Enacting a User Fee Policy to Establish Cost Recovery Goals

The following is an excerpt from the 2009 edition of the LGC publication Basic Financial Policies: A Guide for New Hampshire Cities and Towns.

Generally speaking, there are four major revenue sources for municipal operations: (1) tax revenue, (2) state aid, (3) local estimated revenues and (4) available funds (such as reserve funds and general fund balance). With the pressure to minimize property tax increases, leveling of state aid payments and depletion of reserve funds, increasing attention is being focused on the amount and type of locally estimated revenues, some of which are referred to as “charges" and “user fees." Although most municipalities in New Hampshire assess charges and user fees for a variety of purposes, very few have formal policies governing the adoption, review and revision of those charges and fees.

Fees Versus Charges

As explained in the Government Finance Officers Association (GFOA) Recommended Practice on Setting Government Charges and Fees, fees are distinctly different from charges, although both terms are often used interchangeably. As defined by the GFOA, “charges" are voluntary payments used to finance traditional governmental services such as water, sewer, recreational activities (such as golf and swimming) and library programs. A “fee" is imposed as a result of a public need to regulate activities, typically related to health, safety or other protective purposes. Fees result in the purchase of a privilege or authorization, such as building, fire and pistol permits.

Public Services Versus Specific Services

Before discussing the factors to consider when establishing charges and fees, there needs to be a distinction made between the types of municipal services that are appropriate for assessment of charges and/or fees. This is the distinction between a public service and a specific service provided by a municipality. As defined in the GFOA publication, Financial Policies: Design and Implementation, a “public" service is one in which a citizen cannot choose to be excluded or one which delivers a benefit to the general public. A public service is not usually subject to a user fee. Contrary to a public service, a “specific" service is one that benefits a specific segment of citizens.

Many municipal departments provide a combination of public services and specific services. For example, routine police patrols are a public service (one which provides a public good and which an individual citizen cannot opt out) whereas police presence at a special event, such as a motorcycle rally or concert, would be a specific service. Maintenance of the municipal park or the Fourth of July celebration would be considered public services, whereas a trip to the Boston Flower Show sponsored by the recreation department would be a specific service. Activities accounted for in enterprise or proprietary funds are generally for specific services to a particular constituency. These would include water, sewer and airport operations.

Statutory Authority

Since New Hampshire is not a “home rule" state, cities and towns only have the authority to do that which the legislature has granted authority to do. So, the first step in establishing a charge or user fee is to determine whether statutory authority exists to assess that particular charge or user fee. Although not an exhaustive list, Appendix K in the Basic Financial Policies: A Guide for New Hampshire Cities and Towns provides a list of the most common purposes for which municipalities assess charges and fees, along with the corresponding statutory reference cites. Some of those statutes also outline the steps necessary to establish the charge or fee, steps which may include public hearing requirements and authorization from the legislative body.

Level of Cost Recovery

After verifying statutory authority, one of the primary policy issues to consider when establishing charges and user fees is the desired level of cost recovery for the services being provided. Some rates are established to recover 100 percent of the costs, whereas other rates may recover less than the full cost of providing the services. As stated in the GFOA recommended practice, factors to consider include “the need to regulate demand, the desire to subsidize a certain product, administrative concerns such as the cost of collection, and the promotion of other goals."

Whether recovering the entire cost or only partial cost of providing a service, the full cost of the service should initially be determined. This includes direct and indirect costs, such as operating and maintenance costs, and charges for facility usage. The direct costs for some activities, like water and sewer, should also consider capital and depreciation costs associated with the on-going and future operation, maintenance and/or expansion of those systems. Indirect costs include payroll processing, accounting services, computer usage and other administrative services. Once the full cost is known, then a policy can be established stating the desired percentage of cost to be recovered for a particular service.

As previously stated, some services warrant a 100 percent cost recovery, whereas others may warrant something less. For example, water and sewer rates are often set at the level necessary to fully pay for those services and to avoid any subsidy from general fund appropriations. The corollary to that is the fact that state laws prohibit water and sewer funds from being used for any purpose other than adjustment of future rates or previous system expansion/replacements. (See RSA 38:29 for water funds and RSA 149-I:10 for sewer funds). This is a “no cross-subsidization" provision in law that prohibits water and sewer revenues from being used for other general services, like fire protection or road maintenance.

However, some charges and user fees are deliberately set at rates lower than 100 percent cost recovery, acknowledging a desire to provide a general subsidy for this service. In some cases, the percentage of cost recovery is based on the population being served, such as lower cost recovery rates for youth or senior services. In cases where less than 100 percent of the cost is being recovered, the rationale for this provision should be explicitly stated in the policy. Finally, some charges and fees may differentiate between rates for residents versus non-residents.

Periodic Review and Publication of Charges and User Fees

As stated in the GFOA recommended practice, charges and fees should be reviewed and updated periodically based on factors such as the impact of inflation, other cost increases, the adequacy of the coverage of the costs and current competitive rates. There are several options for updating charges and user fees. The first is to base the change on an updated analysis of the actual costs, with such an analysis conducted at stated intervals, such as annually, biennially or every five years. The second is to adjust the charges and fees based on a stated formula, such as the annual increase in the consumer price index. The third is to set the charges and fees based upon those assessed by comparable municipalities. However, the risk associated with this third option is that the actual costs for one municipality may vary considerably from those of other municipalities. Therefore, setting rates based solely on what other municipalities are charging may not accomplish your specific cost recovery goals.

Different time periods for a review and update may be justified for different types of charges and fees. High cost recovery charges and fees may warrant an annual review whereas low cost recovery charges and fees, particularly those assessed infrequently, may justify a review once every three to five years. It is recommended that the municipality maintain a comprehensive log of all municipal charges and fees. This should include the name, amount and description of all charges and fees, the department responsible for collection and the date of the last review. This information should be made available to the public and should be incorporated into the annual revenue budgeting process.

Whether instituting a new charge or fee, or increasing an existing one, a key factor to consider is the process to foster community buy-in. Involving all stakeholders early in the review process will help build consensus regarding the costs of the service and the need to fund the service from revenue other than property tax revenue.

The 2009 edition of the LGC publication Basic Financial Policies: A Guide for New Hampshire Cities and Towns contains additional information regarding user fees, including a listing of fees and charges authorized by statute, an example of a cost recovery policy and discussion of various means to account for fees and charges. A copy of the 2009 edition of this publication was mailed to each city and town in January 2009. Additional copies are available for purchase by calling 800.852.3358, ext. 100 or e-mailing publications@nhlgc.org.

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