. In addition, it is beyond the scope of this paper to systematically evaluate current and prospective user fees in the District within the framework developed here. The purpose of this section is to discuss representative illustrations of how such fees might be utilized in the District. Two specific examples are present — solid waste management and transportation utility fees. Solid Waste ManagementIn the District, private haulers collect and dispose of waste for all residential buildings with more than three units, commercial properties and the federal government. The District government provides this service to residential buildings with three or less units. This service is financed through general revenues so that all taxpayers effectively subsidize solid waste collection and disposal for residents living in residential buildings with three or fewer units. The cost of solid waste management reflects the costs of both the collection and disposal of solid waste. Collection and disposal costs, in turn, depend on the amount and type of refuse and should also reflect the environmental costs associated with that collection and disposal. A user charge to cover these costs should vary by type of service provided (e.g. the collection and disposal cost of a pound of household garbage is different from that of a pound of used nuclear fuel).(18) One administrative problem of applying such a fee is measuring how much solid waste is collected from each user. One innovative response to this administrative problem is to require that all refuse be deposited in specific bags sold by the local government or in bags with special stickers sold by the government. Such bags or stickers may be characterized by distinctive colors or insignia. The fee per bag charged by the government should include not only the cost of producing the bag, but also the collection and disposal costs associated with each bag or trash. In this case, the consumer will also incur a transaction cost. Specifically, each consumer will have to purchase the special bags or stickers. This compliance cost can be minimized to the extent that the bags or stickers are sold by private enterprises as well as the government. This approach could also be extended to charge different amounts for different types of garbage. For example, glass bottles could be in one type of bag, metal cans in another, paper in yet another, and so on. The equity of such a pricing structure can be improved by offering special rates to low and fixed income individuals. In order to reduce personal expenditures on waste removal, citizens will be more cognizant of what they throw out. Many will increase recycling and composting efforts as well as considering waste volume when making purchases and consumption decisions. Clearly not every resident will change their behavior. Numerous cities, however, have realized the added benefit of reduced waste volume when initiating a user fee of this type. A Duke University study conducted by Dr. Daniel Blume found that 14 cities employing volume pricing experienced waste reductions from 18 to 65 percent, with an average reduction of 44 percent.(19) Another study by Miranda and colleagues examined the results of unit pricing for municipal solid waste in 21 cities. They found that there were significant reductions in waste disposed in landfills in the year following the introduction of the unit pricing system. Overall, the average reduction in tonnage landfilled was 40 percent, with the range from a high of 74 percent to a low of 17 percent.(20) There is often a concern that if prices are charged for the amount and type of trash discarded, there will be an incentive for people to avoid paying the fee by illegally dumping their trash. This concern may not materialize to the degree feared. A report on unit pricing of solid waste management by the EPA states that illegal dumping proved to be less of a problem than anticipated by communities with unit pricing programs. Seattle, Washington found no evidence of increased illegal dumping as a result of unit pricing. Seattle discovered that their greatest source of illegal dumping was not related to unit pricing in solid waste collection at all. Rather, they found that 60 to 80 percent of the city's illegal dumping was with remodeling waste, refrigerators and construction debris, probably resulting from small contractors who provide hauling services on the side, and then do not properly dispose of the waste(21). Austin, Texas conducted a study measuring what households do when garbage does not fit in their prescribed cans. The city requires $2 dollar stickers be attached to every bag of extra trash. The 554 respondents gave the following answers:
In addition to illegal dumping, administrative costs associated with unit pricing of solid waste management include establishing the correct fee level, collecting the fee, charging multi-family housing, and community relations. Such an approach in the District might be implemented in a couple of ways. First, private haulers could be given the task of collecting from residential properties with 3 or fewer units in addition to their responsibilities for collecting solid waste from all others in the District. Part of the condition of giving the private sector this additional franchise could be the requirement that a pricing scheme based on volume, like the one discussed above, be implemented. Second, such a volume based approach could be implemented in conjunction with the current system of giving each resident a large can which is mechanically collected. For example, perhaps smaller containers can be given to households and collected mechanically for a fixed monthly fee. Then, if there are additional items to be collected they