Beneficiary Charges: The Cinderella of Subnational Finance

The revenue objective to cover the identifiable costs (in full or partly) is important with respect to both fees and charges. All revenue sources -- taxes, fees, fines and user charges -- are instruments of cost recovery to meet the financial obligations of public administration and the public and private supply of public goods and services. In the case of publicly supplied local goods, such as public administration, public education, health services, street lighting and sanitation, cost recovery may not be the dominant objective. But cost recovery is tremendously significant in the case of privately supplied local public goods, such as water supply, sewerage, electricity and telephone. In recent years, user fees and charges have gained significance at the sub-national level mainly because of hard local budget constraints. Recession resulted in drastic cuts in intergovernmental transfers and reduced access to market loans. According to the 2009 International City and County Management (ICMA) State Survey in the US, for instance, 46 percent of reporting local governments increased existing fees by 23 percent and added new levies for additional funds (Ebel and Petersen, 2012). While these trends are encouraging, there is no systematic research to assess the efficacy of local government in collecting fees and user charges vis-à-vis performance of other institutional arrangements such as off- budget supply and privatization. The structure of this paper is as follows. Section 2 discusses the principles and practices of user fees and charges and their revenue potential. Section 3 analyzes factors adversely impacting the growth of beneficiary charges in local government budgets, including the centralization of revenue, intergovernmental fiscal transfers, and alternative fiscal strategies such as tax earmarking and piggybacking. Section 4 examines the trade-off between budgetary and privatization regimes of water supply and the efficacy of cost recovery policies. Section 5 examines the implications of water utility policies for full and partial cost recovery vis-à-vis the marginal cost of public funds. This section also includes an analysis of the impact of willingness to pay for water on the marginal cost of public funds. An empirical analysis is carried out using the results of a contingent valuation survey in Mauritius and estimating an empirical model for measuring the welfare effects of water charges in terms of the willingness to pay and the cost of providing water. When willingness to pay exceeds the average cost of supplying water, the marginal cost of public funds is reduced, thus increasing the revenue potential of water charges. The last section concludes with policy implications.