Segmented Pricing for Fines and Fees: Increasing Revenues and Fairness at the Same Time.

• Author: Dube, Jean-Pierre
• Position: RETHINKING REVENUE: SEGMENTED PRICING

Cities and counties across the U.S. increasingly rely on fines and fees to balance their budgets. For example, an in-depth study of the 39 largest cities in the U.S. showed that charges grew so much from 2003 to 2018 as to equal tax revenue for half the cities. (1) However, fines and fees disproportionally fall on low-income residents who often are strained to pay. (2) This has many ill effects: from causing harm to the most vulnerable communities that government serves to reducing the revenues raised by local government.

For these reasons, local governments must become savvier about how they manage fines and fees. A good start would be to define fines and fees and the purpose they serve. Auserfee attaches a price to a public service. This raises revenue by allocating part of the cost of the service to the person who receives the service. User fees also limit demand for a service. A fine is meant to punish transgressors of regulations and deter potential transgressors. The contention of this article is that a pricing strategy called "segmented pricing" can serve these purposes while reducing the hardships that fines and fees can place on low-income citizens. The essence of segmented pricing is to charge the citizen the price they can afford--no more, no less.

Most fee and fine structures are flat, with little or no differentiation in the price for people of different abilities to pay. Citizens pay fines and fees from their discretionary income, which is the income remaining after essentials are paid for, like housing and food. Customer segmentation recognizes that different people have different abilities to pay, and people are, therefore, treated differently based on their ability to pay. Segmentation is common in the private sector. Any time a sales representative is authorized to provide a discount to convince you to buy, the company is engaging in segmented pricing. Insurance companies segment by the risk posed by the insured. Airlines provide seating options at different price points. Universities segment by offering scholarships to low-income students.

Local governments commonly engage in segmentation too, perhaps without realizing it. The best example can be found in the most important local tax: the property tax. Senior citizen tax exemptions assume that seniors are on a fixed income and have less ability to pay the tax, so the exemption reduces the tax owed. This is not so different from senior citizen discounts provided by private firms. In the public and private sector, segmentation of seniors makes it more likely that seniors will pay because the price does not exceed their willingness or ability to pay. A more widespread example is segmentation by wealth. Property tax rates mean that taxpayers are charged according to property wealth--a proxy for their ability to pay. Income taxes also segment by the ability to pay, and the segmentation is even more obvious.

Segmentation can be applied to fines and fees. But, before we go further, it is important to address a question that some readers may have: If fines or fees are lowered for some people, might that encourage overconsumption of services or even scofflaws? This is a valid concern. For example, one study of day care services showed that charging parents a small fine for picking up their children late came to be seen by parents as a fee they could pay for the privilege of picking up their children later. (3) In another example, anyone who lives in a big city has heard stories of well-off people who park their cars when and where they please and regard parking tickets as a cost worth paying. These examples show that fines can be ineffective deterrents if set too low. However, the approach we advocate for in this article is not to undercharge anyone but rather to find the right charge for everyone--a charge that fits people's financial circumstances more precisely so that they will be able to pay the charge and the charge still fulfills its function for limiting demand or creating deterrence. Even in the case of a user fee that is intended to generate revenue, we will show that a segmented pricing strategy has the potential to increase total revenue, even if applied only to low-income individuals.

In addition to creating financial benefits for governments, segmented pricing can support more ethical government. The ethics of public service commits public officials to treat people fairly and produce good results for the community. (4) For example, the typical one-size-fits-all structure of fines means that low-income people pay proportionately more. That means the punishment is greater for low-income people. This is not fair. (5) Furthermore, excessive fines and fees can further imperil the financial health of vulnerable citizens. For example, most low-income people don't have much, if any, discretionary income. (6) A financial shock, in the form of an excessive fine, makes it harder for these people to afford essentials. This might cause them to accumulate debt with the local government. Aggressive collection practices could worsen the situation. (7) For example, suspending a driver's license makes it harder to get a job, or a collection agency might damage a person's credit score. These situations can lead to a poverty trap. (8) Further, people struggling to pay their other bills tend to become less compliant with other regulations, like laws, building safety, etc. (9) None of this is a good result for the community.

Customer segmentation: the key to a better approach

In economics, a person's willingness/ ability to pay is represented by a demand curve, which we depict in Exhibit 1. It shows that different quantities of any good or service will be purchased at different prices. Local governments typically set a single, one-size-fits-all price for everyone [e.g., a water rate, a set fine for a given infraction]. At the given price, a given quantity will be purchased. (10) This is where the two dotted red lines intersect the blue demand curve in Exhibit 1.

A greater quantity will be purchased as the price decreases. However, it could be financially unsound for local government to simply lower its one-size-fits-all price because the new price multiplied by the new quantity might be less than the old price multiplied by the old quantity.

This is where segmentation comes in. Every person's willingness/ability to pay can be understood to fall along some point on the demand curve. To illustrate, the "X" on Exhibit 1 represents a hypothetical willingness/ ability to pay for a low-income person. Because the set price is above their willingness/ability to pay, they will likely not pay, either because they don't have the money or because they are likely to spend the money on other things [e.g., food, housing, etc.]. Hence, the local government can realize greater revenue by charging our hypothetical low-income person the price that person is willing/able to pay. The math is simple. If the government maintains the price for the...