Part 3: Setting fees and levies

Setting and administering fees and levies for cost recovery: Good practice guide.

In this Part, we discuss what public organisations need to consider when they set fees and levies.

This guide does not set out a single standard that you must follow when setting fees or levies. Instead, we provide guidance on the information that you should consider.

This is because a public organisation can charge fees or levies for various reasons. A public organisation could also charge fees or levies for two different types of goods or services that each have their own legal authorities, policy justifications, and cost structures.

As well as expecting you to follow the principles discussed in Part 2, we expect you to consider the following questions:

  • What legal authority do you have to charge?
  • What is the justification for charging?
  • What type of fee or levy makes the most sense?

What legal authority does your public organisation have to charge?

When considering the legal authority to charge a fee or levy, you need to be clear about:

  • the legal authority’s purpose and scope; and
  • whether the fees or levies are consistent with the legal authority’s purpose and scope.

Purpose and scope of the legal authority

Some public organisations have the legal authority to charge fees or levies under different sections of one Act and/or under different Acts.

The legal authority can differ subtly or substantially between different Acts. This is also the case for empowering provisions. Some cost elements could be recoverable under one empowering provision but not under another. You will need to check the precise terms of each empowering provision.

For example, section 150 of the Local Government Act 2002 is an empowering provision that allows councils to charge fees for various services, including certificates, permits, and consents. This empowering provision states that fees must not recover more than the reasonable costs incurred by a council.

Section 36 of the Resource Management Act 1991 states that councils must follow what is set out in section 150 in the Local Government Act when charging fees for resource consents and other services and must also use the special consultative process in the Local Government Act.

You need to clearly identify and understand the scope of the empowering provision, as well as any constraints or limitations on it, before deciding how you will charge and how much.

Some Acts may require a public organisation to charge a fee or levy, while other Acts may state that charging is up to the public organisation. You should also be aware of any details in subordinate legislation, such as regulations, that set out how charges may be designed or administered.

Good practice would be to document your understanding of the legal authority in a policy manual or similar document. Ideally, this document should be in plain English and publicly accessible.

General principle of cost recovery

Setting a fee or levy that recovers more than the cost of producing the goods or providing the services could be viewed as a tax. Unless authorised by an Act, this would breach the constitutional principle that Parliament’s explicit approval is needed to impose a tax.7 Therefore, any legal authority to charge a fee or levy is implicitly capped at the cost of producing the goods or providing the services.

However, in many instances, public organisations may be authorised to recover deficits from a previous period of under-recovery. Sometimes, there are limits on recovering deficits. It is important for you to be aware of any legal restriction on the period you can recover historical deficits for.

You can manage these issues if there is enough scope in the legal authority and it is clear, at an administrative level, that you are managing surpluses and deficits within a reasonable budgeting framework for managing costs and setting fees or levies over a period of time. Memorandum accounts can be helpful in managing surpluses and deficits (see Part 4).

You will need to carefully consider the implications of any attempt to recover historical deficits through current fees or levies. In some instances, it might not be equitable to recover deficits.

For example, if recovering historical deficits is likely to result in you charging current fee and levy payers more than the costs of the goods or service they receive, the current recipients of those goods or services could be subsidising the costs of previous recipients (see paragraphs 3.25-3.29).

This might be a particular concern when a deficit is a result of an unexpected significant shock. For example, when a pandemic closes borders, agencies that charge fees for border services will see a significant decline in revenue, even though their costs remain relatively fixed. This might result in significant
under-recovery of costs.

How a public organisation addresses the deficits resulting from such a situation is a policy matter that is outside the scope of this guide. However, regular fee reviews are one way of managing equity considerations between current and future users of goods or services. We discuss this in Part 4.

Policy and other considerations affecting the amount of the fee or levy

A range of policy considerations might influence the amount you set fees or levies at. For example, although you could fully recover your costs by charging fees or levies, you might choose not to.

The fees set for civil court proceedings are an example of a public organisation charging less than full cost recovery because of policy considerations. Historically, these fees have not recovered all costs because to do so would limit people’s access to justice.8

A public organisation’s ability to charge less than the full cost of the goods produced or services provided depends on other sources of funding, such as Crown funding or rates revenue. Not all public organisations will have this option.

The circumstances that this is appropriate in are outside the scope of this guide. However, we expect you to document the policy decisions you make about charging less than the amount you need to recover costs in the methodology you use to set the fees or levies.

We encourage you to refer to the Treasury’s guidance when considering the appropriateness of charging fees or levies at a particular amount. It contains useful information on the objectives for charging fees and appropriate charging methodology.

Need to consider cross-subsidisation

Cross-subsidisation occurs when the fees or levies collected for one type of good or service cover some of the costs of providing another type of good or service. As a result, the cost of some goods or services might be over-charged and others under-charged, and some goods or services might be over-recovered and others under-recovered.