might be put in bags with the approved stickers. This could be very much like the Austin example. The point is that moving from the current system funded by general taxes to one that charges according to volume, or some variation thereof, will improve the cost effectiveness of providing this service. On the disposal side, another potential to generate significant non-tax revenues, currently underutilized by the government of the District of Columbia, is charging fees to the numerous private haulers operating in the District. The tipping fee is recognized to be extraordinarily high within the region, largely due to the recycling surcharge. This noncompetitive tipping fee reduces total revenue because private haulers avoid payment of the tipping fee by dumping in landfills outside of the District and illegal dumping. Therefore, by reducing this fee to make it competitive within the region, significant revenues could be generated. Alternatively, additional revenues could be generated by restructuring the prices charged at transfer stations to reflect the costs of processing an additional unit through each station. Transportation Utility FeeTypically, local governments like the District finance operation and maintenance of local road networks from property taxes, special assessments, or other general revenues. Often, however, road needs (especially in older central cities) out pace the ability to raise additional revenues from traditional sources. In the last several years a number of local governments have implemented Transportation Utility Fees (TUFs). The first jurisdiction to impose such a fee was Fort Collins, Colorado in 1981, but it was not declared valid until 1989. In jurisdictions with TUFs, the local road network is treated as a public utility, and developed properties are charged a fee for service in much the same way they are charged for water, sewer, and trash collection. TUFs are imposed on a jurisdiction wide basis and provide financing of ongoing operations and maintenance activities. The primary advantage of a TUF is that every local traffic generator pays to support the local transportation network, and responsibility for supporting that network is distributed across properties in relation to their use of the system.(23) The District might consider developing a Transportation Utility Fee as a means of financing road operation and maintenance. The objective of a TUF is to make it a financing mechanism for local road operations and maintenance which is as much like a fee as possible and as little like a tax as possible. The distinctive feature of a user fee is the direct link between the service consumed and the fee paid. Therefore, a TUF should be based on the amount of traffic which is typically generated by different types of development on a property. For each type of land use, expected traffic can be estimated based on average trip generation rates per acre. The rationale for basing the fee upon trip generation is that each vehicle trip entering or leaving a site creates an impact upon the street systems which can be associated with increased maintenance costs.(24) Austin, Texas recently implemented a TUF. Their fee structure uses trip generation rates from the Institute of Transportation Engineers (ITE) as the basic source of traffic projections. Normally, trip generation is figured on the basis of the number of units for residential uses or the square footage of floor area for non-residential uses. In order to place all land uses on an equal footing for development of the fee, Austin adjusted the trip generation rates to use acreage as the standard unit of comparison. In addition to linking the fee to actual usage, the fee structure must reasonably reflect the cost of providing the service. This is one area where administrative concerns might mitigate for something other then the pure marginal cost pricing rule. For example, the "cost" of a trip may vary by location and time of day. However, monitoring such variation is extremely costly and the resulting complex fee structure would be difficult to understand and sell to the public. In part for these reasons, Austin, and most cities with TUFs, use average costs as a basis for the fee. Such cost of services based fees are generally acknowledged to meet the "fair and reasonable" standard applied to utility rates. However, the fact that user fees must be reasonably related to use of facilities and service costs does not mean that fees must be based upon precise estimates of use or costs occasioned by use. In Fort Collins, the state Supreme Court held that
A number of other issues must be addressed in designing and implementing a TUF which will withstand court appeal. Specifically,
On the administrative front, there may be significant set-up costs involved in implementing a TUF, but once initial trip estimates are made and fees calculated the annual recurring costs are relatively minor. However, land use changes need to be tracked since they will affect the trip estimates for individual properties. To re-enforce the notion that TUFs are utility fees, most jurisdictions collect the fee in conjunction with other utility fees. Austin, Texas makes their TUF part of the electric utility bill. Other jurisdictions add the fee to water and sewer fees, trash collection fees, etc. In most cases, no additional collection costs are incurred by the local jurisdiction once the TUF has been implemented. Finally, payment of fees is typically enforced by cutting off the other public utilities billed with TUFs. TUFs must have an avenue to appeal a fee. Any property owner in Austin can dispute their category of land development, size of commercial developed property, or amount of fee assessed. The property owner can