FOUNDATION FISCAL PARTNERS, PHASE V

The Appropriate Role of User Fees and Charges in State and Local Finance

Updated 29 July 1999

Executive Summary

User charges--charges imposed for providing current services or for the sale of products in connection with general government activities--have been a significant part of public finance for decades. Common examples include tuition at state colleges and universities, athletic and other extracurricular activity fees at public elementary and secondary schools, highway tolls, public transportation charges, and parks and recreation charges.

Proponents argue that user charges allow governments to impose the cost of services on the citizens who demand those services and thus allow market forces to set an economically efficient level of services. User fees may be particularly appropriate when state or local governments provide services that also are provided by the private sector, particularly if they are not core government services. User charges also may be an effective method of reducing consumption of scarce resources. State and local governments also impose user fees on businesses under the benefit principle--that is, firms that benefit from government services should pay for them. User fees may not be appropriate to finance core government services, particularly social services and education programs where services and benefits are provided based upon social objectives like reducing poverty or providing equal educational opportunities.

Opponents of user charges argue that these fees may make state and local revenue systems more regressive than they already tend to be. The problem can be exacerbated at the local government level when shifting from property taxes to user fees because property taxes are only mildly regressive--higher home values (and property tax payments) typically are associated with higher income levels.

Impact fees are one-time payments from property developers to municipal, county, or school district governments for off-site improvements necessitated by new development. Impact fees are a relatively new phenomenon that involve cash payments to local governments for off-site improvements like schools, public safety, transportation, and parks and recreation facilities. Many states adopted impact fee statutes in the 1980s and early 1990s, making such fees an important source of local government revenue in some states. Nationally, however, impact fees play a relatively small role in local public finance.

Proponents of impact fees argue that impact fees require new development to pay its own way and allow localities to use a "pay as you go" financing arrangement for new projects that avoids using general obligation debt. Opponents argue that impact fees subsidize existing residents by paying for improvements that benefit all property owners,make housing more expensive and put homeownership out of the reach of lower- and moderate-income households.

An important consideration in state and local debates about the imposition of impact fees is the incidence of such fees--that is, who ultimately pays them. It is possible for the burden of impact fees to be borne by the homebuyer (in the form of higher prices), the home builder (in the form of lower profits), the landowner (in the form of lower vacant land values), or some combination of the three.

When it comes to impact fees, education appears to be a special and difficult case. Clearly, new development can impose staggering new costs on school districts, and school boards often have little or no control over the development decisions that drive these costs. Allowing school impact fees can help give school boards a voice in steering development to areas where school capacity is available. On the other hand, education clearly has statewide benefits in terms of economic development, a qualified work force, an educated citizenry, and the increased earning power of educated citizens. Recent court decisions in Arizona have questioned localities' ability to use of impact fees for capital construction because of disparities in local governments' resources. State legislatures will want to consider the potential effect of such court decisions when determining the future role of impact fees in school construction financing.

During the past 25 years, state and local governments have reduced reliance on taxes--especially property taxes--and have increased reliance on user charges and miscellaneous revenues. Several factors that have contributed to this trend include:

The property tax revolt of the late 1970s and early 1980s and other restrictions on state and local taxation;
Policymaker and voter acceptance of fees; and
The effectiveness of fees in influencing behavior.

Issues that legislators should keep in mind when considering the appropriate role and use of user charge and impact fees are:

User charges may be appropriate when government is performing a service that narrowly benefits an individual taxpayer, or for certain government activities that compete directly with private sector providers.
User charges may be appropriate to provide market-based incentives to encourage or discourage the use of public resources.
Policymakers need to consider the impact on low- and moderate- income citizens of shifting reliance from broad-based taxes to user fees.
User charges may not be appropriate to fund services when states have a constitutional or statutory obligation to provide those services to all citizens.
User charges should cover the cost of the services provided. They should not be used to generate excess revenues that are diverted to unrelated programs or services.
Property-related assessments and impact fees may be appropriate to finance services tied to new development, but should not be used to subsidize new services for existing residents. In states where impact fees are deemed appropriate, state legislatures should adopt enabling legislation that governs the imposition of such charges.
Policymakers should be mindful of how property-related assessments and impact fees for new school construction are integrated within the state and local school construction program.

Reviewed December 2003
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