User financing—in the form of user fees, user charges, or excise taxes on certain products—is one approach to financing federal programs or activities. User fees assign part or all of the costs of these programs and activities—the cost of providing a benefit that is above and beyond what is normally available to the general public—to readily identifiable users of those programs and activities. Because user fees represent a charge for a service or benefit received from a government program, payers may expect a tight link between their payments and the cost of providing services and have expectations about the quality of the related service. For the purposes of this guide we use the term user fees to include user fees as well as excise taxes with a “user pays” element. Examples include those imposed on motor fuels, tires, and heavy vehicles that accrue to the Highway Trust Fund, from which Congress appropriates funds for federal highway and transit programs. Similarly, Federal Aviation Administration (FAA) activities are funded in part by excise taxes assessed on airline tickets, aviation fuel, and certain cargo. A highway toll may also be considered a user fee because it is related to the specific use of a particular section of highway. The boundaries between fees and taxes are not always clear and the tradeoffs among design elements presented in this guide can be relevant to both. In general, a user fee is related to some voluntary transaction or request for government goods or services above and beyond what is normally available to the public, such as a request that a public agency permit an applicant to practice law or medicine or construct a house or run a broadcast station. Taxes, on the other hand, arise from the government’s sovereign power to raise revenue and need not be related to any specific benefit, and payment is not optional; when Congress imposes taxes, it need not consider benefits bestowed by the government on an individual but may base taxation solely on an individual’s ability to pay. The Supreme Court has ruled that a tax is “an enforced contribution to provide for the support of government.” The legal distinction between a “fee” and a “tax” can be complicated and depends largely on the context of the particular assessment. Whether a particular assessment is statutorily referred to as a tax or a fee is never legally determinative. Instead, federal courts will examine the structure and the context of the assessment’s application. Fees vary in the degree to which they can be considered truly voluntary because the availability of reasonable substitutes varies. For example, to enter certain national parks, one must pay an entrance fee. The fee is voluntary to the extent that there are alternatives to national parks for outdoor recreation, for example, state, county, or private parks and recreation facilities. In contrast, people who want to operate radio stations have no similarly close alternative and must obtain a license from the Federal Communications Commission and pay a fee for that license. Agencies derive their authority to charge fees either from the Independent Offices Appropriation Act of 1952 (IOAA) or from specific statutory authority. IOAA provides broad authority to assess user fees or charges on identifiable beneficiaries by administrative regulation. User fees assessed under IOAA authority must be (1) fair and (2) based on costs to the government, the value of the service or thing to the recipient, public policy or interest serviced, and other relevant facts. Fees collected under this authority are deposited in the general fund of the U.S. Treasury and are generally not available to the agency or the activity generating the fees. Unless otherwise authorized by law, IOAA requires that agency regulations establishing a user fee are subject to policies prescribed by the President. OMB provides such guidance to executive branch agencies under this authority through Circular No. A-25. The Circular establishes federal guidelines regarding user fees assessed under the authority of IOAA and other statutes, including the scope and types of activities subject to user fees and the basis upon which the fees are set. It also provides guidance for executive branch agency implementation of fees and the disposition of collections. In many instances, Congress has provided specific authority to federal agencies to assess user fees—in agency authorizing or appropriations legislation, for example. Legislation authorizing a user fee may enact a specified rate or amount to be assessed or may stipulate how the fee is to be calculated, such as a formula; the method and timing of collection; and the authorized uses of the fee collections, which may be broadly or narrowly defined. The amount of a fee may be set to partially or fully recover costs or may be set according to some other basis (e.g., market value). Specific authorizing statutes may even grant the agency broad discretion to set and revise fee rates without Congressional approval—that is, solely through the regulatory process—based on various factors. Specific user fee statutes should be construed consistent with IOAA and OMB Circular No. A-25 to the extent possible as part of an overall statutory scheme. Of the four components of implementing a user fee, setting the rate of the fee is perhaps the most challenging because determining the cost of the service is often quite complex and requires consideration of a range of issues (see fig. 1). In theory, the extent to which a program is funded by user fees should generally be guided by who primarily benefits from the program, though, as we discuss later, the extent to which a program benefits users or the general public is not usually clear cut. This is known as the beneficiary- pays principle. Under this principle, if a program primarily benefits the general public (e.g., national defense), it should be supported by general revenue, not user fees; if a program primarily benefits identifiable users, such as customers of the U.S. Postal Service, it should be funded by fees; and if a program benefits both the general public and users, it should be funded in part by fees and in part by general revenues. As shown in figure 2, the beneficiary-pays principle can promote equity by assigning costs to those who both use and benefit from the services. First, as shown on the left side of figure 2, the extent to which a program provides benefits to the general public versus users should guide the proportion of total program costs that are paid for by general revenues versus user fees. Second, as shown on the right side of the illustration, the cost of providing the benefits to each user should be determined and assigned through user fees. Figure 3 depicts selected federal programs funded according to this principle. Secondary beneficiaries of a program generally are not considered in this examination. For example, consumers of new prescription drugs are secondary beneficiaries of prescription drug reviews, which provide a primary benefit to the drug sponsors. Similarly, fees should be charged to the direct user, even if that payer then passes the cost of the fee on to others. The entities that bear the burden of a fee—what economists call the incidence of the fee—are not necessarily those who legally must pay the fee. Fees may be passed along to others through price changes, as the fee may change the price of one good relative to another and therefore affect the allocation of resources. How prices change—and therefore the incidence of the fee—depends on (1) how responsive market supply and demand are to price changes (price elasticity) and (2) market conditions that affect an entity’s ability to control prices. The ability of payers to pass along the fee does not necessarily change the economic efficiency effects of the fee but can affect its perceived equity and the transparency of the fee. User fees set under the beneficiary-pays principle can also enhance economic efficiency by ensuring that resources are allocated to the most highly valued use, as users make adjustments to their consumption of the service based on their costs and benefits. For example, setting a Food and Drug Administration (FDA) fee for new prescription drug applications too high could discourage the development of new drugs. On the other hand, setting the fee too low induces overuse of agency resources and services. To the extent a fee is voluntary, user fees based on a program or service’s total costs may also act as a market test and can help ensure that the benefits of the program are at least as great as its costs. Under the beneficiary-pays principle, the government may wish to charge some users a lower fee or no fee to encourage certain behaviors that provide a public benefit, such as advancing a public policy goal (e.g., promoting free trade). For example: Potential profits from the development of “orphan” drugs—those that treat rare diseases—are limited by the small size of their market, and therefore drug companies may be reluctant to invest in them; such drugs are exempt from the FDA prescription drug application fee to encourage their development. Imports from certain least developed countries are exempt from CBP’s Merchandise Processing Fee (MPF), which both addresses their ability to pay and may help promote their economic development. DHS officials noted that in other cases MPF exemptions have been used as a tool to negotiate free trade agreements; an exemption may be extended as a concession for the reduction of import tariffs on certain U.S. goods. Low-income taxpayers are exempt from the $150 application fee for the Internal Revenue Service’s Offer in Compromise (OIC) program—a program for taxpayers unable to fully pay their tax liabilities—to make the program more accessible and encourage participation. Although user fees can promote one facet of equity—the beneficiary-pays principle—they may run contrary to another facet—the ability-to-pay principle. To the extent that user fees are a substitute for funding through general tax revenues, they may be less progressive than taxes and therefore shift additional burden on those less able to pay. Fees (or taxes) that are proportionally more burdensome for low-income than high- income individuals are said to be regressive.