Thursday, June 09, 2011

User Fees

The federal government is considering “user fees” as a way of addressing Canada’s deficit. To be sure, user fees will not be the be all and end all of the federal government’s deficit reduction strategy, but it look like it could form a key component of them. What are user fees? Do they make a difference? And, how do they differ from other ways of raising money for programme delivery, say taxes?

User fees sound different from “taxes” and, in some ways, more fair: those using the service pay for it. Economists, however, don’t completely agree. The distinction between user fees and taxes need not be hard and fast and is not necessarily more just.

User fees can be like taxes in the sense that we already have taxes that are targetted in the sense that not everyone pays them. For instance, not everyone pays the tax on gasoline. Only those who purchase gasoline (admitted most -- but importantly not all -- of us) pay this tax. Sin taxes (applied to alcohol and cigarettes) are paid only by those who purchase those items.

User fees are also like taxes in that they transfer money from people to the state. Here is where things get a bit complicated. One reason for having lower taxes, according to Conservatives, is that lower taxes stimulate the economy but keeping more money in people’s pockets which they then spend on things they want. So … one cannot raise taxes to pay off the national debt or to balance the books. But, if you have a user fee, the exact same amount of money is being taken out of people’s pockets. How so?

Think about it like this. Imagine that there is a programme that costs $100.00. Imagine, too, that there are 100 people in our hypothetical country (let’s call it Canuckland). To raise this $100.00, the government could tax each citizen $1, hence removing $100.00 from people’s pockets.  The government does not want to raise taxes (because that would hurt the economy) and so instead decides to have a user fee. Now, not everyone wants this service. Imagine only half of our Canuckland citizens want the service and so they each have to pay a user fee of $2 (as opposed to a tax of $1) to get this service (say, fire protection, just as an example). Those people who have not paid the user fee now have $1 more in their pocket they they otherwise would have. They are happy. They can take their $1 and buy a chocolate bar or something. But, the people who have paid the user fee have $1 less then they otherwise would have. They find themselves in a position where they need to forgo a purchase (say, they cannot buy a chocolate bar that they otherwise would have).

What is more, the exact same amount of money has been removed from the economy: $100. In other words, on an aggregate level, the user fee has not made a difference in the total level of consumer spending. The chocolate bar store owner has sold no more chocolate bars. The extra purchases from those who had $1 extra are offset by the absent purchases (that otherwise would have taken place) by those who have $1 less.

What you can see, then, is that shifting to a user fee from a tax makes no economic difference. Because the price of the service (in our case fire protection) is constant the distinction between user fees and taxes in terms of macro economics is non-existent. Our shopkeeper (our economic engine in this fictional Canuckland) is no better off. He has no extra sales so he needs to hire no new staff, order no new product, has not extra profit to devote to his or her own consumer purchases.

But, are user fees more fair? If they ensure that only those using a service have to pay for it, that might be a reason for having user fees (and, potentially, a very good one). My example is loaded but you can see from it that, in fact, the issue is more complicated then a simple “user pay” argument. Everyone benefits from fire protection whether they pay the user fee or not. How so, those not paying the fee might ask. I didn’t pay the fee knowing that the fire department will not come to my house if it is on fire. I am taking my own risk. This is true but fires are not discriminate. If my house catches on fire, then those people who live near to me are in danger (whether they have paid the user fee on not). Just by putting my house out, those around me benefit. They are safer (hence, for instance, have to pay less house insurance) by virtue of the fact that I paid the user fee. Economists call this the “free rider effect”: a person derives a benefit for which they did not pay. Generally, most people consider this unfair (getting something for nothing or getting something for which someone else had to pay) and it is one of the rationales for taxes. By making everyone pay taxes, the free rider effect (having someone else pay for your benefit) is eliminated.  The same thing can be applied to other situations: everyone in a town benefits from a good minor athletics programme, whether or not their kids play, say, soccer. How? Well, by keeping kids off the street, frankly, fewer people are harassed by crowds of teenagers.

This does not mean, I hasten to add, that user fees are unfair. It does mean that this issue is not straight forward. Sure, my examples are loaded but I am trying to make a point, or rather two: (1) the economic rationale for user fees (v. taxes) is not clear and may amount to a wash, and (2) the ethical argument for user fees is not clear and they may end up creating unfairness.
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