12.2 Design Considerations for User Charges

The feasibility of implementing a user charge depends on the ability to measure the service’s output. This involves determining the appropriate type of output measure and ensuring that the measure is practical and cost-effective. Effective exclusion of non-payers is also essential, and the system should minimize opportunities for charge avoidance. The extent to which a user charge covers the cost of a service is influenced by objectives related to resource conservation and/or externalities. In the case of positive externalities (e.g. public health), governments may be inclined to have a lower fee (compared to the cost of the service) whereas for negative externalities, cost may be higher. The setting of the user charge should align consumption with broader societal goals, either by promoting or discouraging certain behaviors.

12.2.1 Price Discrimination and User Charges

User charges can vary with (1) usage volume, (2) time of use, and/or (3) type of user. When charges increase with higher usage, it reflects a constant or rising marginal cost per unit, promoting conservation by discouraging excessive consumption. Conversely, if charges decrease with higher usage, it can encourage higher use. Charges can also vary by time of use (e.g., day, week, month) depending on demand patterns. For services with significant demand variation or limited capacity at peak times, adjusting charges can help manage congestion. The feasibility and cost of adding capacity during peak times also influence this approach. For example, a zoo might vary its entry fees by season or time of day, charging higher prices during peak periods to encourage more uniform attendance.

User charges can also vary by the type of user, reflecting different pricing strategies for specific groups like seniors, children, or students. This differentiation considers variations in unit costs among user types and/or differences in willingness-to-pay. It is also possible that the presence of externalities associated with certain groups can justify differentiated charges. In some industries, price discrimination based on varying willingness-to-pay allows for higher profits by tailoring prices to different users. Differentiation based on the ability-to-pay is another approach that is motivated by equity considerations. This can involve means-testing to adjust charges according to financial capacity, especially when services are essential. However, applying user charges can sometimes create a regressive impact, placing a greater financial burden on lower-income users who may need these services.

Non-residents may be subject to different pricing structures to account for the higher costs associated with providing services to them. Since public services are often subsidized by general taxes paid by residents, differentiated charges ensure that non-residents contribute fairly to their usage. This pricing approach also helps preserve adequate capacity for residents by discouraging excessive non-resident use, similar to the distinction made between in-state and out-of-state tuition fees at public universities. An example of this practice is seen at the Memphis Zoo where it is called “Tennessee Tuesday”:

The Memphis Zoo allows free general admission to Tennessee residents with ID on Tuesday afternoons from 2 p.m. to close.

This policy provides residents with a benefit funded by local resources, while non-residents continue to pay regular admission fees, aligning with the principle of local tax support for public services.

A two-part user charge divides the total fee into a fixed component and a variable component, where the full charge is the sum of a fixed fee and a charge per unit of usage. The fixed fee is often linked to depreciation costs for capital components of the service and other fixed costs, distributed across all users. The variable charge per unit reflects the unit cost of non-fixed expenses, aligning charges more closely with actual usage. The primary advantage of a two-part used charge approach is that it allows for full cost recovery while promoting efficient consumption decisions, as users pay directly based on their usage level. However, a notable drawback is that the fixed fee portion of the charge tends to be regressive, disproportionately impacting lower-income users, as they pay the same fixed amount regardless of usage.