“What’s in a name? That which we call a tax by any other name would smell as putrid?” I am paraphrasing Shakespeare here (from Romeo and Juliet) as it seems apt for this blog topic. People complain a lot about taxes, even when what they are complaining about is, in fact, not a tax. When I try to make this clarification, the end result is not pleasant, at least for me. They usually say that it does not matter, that a tax is a tax is a tax. This attitude seems to reflect a notion that the distinction between taxes and other types of government levies is increasingly blurred. But there are very important distinctions between some revenue instruments. In fact, the courts recognize and distinguish between three main revenue instruments: a tax, a user fee, and a regulatory charge.
What is a tax? According to the courts (under the decision in Lawson) a tax is: enforceable by law, imposed under the authority of the legislature, imposed by a public body, and generated for a public purpose. Hmmm, you say, it seems that all revenue instruments would meet that definition. Not so fast, it is the last element which is the most important. What does a public purpose mean? It means that the instrument is used solely to raise revenues. That means that revenues can be used for any means. That is, a tax is a mandatory payment for the purpose of raising revenues not connected to the activity being taxed. For example, using income tax to pay for national defense or property taxes to pay for police services.
What is a user fee? A user fee, in contrast to a tax (under the decision in Eurig), is: (1) a charge for a publicly provided good or service, (2) where the revenues from the fee are solely used to offset the costs of providing the good or service, and (3) the size of fee is dictated by the cost of providing the good or service. That is, the monies collected from a user fee cannot be deposited into general revenues to offset general expenditures, but instead must be earmarked and spent purposefully. In other words, you get what you pay for. In economics lingo, user fees work on the basic principle of fairness as measured by the benefits received principle because you pay for what you get. This makes user fees ideal for goods or services where each individual user directly benefits from consuming goods or services and where the municipality may want to directly influence the level of consumption by pricing the good to encourage reductions in consumption.
In addition to revenues having to be earmarked, note carefully that the size of the fee must be directly related to the cost of the good or service. The fee can’t just be made up by deciding how high that it can be set without causing outrage. Instead, a nexus must exist between the quantum charged and the cost of the service provided in order for the levy to be constitutionally valid. If it costs $50 to provide a service, you have to charge $50 or less for that service. This also means that user fees cannot generate surpluses. Is it any wonder why economists say, “whenever possible, charge”? We like user fees because not only are the efficient, but they have a high level of accountability built into them. User fees keep the government in check and that check is built right into the revenue instrument.
What is a regulatory charge? These are very similar to user fees except that instead of being a charge for a publicly provided good or service, they are a charge for a right or privilege awarded or granted by the government. Regulatory charge must be ancillary or adherent to a regulatory scheme. The funds collected under the regulatory scheme are used to finance the scheme or to alter individual behaviour. Like with user fees, the charge must be supported by a proper estimate of the costs of the scheme. For example, fees for gravel or soil removal are regulatory charges.
As you can see, there are clear distinctions between these revenue instruments. They have very different objectives, very different requirements, and very different obligations on the government. A tax is a tax, a fee is a fee, and a charge is a charge.