The extent to which it is possible to have any cross-subsidisation between different fees or levies depends on the wording of the empowering provisions.

For example, the Department of Internal Affairs charges for many of its activities, including passports and licences for gaming machines.9 A cross-subsidy could exist if the Department over-charged for passports and used that income to cover some of the costs of providing gaming machine licences. Another example would be if the Department over-charged for an adult’s passport and used that income to cover the cost of a child’s passport.

It might not be possible to completely prevent cross-subsidisation. Estimates of costs and division of services are unlikely to be completely accurate in all circumstances. You might not have systems that break down costs enough to avoid the risk of cross-subsidisation, and it might not always be cost-effective to do so.

However, we expect you to be aware of equity issues that cross-subsidisation can create and take reasonable steps to minimise those risks as much as practicable.

Some levies might be an example of authorised cross-subsidisation. Levies often impose a uniform cost on all levy payers, even when the costs of producing a good or providing a service to one individual might be greater than providing it to another. This might be because it is not practical or efficient to identify and charge the precise cost to produce the good or provide the service to everyone.10

Given the potential equity issues with cross-subsidisation, you might need to obtain legal advice if you are unclear about the purpose and scope of your ability to charge fees, including any questions about cross-subsidisation.

Waivers, refunds, and exemptions from fee and levy payments

A fee or levy may be waived or refunded for various reasons. There are also various reasons why a party or parties may be exempt from paying the fee or levy. A waiver, refund, or exemption might mean that, in certain contexts, other fee or levy payers will pick up the costs associated with delivering the goods or services.

For this reason, the ability to waive, refund, or exempt should be fully justified (ideally, by being explicitly provided for in the Act that gives the legal authority to charge fees or levies). In many instances, reasons for a waiver, refund, or exemption will be provided for in the relevant legislation. You need to consider any relevant provisions.

So that your decisions to grant a waiver, refund, or exemption are transparent, you also need to have clear, well-documented policies or procedures.

What is the justification for charging?

Justifying a charge means that you have a sound basis for any charge. This is found in:

  • the policy basis for the charge (which is outside the scope of this guide) and its legal authority;
  • the choices you make about the design of any charge; and
  • the efficient and fair allocation of the costs incurred in producing the good or providing the service.

The choices you make about the design of a charge can include policy considerations that might benefit from considering the principles provided in this guide (even though policy considerations are outside the scope of this guide). In making decisions on charges, we expect you to make practical and efficient choices, so that the administrative costs are not too high.

You should clearly document the justification for any charges you set and administer, so how you have reached the amounts of the charges is transparent.

Establishing the costs of producing a good or providing a service

Fees or levies should reflect the costs that you estimate that producing the goods or providing the service will incur.

Establishing the cost involves:

  • identifying the different goods that will be produced or services that will be provided and the level or quality of service needed;
  • estimating how much of each type of good will be produced or the services that will be provided in each period; and
  • identifying the resources used in producing each type of good or providing each service.

When you consider the way you structure your costs, you should also consider:

  • whether you could improve the efficiency of services to reduce costs, including the costs of administering and collecting the charges (the transaction costs in managing a charging regime should not be out of proportion to the sums involved);
  • how to deal with capital expenditure, fixed assets, and depreciation (see paragraphs 3.75-3.77); and
  • the allocation of indirect costs between activities.

Once you have gathered all this information, you can set fees or levies to charge for each type of goods or service.

Identifying and grouping goods and services

You should identify, then logically group, the goods and services that you are charging for. For services, you need to be clear about the service to be delivered and the expected service level.

It might be more practical to divide complex services into smaller components. Sometimes, it might be easier to group several related products together for costing purposes (as long as the legal authority provides for this and you take reasonable steps to minimise the risk of cross-subsidisation).

Over time, you should use forecast information to describe and calculate the anticipated changes to costs.

Once you have identified and grouped the goods and services, you need to determine and cost the resources used to produce or provide them. These resources usually include labour, materials, overheads, depreciation on fixed assets and related costs, and other relevant costs.

Your cost analysis should identify any associated activities that might not be directly related to producing the goods or providing the services, such as specific research activities or providing legal advice to the team that produces the goods or provides the services.

This will help you to consider the relationship of these costs to the goods or services. In turn, this will enable you to make a clear choice about the allocation of these costs and their recovery through the fees or levies that you charge.

You should understand the drivers of cost and consider any opportunities to improve efficiency. For example, when you assess applications, do applicants provide enough information for you to carry out the assessment efficiently? If not, costs for service users could be higher than necessary, and you could improve your communication to applicants about the information they need to provide. Greater efficiency could reduce costs to users.