petition the Director of the Department of Public Works and Transportation for a hearing on a modification of such determination. A petitioner should be able to demonstrate that the trip characteristics of his or her property are significantly different from other properties similarly classified, either because the intensity of the development is different from the average or because the use itself does not generate the amount of traffic that wold normally be expected. Finally, equity issues need to be addressed. For example, families without an automobile are typically exempted from the fee. Similarly, vacant land and unoccupied structures are typically exempt from paying the fee. Finally, the problems of the low-income must be addressed. In Austin, taxpayers are allowed to contribute to a fund which helps low income residents pay their utility bills. The program is called One+. Austin also discovered that some income support programs could be used to help pay TUF obligations for low-income families. PART III: RECOMMENDATIONSThe District of Columbia relies on non-tax revenues for a smaller share of its own-source revenues then the comparison jurisdictions examined in this paper. In part, this reflects the unique mix of goods and services provided by the District. However, when comparisons of specific expenditure categories are made, the data indicate that the District often does not recoup and equivalent share of expenditures from user fees as other jurisdictions. This evidence suggests the District's relatively low reliance on non-tax revenues is in part do to the relatively low utilization of user charges that are in effect. Finally, there may be opportunities to fund, or partially fund, the cost of certain goods or services via user fees that are not being exploited in the District. Given the benefits associated with greater reliance on user charges as a source of local revenues, it is recommended that the District set a target share of own-source revenues that could be generated by user charges, e.g. a target might be that 20 percent of total own-source revenues come from non-tax revenues. To achieve this target, two initiatives need to be undertaken. First, it is recommended that the Office of Tax and Economic Policy, in cooperation with the Department of Consumer and Regulatory Affairs, undertake a systematic and comprehensive initiative to rationalize the current system of user charges in the District of Columbia. Such a review should apply the framework for implementing user charges described in the Appendix of this paper analyzing each of the 2000+ user fees listed on the books in the District. If a specific fee makes sense in the context of the framework presented, it should be structured along the lines discussed in the Appendix and enforced regularly. If a specific fee does not make sense, it should be removed from the books. Rationalizing the current fee structure in the District is necessary, but not sufficient, for increasing the reliance on user fees as a source of local revenue. In addition, new creative uses for such charges and fees need to be explored. It is recommended that new creative application of the user fee concept be identified and explored in the District of Columbia. Such new creative uses could include developing a transportation user fee to finance the operation and maintenance of the local road network, Payment-in-Lieu-of-Taxes programs for government agencies and non-profit organizations to pay their fair share of the cost of delivering the locally produced goods and services they consume, or exploring the use of special assessments as a means of financing certain types of infrastructure investments. Increasing reliance on user fees as a means of financing locally provided goods and services is not a panacea for the District. In fact, given the District's recent budget surplus, increasing reliance on user charges may seem almost irrelevant. However, increased reliance on local user fees reduces the reliance on other tax revenues. As a result, tax rates in the District would be lower then they otherwise would have been thereby reducing distortions that result from tax rates higher then surrounding jurisdictions. Also, increased reliance on user charges can make government more efficient and improve the overall level and quality of service provided at a reduced "price" to the taxpayer. APPENDIXUSER CHARGES: CONCEPTUAL CONCERNS, DESIGN ISSUES, AND IMPLEMENTATION STRATEGY(26)In public finance, there are two alternative approaches to allocating the cost of financing government activities among citizens. First, the ability-to-pay theory of taxation advocates that the distribution of tax payments be imposed in an equitable fashion. In practice, this means that those with higher incomes should pay higher taxes — including the possibility of actually paying a larger share of their income in taxes. In his first maxim of taxation, Adam Smith endorsed the ability-to-pay approach to taxation when he argued that
Second, the benefits-received principle of taxation advocates that taxes be considered more or less voluntary payments rendered by individuals in exchange for goods and services supplied by the government in accordance with their personal evaluation of such goods and services. In practice, user charges operate as benefit taxes with an individual's charge depending on both the benefit received from the good or service and the cost of providing the good or service.(28) The purpose of this section is to outline a framework for designing and implementing user charges. The next section discusses some illustrative examples of opportunities for generating more revenues from user charges in the District. In the private sector, prices serve the dual purpose of rationing available goods and services among potential consumers and of determining the quantity of goods and services produced. User charges play the same role in the public sector by
