Guide to Establishing the Level of a Cost-Based User Fee or Regulatory Charge

Step 1: Costing

Estimating the activity's full cost is the first step for all fee setting exercises. A thorough assessment of costs provides for open consultations with stakeholders as well as informed decision making.

The Treasury Board of Canada Secretariat's Guide to Costing provides detailed information and a systematic approach to costing government activities and services. The Guide to Costing should be followed in every fee-related costing exercise.

For cost-based user fees and regulatory charges, full cost information is essential because it both frames the financial context and generally represents the maximum allowable level of revenue that a given fee level can generate. This principle is most commonly referred to as "full cost representing the maximum fee level or upper limit."

Step 2: Assessing the Upper Limit

The upper limit of a fee is the departure point for determining its final price. For cost-based user fees and cost-based regulatory charges, the upper limit of the fee is marked by the estimation of full cost.

The common law and some legislative provisions, such as subsection 19(2) of the Financial Administration Act (FAA), establish that an activity's estimated full cost represents the maximum allowable price for cost-based fees and charges relating to it and fixed pursuant to the FAA. Full cost may be viewed within the context of all costs to the Crown in the provision of the associated activity.

In addition to the FAA, the authority to establish fees may be granted through some departmental or enabling legislation. If instruction regarding cost-based fees and charges is not provided in those other acts, departments should abide by the provisions of subsection 19(2) of the FAA.

The principle underlying subsection 19(2) of the FAA is that fee levels should not be designed to exceed estimated full costs. It recognizes that cost and demand forecasts are estimate-based inputs to the pricing function. As such, isolated occurrences of revenues exceeding full costs may occur without constituting a breach of the cost-based principle. It is the repeated result of revenue surplus that indicates that the level of the charge should be reviewed.

In most cases, estimated full cost is derived by totalling the costs of all functions that support the primary activity. This estimate encompasses direct and indirect costs, the latter including departmental support costs and the costs of other government departments for any material services they provide.

In other cases, however, there may be additional functions that enhance the primary activity but in a less evident or straightforward manner. The costs of these additional functions may not figure into the set of indirect costs typically associated with the primary activity, although it would be permissible to do so. The Supreme Court of Canada has confirmed, for example, that the costs Parks Canada incurs in the overall operation and administration of a park contribute to the benefit of owning a business licence to operate in that park. The business licence fee, therefore, did not need to be limited to the direct and indirect costs attached to the primary licence-issuing activity. That is, it would be valid to include the costs of maintaining the park in the full cost estimation of business licensing.^{Footnote 1}

This scenario is referred to as the cost of the regulatory scheme and represents a legitimate cost base and upper limit for fee setting purposes. Costing and fee setting on the basis of a regulatory scheme is appropriate when the recognition of the costs of additional functions is more representative of the true costs of providing the primary activity.

Step 3: Consideration of Pricing Factors

There are a number of additional factors that should be taken into account following the assessment of the maximum fee level. These pricing factors include the mix of public and private benefit, impact and contextual analysis, and stakeholder consultation. Any combination of these factors can suggest establishing the final price at a level below full cost.

It should be recognized that general taxes, through departmental appropriations, subsidize cost-based user fees and cost-based regulatory charges that do not recover the full costs of their associated activities from the users. Departmental reporting of user fee information should present both cost and revenue elements.

Departments must carefully assess the actual dollar-value impact that pricing factors will have on fee levels. Although department-wide pricing strategies may be preferable, it is reasonable that sections within a department could have charging activities that incorporate some differences in their pricing factors. This may be due to differing program mandates or regulatory requirements.

The review of pricing factors is recommended even when departmental charging strategy already suggests cost recovery at a pre-determined rate, being at the level of full cost or otherwise.

Fee Formulas

On the basis of prior stakeholder consultation, fee formulas allow for the possible adjustment of fees and charges in a predetermined fashion. Under fee formulas, fee level adjustments are automatic and generally remove the need for consultation and other analytical efforts typically associated with fee level changes. Formula-based adjustments may be activated on the basis of time or on the basis of changes to costs or demand or other factors.

The use of fee formulas can benefit both departments and users by reducing the amount of time and administrative process required to effect fee level changes. Greater fee level responsiveness in certain environments, for example, can help maintain service performance levels in the face of increasing activity costs or other production factor changes.

Section 19.2 of the FAA gives standing to fee formulas by providing authority for the automatic adjustment of certain fees and charges on the basis of predetermined amounts and ratios. The FAA requires prior public notification of the revised fee level and the manner in which it was determined. Stakeholder notification should be considered standard management practice whenever the fee implementation process provides allowances in relation to consultations.

In light of their intrinsic uncertainties, it is recommended that fee formulas contain provisions that can safeguard stakeholders from unanticipated fee level outcomes. One possible safeguard could be to reflect the mandatory review of the fee level and fee formula after a specified period of time. Another form of safeguard could reinstate the comprehensive fee setting process if application of the formula would result in a fee increase beyond a given threshold.  

Departments should be aware that, depending on their construction, fee formulas can result in fee level reductions.

Departments considering the use of fee formulas should always consult with legal advisors.

Differentiated Pricing

Departments may establish pricing regimes that recognize the varying service needs or profiles of users. For example, the level of a cost-based user fee or cost-based regulatory charge may reflect the desire for expedited service or the differing financial circumstances of citizens or within industry user groups.

When supported by relevant analysis and stakeholder consultation, differentiated pricing upholds the fairness and equity principles of user charging. Differential charges demonstrate added recognition of the issues affecting specific members of a user group.

Differential charges should not be simply read as cross-subsidization among paying stakeholders. Differentiated pricing may indicate, for example, varying levels of general taxpayer subsidy. Clear definition of user groups and understanding of the concept of the regulatory scheme will assist departments that contemplate differential charges. Consultation with legal advisors is recommended.