Determining the cost of goods and services

There are different ways of allocating costs. These include the time needed to produce goods and provide services, the materials used, the number of goods requested, or service usage levels. We expect public organisations to have a system for allocating and collating cost information.

A system to allocate and collate cost information should take account of the context your public organisation operates in and be in proportion to the level of revenue and costs that you need to track.

Effective cost accounting methodologies that identify a public organisation’s total costs of producing a good or providing a service (by assessing the variable costs of each step, as well as fixed costs and overheads) are essential aspects of good charging practice.

To identify the resources and costs involved in providing the forecast volume of goods or services for a specified period, you need to use the best information available and make reasonable assumptions about prospective information.

You can use several methods to forecast costs. Generally, a good understanding of past costs that are adjusted for any inflationary and demand factors will provide a reasonable basis for future estimates. We expect cost inflation and demand assumptions to be documented and transparent.

It might also be necessary to consider any anticipated future costs that might affect both the forecasting of costs and recovery of them through fees and levies. Reviewing costs provides a good opportunity to look at any areas where you might be able to generate efficiency savings.

It could be appropriate to estimate a “standard rate” that averages out the resources that you expect to use to produce or contribute to a particular good or to provide or contribute to a particular service.

For example, even though workforce costs may vary, it might be useful to use an average rate based on the time it will take to produce or contribute to a particular good or to provide or contribute to a particular service. You can then use this as a basis to estimate costs over a forecast period.

Direct and indirect costs

The costs discussed above can have a direct or indirect relationship with the goods or services.

Direct costs are directly associated with producing a good or providing a service (such as labour costs to provide a service or the materials that go into making something). These should be relatively easy to identify, and include, in the cost of a good or service.

Direct costs might also include depreciation and the capital charge levied by the Treasury for those assets that you exclusively use to produce the goods and provide the services you are charging for.

If there is a clear and immediate relationship between a cost and an activity, you should, as far as practicable, include these in the cost calculation as direct costs.

Indirect costs contribute to the production of a good or provision of a service but are not incurred exclusively for that purpose (for example, rent or electricity costs for premises used for multiple outputs). They include a proportion of the capital costs associated with those assets that partially contribute to those products – for example, those associated with the building that the whole organisation is located in.

Indirect costs should be allocated based on the extent to which the indirect cost contributes to, or was caused by, the goods or services. Examples are the floor space the team providing the service uses in the building or the percentage of time that managers spend supporting that service relative to other services.

If a direct or indirect relationship is not readily identifiable (such as the percentage of a chief executive’s time that is used in overseeing one service relative to others), the costs should be allocated systematically between the various goods or services.

This could be done by including these costs as an overhead. There is considerable accounting knowledge on overhead allocations, and you should apply good practice in this area with reference to your public organisation’s circumstances.

Sometimes, overhead costs are better treated as direct costs. For example, legal costs might be better treated as direct costs if a substantial proportion of the legal team’s time is spent on issues specific to the service you are charging for. Separately estimating those costs and including them as direct costs is likely to be more accurate and transparent.

If you do this, you need to treat these costs appropriately in the overhead calculation for the charge and make sure you do not count them twice.

Allocating indirect costs might not always be straightforward, but you need to make a reasonable assessment of indirect costs and their allocation against goods or services. Whatever approach you take, you should clearly document the method for allocating overheads and other business support costs, and any assumptions should be explicit and transparent.

Typical costs incurred

Typical costs that are incurred in producing goods or providing services include:

  • labour;
  • materials;
  • overheads; and
  • depreciation and other costs related to capital.

Labour includes remuneration costs and other employment-related costs, such as fringe benefit tax and Accident Compensation Corporation levies.

Time is often an appropriate basis for allocating labour costs to different activities. If employees work on more than one type of good or service, you need to determine how to allocate their time.

If full-time recording is practical, you could gather this information by recording the time spent (by a sample of employees on different types of goods or services). If this is not practical, you could develop an informed estimate. In developing your estimates, you should clearly document any assumptions that the estimate is based on.

You can determine the average quantity of materials needed to produce goods or provide services using previous information. If that is not available, you can make estimates or do a trial run. The quantity of materials includes any usual scrap or wastage.

If you already know the volumes and costs of materials used in each period, you could determine the standard material cost for an item by dividing the estimated total material cost by the estimated number of individual items produced in the period.

Overheads include the costs of all business support services received or purchased from other parts of the organisation or from third parties (such as rent and information technology).

It is generally not appropriate to include capital expenditure (purchasing fixed assets, such as land, buildings, other physical construction, and equipment) in the calculation of costs for setting fees or levies.

Recovering the costs in the year they were incurred can treat current and future fee and levy payers inequitably, because one group will be paying for something (such as an improved information technology system) that they might not get the benefit of. This is usually not appropriate.