The basic rule of efficient public pricing states that the price of a public good or service should be set equal to the marginal cost of providing the next unit of the good or service. Social welfare is maximized when the benefit of an additional unit of service —reflected by the consumer's willingness to pay a given price for the good or service — is equal to the cost of providing that additional unit. If the additional benefit of an extra unit exceeds the cost of providing that unit social welfare is increased by expanding production. Alternatively, if the cost of providing an additional unit exceeds the benefits generated, social welfare will be increased by reducing the production of the good or service. This rule produces the greatest net social benefit from service delivery. The marginal cost concept used here is short-run marginal cost. To the extent capacity can be expanded in small increments, short-run marginal costs will equal long-run marginal costs in an efficient plant. The situation is more complicated if capacity can be expanded only in large increments — or "lumpy stages" — which is the case for most urban services like sewage treatment facilities, transportation networks, schools, etc. In principle, if there is excess capacity in the system, all that should be charged for an additional unit of service is the variable cost of increasing service output at that time. For example, an additional unit of potable water will require additional pumping and treatment expenses, but not much else. Similarly, an additional passenger on a half-empty bus may impose virtually no additional cost. Therefore, a strict interpretation of the principle of marginal cost pricing, when there is excess capacity, suggests the charge should be very low, possibly even zero. However, there may be times when the existing capacity is fully utilized. In this situation, a corollary of the marginal cost pricing rule applies — whenever capacity is fully utilized, the price should be set at a level that equilibrates the supply of and demand for the service. In the case of fully utilized capacity, price is seen as a preferred rationing mechanism (instead of waiting lines or administrative decree) because it allocates the scarce commodity or service among users according to the highest marginal valuation; it saves administrative costs; and it may prevent losses associated with over-crowded facilities. Thus, if the expansion of capacity of a public facility is only feasible in lumpy stages, price will fluctuate over time. During periods of excess capacity, price will be low, increasing as capacity is exhausted. Investment in new capacity will take place when consumers are willing to pay the long-run costs of system expansion. Thus, the marginal cost pricing rule serves as a guide for investment decisions as well. Refinements to Marginal Cost Pricing RuleTwo refinements to this general rule have to be kept in mind. First, in applying the marginal cost rule a distinction must be maintained between the consumption of the good or service (e.g. a gallon of potable water, waste disposal, or education) and access or connection to a service. In the first instance, the relevant marginal cost concept is the short-run marginal cost of producing and distributing an additional unit of the good or service. In the second instance the relevant marginal cost concept has two dimensions — the additional infrastructure costs required to connect a customer to the distribution (collection) network, and the additional capacity necessary to be ready to provide the additional service. In this situation, a use-related charge should reflect the marginal cost of production and distribution while a one-time connection charge should reflect the marginal connection costs and the capacity costs related to the need to be ready to serve those who are connected. A second refinement to the marginal cost rule is necessary to reflect differences in costs across space, time, and customer classes. There are three types of spatial cost differentials — sectoral (between rural and urban areas), interregional (between jurisdictions within a metropolitan area), and intraregional (between neighborhoods within a city). An efficient system of service prices should reflect these location cost differentials. However, in practice this is not always the case. For example, when the service is provided by a suprasectoral or regional authority, costs are frequently averaged across the region. Such cost averaging may be a deliberate policy designed to achieve equity objectives or to encourage development in certain areas. Very often, however, there is simply a lack of knowledge about, or awareness of, such cost differentials. Such spatial differences are reflected in the costs of factor inputs and thus, the cost of providing the service. In addition to such cost differences, the demand for a good or service may vary over time which may be characterized by seasonal, weekly, or daily peaks in consumption. The main point about such intertemporal demand variation is that, although excess capacity exists during off-peak periods, peak demand typically runs into capacity constraints beyond which supply cannot be expanded or can be expanded only at the cost of increased crowding or congestion. Thus, during off-peak periods price should be set equal to the short-run marginal cost of providing an additional unit of service, while during peak periods of demand price should be used as a rationing mechanism to equilibrate demand and supply. Another reason to