Final Report: Detailed Analysis
E1. User charging
Another reason why it is difficult to determine how to price many government goods and services is that the same good can be partly private and partly public. In particular, many natural resources are 'common pool'; that is, they provide common benefits to everyone, but unless potential users can be excluded, individuals have an incentive to over-exploit them.
Common pool resources — such as fisheries, underground water and forests — include a range of environmental assets managed by the government on behalf of current and future Australians (see Section E2 Taxes to improve the environment). Without government intervention, individuals may use such assets without taking into account the fact that by doing so they reduce other people's access to them. This can result in a 'tragedy of the commons', where assets are over-exploited and may, in the worst cases, disappear altogether.
Such problems can be addressed by creating property rights over the 'commons'. This relies both on the availability of technology to exclude users and on the community allowing the imposition of a charge for what it previously considered 'free'. A property right enables its owner to exclude users and charge them for any use that reduces the value of the resource. Set properly, the right will internalise any spillover costs so the owner has an incentive to maintain the environmental value. This has been a common solution to many current environmental problems — such as the over-exploitation of northern fisheries and water in the Murray-Darling Basin, possibly because it often provides existing users with a share of the asset, satisfying community expectations of fairness.
Alternatively, governments can maintain ownership of community resources and impose regulatory fees or charges to ration their use. Setting the optimal price can be difficult because the marginal social cost may not always be apparent (see Box E1–2).
Box E1–2: Broadcasting licence fees
The radio spectrum is an example of a common pool resource — without some form of regulation, individuals would have an incentive to congest the airwaves, reducing the benefit to society overall.
Broadcasting licence fees charge broadcasters for access to the bands of the radio communication spectrum that are primarily used for commercial television and radio services. Legislative restrictions on the number of licences made available also create large economic rents for the small number of licensees. Licence fees are imposed as a means of charging for access to the spectrum and recouping the rents. In 2008–09, approximately $311 million was collected in fees: $287 million from 55 television licences and $24 million from 273 radio licences (ACMA 2009).
Licence fees are based on a percentage of gross earnings from broadcasting advertisements, calculated in accordance with an increasing scale under which the ratio of fee to earnings rises with earnings.1 There is, however, no clear link between the fee and either the amount of spectrum that is being provided or the economic rents accruing to the licensee. Other users of spectrum pay fees for the right to use spectrum via auctions or annual taxes based on the amount of spectrum used.
The current broadcasting spectrum licence fees are unlikely to reflect the opportunity cost of spectrum and could be leaving significant economic rents to licence recipients. Charging broadcasters a fee based on spectrum use (possibly through an auction) would bring them into line with other commercial spectrum users and would encourage more efficient use of the spectrum.
Charges are particularly important for natural resource management. An environmental 'user charge' reflects the costs that individuals impose on others by exploiting common pool resources. Importantly, the user charge should not reflect the free market price. That would simply replace failing market prices with failing government user charges. For example, governments should not sell their forest timber at prices set by markets in which timber is over-exploited due to the 'tragedy of the commons'. Rather, the price should reflect the market value given sustainable management of the common pool resource.
One way to think of it is that the appropriate user charge would be similar to the price that owners with secure property rights, such as a single profit-seeking owner of the whole resource, might charge even if they were unconcerned with any environmental benefits to the wider community. In such circumstances, the monopolist (including a possible government owner) would have an incentive to maintain the sustainability of the natural resource and would charge accordingly. This should be the minimum value that Australians expect to receive for the sale of such resources (see Box E1–3).
Of course, even a price that reflects a sustainable timber yield may not reflect the full social value of timber. To the extent that there are wider public benefits from protecting some natural resources more than others, additional taxes, regulation or subsidies are likely to be needed. For example, some forest habitats may have particularly important ecosystems that make them particularly valuable to the wider society.
A sustainable system of taxes and charges should ensure that decisions to harvest native flora and fauna are informed by the environmental and social costs that harvesting can cause. In regulating harvesting activities, it is important for governments to assume that these costs are not negligible. At a minimum, governments should ensure that harvesting does not threaten biodiversity. A socially optimal level of harvesting could be delivered through a pricing structure that appropriately reflects environmental and social value.