The cost of goods or services should include depreciation charges on the relevant fixed assets. Depreciation should be calculated based on your normal accounting policy. Where charged, the capital charge represents a cost to the organisation and should be included in the cost calculation.

The fees or levies will need to include goods and services tax in accordance with the Goods and Services Tax Act 1985.

In determining costs for charging fees or levies, you need to be careful to avoid including expenses funded through other means.

Estimating demand for goods and services

You also need to estimate the demand for each type of good or service in the period that you are carrying out the analysis for. Sometimes, this can be forecast using information from previous periods. At other times, it will be less clear, and you will need to make assumptions about the different factors that might affect demand.

Once you have information about the expected demand, you can estimate the resources you will need and their costs.

When quantifying the costs of the resources needed to meet the expected demand, you need to consider both fixed and variable costs.

Fixed costs are stable within a certain volume range and change only when significant changes in volume occur. Variable costs change continuously with changes in volume. Any technology or capital investments might also change service levels or costs.

You will need to make transparent your assumptions about the prices that you expect to pay for the resources needed to produce the goods or provide the services. You will need to use judgement to make reasonable, transparent, and logical assumptions that are based on the best available information on anticipated changes (such as inflation).

Although memorandum accounts should target a zero balance over the medium term, you will nevertheless need to review fees and levies as the relevant Act requires or when there is a significant change in costs or anticipated revenue.

This will help return surpluses or recover deficits in a timely way. It will also help to avoid triggering a limit in the relevant statute that prevents deficits from being recovered11 or a loss of equity between current and future fee and levy payers.

Determining the basis for setting and charging fees and levies

Once you have identified the cost structures and individual cost components, and estimated the volume of demand and costs that will be incurred, you can decide how to set fees or levies. You will need to factor in any policy choices that have been made about the proportion of costs to be recovered through the fee or levy and your understanding of service use.

The appropriate basis for determining the amount of a fee or levy will depend on what is produced or provided. If the goods or services are standardised, it might be as simple as dividing the total costs by the estimated number of goods to be produced or services to be provided.

However, if the costs incurred in producing individual goods or providing individual services vary significantly, an average cost might not be the best method. You might need more specific charges.

Wherever possible, you should set the fees or levies before you produce the goods or provide the services. Users should know the fees or levies in advance so they can decide whether they want to pay their share of the costs associated with the goods or services.

What type of fee or levy makes the most sense?

Types of charges include:

  • fixed charges to individuals (fees);
  • charges to groups of individuals (levies); and
  • variable/differentiated charges to individuals (such as hourly rates or the level of service that an individual service user generates). It is important to check the legal authority to know what type of charge you can use.12

Hourly rates generally recover the costs of staff salaries and a portion of overheads attributable to the service (for example, information management, costs related to premises, and costs related to health and safety). Hourly rates are particularly useful when there is a high degree of variability in the time it takes to deliver a unit of service.

Fixed charges generally recover the costs of staff salaries and overheads. This type of charge is used when there is a high degree of certainty about the time and cost associated with delivering a service.

A combination of a fixed charge and hourly rates might also be appropriate because it provides some of the benefits of both fixed and variable charges.

In these circumstances, you can set the fixed charge to cover the cost associated with most services that you deliver. The hourly rate is then reserved for when it takes longer to deliver the service.

Marginal cost charges charge an initial fee that covers direct costs and overheads. If a service takes longer to deliver than expected, additional charges seek to recover only the additional variable cost.

Marginal cost charges recognise that much of the overhead cost associated with delivering the service is fixed. Therefore, delivering additional service does not necessarily cause the service provider to incur additional overhead costs.

A levy is usually a charge that does not necessarily have a “direct line of sight” to an individual’s consumption of a good or unit of service.

Levies are often charged to recover the cost of a service, or group of services, when it is not efficient to identify the amount of the services that any one individual uses, so it is not feasible to charge for this directly. Biosecurity levies at the border are an example of this.

7: See section 22(a) of the Constitution Act 1986.

8: When the Regulations Review Committee considered these fees in 2004, it concluded that some of the increases to fees proposed at that time would create barriers to accessing the court system. Report of the Regulations Review Committee, Investigation and Complaints Relating to Civil Court Fees Regulations 2004, [2005] AJHR I16H.

9: These fees are set under the Passports Act 1992 and Gambling Act 2003 respectively.

10: Levies can be charged more precisely in some industries. This might apply to a situation where a proxy for the benefit received by a levy payer can be identified (for example, export volume), so costs incurred in establishing a specific regime can be recovered on that basis.

11: For example, section 128(4) of the Electricity Industry Act 2010 includes a limit of five years to recover a “levy shortfall”.

12: For more on the design of a cost-recovery regime, see The Treasury (2017), Guidelines for setting charges in the public sector, Part 5.