charge different prices at different times is to reflect seasonal variations in costs. For example, water may be more expensive during dry seasons when it requires additional pumping or additional treatment. A failure to charge differential prices over time may cause not only efficiency losses from over- or under consumption, but also mistaken investment decisions. For example, excess demand is commonly taken to mean it is time to invest in new capacity, but if this demand is due to a failure to apply peak-load pricing, the investment is likely to be premature. Finally, prices may vary across classes of users. Such variation across consumer groups reflects two possible situations. First, the kind of service provided may differ between groups. For example, residential sewage may require less treatment than industrial effluents or removing and disposing of residential refuse may cost considerably less than removing industrial and commercial waste. In such situations, different prices would be appropriate on the grounds of economic efficiency. Second, different user groups may have different consumption patterns and therefore different price elasticities of demand. For example, industrial users may have a lower demand-elasticity for water then residential users. In such cases, the service provider may act as a discriminating monopolist and extract a higher price from the industrial user than the residential user. In contrast, poor residential consumers may be kept off the system if they have to pay high fixed charges (e.g. they have a more elastic demand for access), and efficiency losses would result. There are several important implications of this basic marginal cost pricing rule which remain relevant even when the rule is refined as discussed above, or modified as discussed below. Specifically,
This formulation of the "pure" marginal cost pricing rule requires a number of restrictive assumptions, including the following:
In the real world, these critical assumptions may not hold. In those cases, the rule must be amended if efficiency in resource allocation is to be achieved by public service pricing. Imperfect InformationThe basic marginal cost pricing rule assumes that consumers have access to all relevant information regarding the pricing structure of each service and that they are able to utilize that information in their personal decision making. For instance, if the cost structure for a service requires a complex system of charges which change by type of service, location, time of use, or user class, consumers should always be aware of what price applies in a particular situation for each of their decisions. The existence of imperfect consumer information implies two things. First, all pricing systems work more efficiently when they are accompanied by an effort to improve consumer information on the current and future pattern of prices. Such information should be made available to consumers on a regular basis. However, the collection and dissemination of such information is not costless. Thus, because of information costs, a systematic application of the basic marginal cost pricing rule could result in efficiency losses. Efficiency gains, therefore, may be generated by the simplification of the pricing structure to capture the most critical elements of cost differences among consumers of different types of services, at different locations, and at different times. In addition, if consumers do not fully utilize available information on future price patterns, some information on future prices may need to be built into the current pricing structure. That is, current prices may exceed (be below) current marginal costs if projected marginal costs are expected to rise (fall). An additional complication may arise when or if consumers are unable to fully understand or appreciate the benefits of a service. One response is to provide better information. Another response may be to assume that information costs are too high and provide a subsidy for the service. Alternatively, one might provide promotional subsidies targeted to new customers, but which are removed or phased out over time as they learn more about the full benefits of the service being provided. ExternalitiesThe basic marginal cost pricing rule assumes that there are no external benefits or costs associated with the private decision to consume or seek access to an urban public service. An externality is a benefit or cost not received by the service consumer but is received by other members of society, and which is therefore not taken into consideration by the user in deciding to consume or seek access to the service. As a result, there is over- or underconsumption of the service if the price is set equal to the private marginal cost. An example of such an externality may be the difference between the social and private benefits of providing potable drinking water; sewerage collection, treatment and disposal; and solid waste collection and disposal. When externalities exist, optimal use of the service may require setting the price below marginal costs and subsidizing the service. However, there needs to be a clear distinction made between subsidizing the delivery of the service and subsidizing access to the service. Sometimes it is access that is critical so there might be a subsidy for connection to a service, but the delivery of the service itself may not be subsidized. One needs to know which dimension of service provision is generating the externalities, the extent of externalities, and whether there are capacity constraints which require price rationing. In the extreme case, the existence of externalities may mitigate against user charges entirely. User charges may not be appropriate when external benefits are significant and will be lost if a user charge is relied on to finance service provision.