Past governments have failed to charge appropriately for the private harvesting of flora and fauna. This has encouraged an unsustainable rate of harvesting, which has led to many species becoming vulnerable, endangered or extinct. In some cases, governments have even charged a negative price through the provision of bounties. For example, bounties were paid on 2,184 thylacines (Tasmanian tigers) prior to the species' extinction. In New South Wales, the bounties paid on more than half a million brush-tailed rock wallabies from 1884 to 1914 have contributed to the species' current listing as vulnerable. Intensive hunting by fur traders of the yellow-footed rock wallaby in South Australia in the 19th century is another example of species overexploitation that could have been avoided through the setting of an appropriate price (DEWHA 2009).
The absence of an appropriate pricing structure has enabled commercial activities to be conducted at an unsustainable rate. For example, commercial harvesting of the cycas megacarpa (a native Queensland cycad) for its starch has contributed to the plant becoming an endangered species (DEWHA 2009). Similarly, while concentrated commercial fishing of orange roughy began only in the late 1980s, it was harvested at an unsustainable rate. It took less than 20 years for it to become the first commercially harvested fish to be listed under the Environment Protection and Biodiversity Conservation Act 1999 (DEWHA 2007).
Box E1–3: Does Forestry Tasmania charge users of forests appropriately?
Tasmanian forests have important social and environmental value for all Australians. Forestry Tasmania is a State-owned enterprise, managing around 1.5 million hectares of forests for commercial, recreational and sustainability purposes.
The financial returns of Forestry Tasmania have been consistently below the risk-free rate of return (Productivity Commission 2006b and 2007).2 This is difficult to reconcile with the fact that it is largely a monopoly supplier of timber, but probably reflects the strong industry focus in how it harvests and prices timber.
Forestry Tasmania harvests its forests according to a sustained yield forest management technique designed to yield the maximum annual volume of wood from a forest in perpetuity. This may have some poor outcomes for the environment, including:
- forests with negative net returns are harvested along with forests with positive returns, as little account is taken of the market price of the timber or its social value;
- harvesting a constant amount of timber each year can lead to inefficiencies, as markets are constantly changing, with prices changing frequently. As a result, social returns may be higher overall if more trees were cut down in high price periods and fewer in low price periods; and
- it may lead to a greater loss of environmental values than under alternative models of forest management as some age classes of wood, especially old growth timber, may be harvested more quickly (Moran et al. 1991, pp. 110–111).
The pricing of the timber may also reflect commercial, over more sustainable, objectives.
The conventional technique used to price native timber in Australia is the residual value pricing method (Marsden Jacob Associates 2001). This disregards the actual price of timber and instead estimates a derived demand for a timber mill by subtracting 'reasonable' costs from the prevailing market price, including an allowance for 'normal' profit. Generally, sawmills and chippers receive the same margin for each tree, regardless of the fluctuations in the market price or variances in costs between trees. The residual value method means that if prices are low, native timber can be sold at a price below its cost of 'production'. This underpricing of timber increases the rate at which native forests are logged, especially in remote areas (Marsden Jacob Associates 2001). Further, prices are generally determined through closed-door bilateral negotiations, and the public is not told what the forest (a public asset) is being sold for. This lack of transparency makes it hard for the public to determine whether they are obtaining an adequate rate of return on timber from the native forest.
Moreover, the residual value method implicitly attaches a zero value to any environmental amenity associated with the forest. If the world price of pulp is sufficiently low, even a 500 year old tree will be sold for nothing — whatever environmental amenity it might be yielding.
Users of rivalrous goods and services should be charged a price that reflects the value from denying the consumption to others. In many cases, this will reflect the market price.
Governments should presume that all native flora and fauna, for which they are custodian, have a positive environmental value. A sufficiently high price should be charged to those authorised to harvest native flora or fauna, to ensure that the rate of exploitation does not exceed what is socially optimal.
User charging means producers are more likely to supply, and consumers more likely to value, the good or service appropriately.
Importantly, user charging relieves the need for publicly provided private goods to be funded by taxes, which are distortionary.
If governments wish to intervene in markets where there are wider social benefits (or costs) from using particular goods or services — for example, where the goods or services help people develop the capabilities they need — they should use transparent mechanisms such as subsidies or taxes.
The size and purpose of cross-subsidies within user charges — apart from those that reduce transaction costs — should be transparent to the community.
1 Section 6 of the Television Licence Fees Act 1964 provides details of the methodology for calculating licence fees.
2 The 10-year Australian Government bond rate is widely used as the risk-free return benchmark. The average rate of return on 10-year Australian Government bonds in 2005–06 was 5.4 per cent (Productivity Commission 2007).
<< Previous Page – E1–1: User charging and taxation