(30) The greater the extent that benefits accrue to non-users, the more difficult it is to design and implement user charges as a means of financing such a service. An example is the financing of the Bay Area Rapid Transit system. It is argued that improving transportation in the region widens the labor market for all employers and expands the market for all goods and services sold in the region. Therefore, the beneficiaries of such a mass transit system are certainly the users, or the riders on the system, but the regional economy benefits as well. Funding the operations of the system entirely out of fare-box revenues (a strict user fee) would result in suboptimal ridership. Rather, the benefits-received principle of taxation suggests that both riders (users) and the general population benefit from the transit system and should therefore contribute to its costs. In the case of BART, approximately half of the operating revenue comes from fare-box revenues and half comes from a regional sales tax. Such a mix of financing is consistent with the benefits-received principle of taxation when externalities exist such that significant benefits accrue to non-users. Administrative and Transaction CostsAs mentioned earlier, the provision and distribution of information by the service provider, and the collection, assimilation, and use of that data by the consumer may involve significant costs. These costs must be weighed against the efficiency gains associated with a very finely tuned marginal cost pricing structure. Other administrative and transaction costs include the cost of monitoring, or measuring, the level of service consumption according to location, time, and type of consumer. Additionally, billing and collection costs of a complex pricing structure may also be high. In fact, the process of calculating and adjusting a complex pricing structure may also be high. Thus, the simple decision rule to be used to make each additional refinement of the pricing structure should simply be a cost/benefit analysis of any proposed refinement in the pricing structure. ENDNOTES1. Carol O'CLEIREACAIN, The Orphaned Capital: Adopting the Right Revenues for the District of Columbia, Washington D.C.: The Brookings Institution Press, 1997, p. 7. 2. Ibid. 3. For example, Medicaid revenues show up in Census numbers as intergovernmental aid from the federal government, not as current charges revenue to the hospital. 4. U.S. Census Bureau, Government Finance and Employment Classification Manual, June 1992, Section 7.21. 5. Advisory Commission on Intergovernmental Relations, Local Revenue Diversification: User Charges, A Staff Report, SR-6, Washington D.C., October 1996, p. 6. 6. For purposes of comparison, total state and local figures are reported for Maryland, Virginia and the U.S. This makes the comparisons more reasonable since the District has both state and local revenue raising, and service delivery, responsibilities. 7. Op. Cit., Census Bureau, Classification Manual, p. 38. 8. Ibid., p. 36. 9. Ibid., p. 32. 10. Ibid., p. 25. 11. Maryland State Department of Budget and Management, Fees and User Charges, processed, October, 1996, p. 1. 12. Interpreting comparisons between the District and other municipal governments is difficult since each of the 50 different state and local systems allocates revenue raising and service delivery responsibilities between the state and various local governments differently. We selected several cities that the District is routinely compared with and several municipalities that are city/country consolidations so their revenue raising and service delivery responsibilities are more like the District's. 13. Downing, Paul B., "The Revenue Potential of User Charges in Municipal Finance," Public Finance Quarterly, Vol. 20, No. 4, October 1992 pp. 512-27, see Table 2. 14. Osborne, David and Ted Gaebler, Reinventing Government: How the Entrepreneurial Spirit is Transforming The Public Sector, Addison-Wesley Publishing Co., 1992, p. 203-5. 15. Advisory Commission on Intergovernmental Relations, Local Revenue Diversification: User Charges, SR-6, Washington D.C.: Government Printing Office, October 1987, p. 3. 16. Downing, "The Revenue Potential of User Charges", op. cit. 17. Ibid., p. 25-6. 18. Fisher, State and Local Public Finance, op. cit., p. 195. 19. U.S. Environmental Protection Agency, Pay-As-You-Throw: Lessons Learned About Unit Pricing, Washington D.C., 1994, p. 9. 20. Miranda, Marie Lynn, Jess W. Everett, Daniel Blume and Barbeau A. Roy, Jr. "Market-Based Incentives and Residential Municipal Solid Waste," Journal of Policy Analysis and Management, 13 (Winter 1994), pp. 681-98 cited in Fisher, State and Local Public Finance, pp. 195-6. 21. Op. Cit. U.S. Environmental Agency, Pay-As-You-Throw. 22. Ibid., p. 73. 23. Reid Ewing, "Transportation Utility Fees," Government Finance Review, June 1994, pp. 13-7. 24. Ibid. 25. Cited in Ibid., p. 13. 26. This section is drawn from Roy W. Bahl and Johannes F. Linn, Urban Public Finance in Developing Countries, The International Bank of Reconstruction and Development, 1992, Part III: User Charges for Urban Services, pp. 239-381. 27. Adam Smith, An Inquiry into the Nature and Causes of The Wealth of Nations, edited by Edwin Cannan, The Modern Library Edition, Random House, Inc. 1965, p. 777. 28. Ronald C. Fisher, State and Local Public Finance, Richard D. Irwin, Inc., 1996, p. 179. 29. Advisory Commission on Intergovernmental Relations, Local Revenue Diversification: User Charges, op. cit., p. 27. 30. Fisher, State and Local Finance, op. cit., p. 180; and Ibid., p. 26. |
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