Regional Science and Urban Economics 30 (2000) 703–718

www.elsevier.nl / locate / econbase

Charging for public services: the case of utilities in

Norwegian local governments
Lars-Erik Borge*
Department of Economics, Norwegian University of Science and Technology, N-7491 Trondheim,
Norway
Received 3 September 1999; received in revised form 3 July 2000; accepted 13 July 2000

Abstract

This paper empirically analyzes the determinants of utility charges using a panel data set
for a sample of Norwegian local governments. There is strong evidence of revenue
substitution in the sense that local governments increase their utility charges when other
sources of revenue (lump-sum grants and regulated tax revenue) become more restricted.
Moreover, local political institutions are shown to be important: a high share of socialist
representatives in the local council leads to high utility charges, whereas a strong political
leadership is able to keep utility charges low.  2000 Elsevier Science B.V. All rights
reserved.

Keywords: Utility charges; Revenue substitution; Asymmetric response; Politics

JEL classification: H71

1. Introduction

Since 1980 user charges have been the fastest growing revenue component of
Norwegian local and county governments. Whereas user charges amounted to less
than 6% of total revenue in 1980, the share had grown to nearly 12% by the mid
1990s. This development is by no means particular to Norway. The reliance on

*Tel.: 147-73591941; fax: 147-73591941.

E-mail address: larseb@svt.ntnu.no (L.-E. Borge).

0166-0462 / 00 / $ – see front matter  2000 Elsevier Science B.V. All rights reserved.
PII: S0166-0462( 00 )00051-X
704 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

user charges by sub-national governments has increased in most industrialized

countries, see Netzer (1992) for discussion of the US experience, Bird and
Tsiopoulos (1997) for the Canadian case, and Bailey (1994) for a survey of 10
OECD countries.
This paper focuses on utility charges that have been of great concern in the
Norwegian public debate. One reason for this is that utility charges have grown
much faster than the general price level. House owners have complained, arguing
that there is no link between the rising utility charges and the costs and quality of
the services delivered. Another reason is the substantial variation in utility charges
across local governments, which has raised a debate concerning horizontal equity
and demand for compensation through the grant system.
The paper should also be of interest beyond the Norwegian debate. First, and as
discussed above, increased reliance on user charges by sub-national governments
is an international trend. Second, in this study utilities include water supply,
discharge of sewage, garbage collection and chimney sweep. These services are
local government responsibilities in many countries, and user charges are
commonly applied. Third, the relationship between user charges and other sources
of local government revenue has been a major theme in both the academic and
public debate on user charges. It is a popular view that increased reliance on user
charges reflects that other sources of revenue, first and foremost taxes and
intergovernmental grants, have become more limited. As an example, the wave of
property tax limitations in the US around 1980 was expected to give a massive
switch to user charge financing. Despite its popularity, the view has received little
support in the scarce empirical literature. Inman (1989) reports a negative, but
insignificant, relationship between user charge revenue and exogenous revenue in
a sample of large US cities, whereas Bailey (1994, p. 746) documents that
‘‘countries with the highest percentage increase in user charge revenues also have
the largest proportionate increases in grants and local taxes’’. The empirical
evidence on revenue substitution is mixed, also for other local revenue sources.
This paper provides new evidence on the revenue substitution hypothesis by
analyzing the relationship between utility charges and other sources of revenue in
the context of a centralized system of financing with effective tax limits. As some
recent contributions in the literature (Stine, 1994; Gamkhar and Oates, 1996;
Goodspeed, 1998), we investigate whether there are asymmetries in the response
to increases and decreases in grants.
The relationship between user charges and other sources of revenue has been
investigated in earlier Norwegian studies (Borge, 1995; Hanssen and Pettersen,
1995; Aaberge and Langørgen, 1997). In contrast to the revenue substitution
hypothesis discussed above, they tend to find a positive relationship between user
charge revenue and other sources of revenue. This finding probably reflects the
ability of local governments to increase the provision of subsidized services when
other sources of revenue increase, and this quantity effect may dominate the
eventual effect of lower user charges. In this study we take advantage of a new
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 705

panel data set on user charges for a particular bundle of utility services. This type
of data makes it easier to interpret how local government charging policy is
affected by other sources of revenue.
The literature on user charges has concentrated on the efficiency potential, the
revenue potential and descriptions on how and to which extent user charges are
applied for various public services, see Bird and Tsiopoulos (1997) and Bailey
(1999, Ch. 7) for updated reviews. Much less is known about the determinants of
actual charging policy. How are user charges affected by the economic and
political environment in which local governments operate? This paper attempts to
answer this question, at least in the case of utility charges levied by Norwegian
local governments.
The rest of the paper is organized as follows. Section 2 gives the empirical and
institutional background. Hypotheses regarding the determinants of utility charges
are presented in Section 3, whereas Section 4 discusses data, estimation methods
and empirical specification. Section 5 presents the estimation results, and finally,
Section 6 summarizes the main findings of the analysis.

2. Empirical and institutional background

Norwegian local governments are important providers of welfare services like

kindergartens, primary and lower secondary education, primary health-care and
care for the elderly. Other important tasks are culture and infrastructure. The main
revenue sources are taxes (45% of current revenues), grants from the central
government (33%) and user charges (16%). Interest and other revenues account
for the rest.
Compared to most other countries, the Norwegian system of financing is quite
centralized. In principle local governments can choose tax rates within an interval
for taxes on income, wealth and property. However, since the late 1970s all local
governments have used the maximum rates in income and wealth taxation. In the
following exogenously set income and wealth taxes are denoted regulated taxes.
The opportunity to influence current revenues is limited to property tax and user
charges. The property tax amounts to 2% of current revenues, and is of little
importance.
User charges are applied for a wide range of services, but utilities, care for the
elderly and kindergartens account for most of the revenues. This paper focuses on
utilities, or more precisely water supply, discharge of sewage, garbage collection
and chimney sweep, which amounts to nearly 50% of total user charges. The
market for utilities can be characterized as a local government monopoly where it
is compulsory to make use of the services. The possibility to utilize market power
is limited by national regulations saying that user charges cannot exceed total
production costs.
706 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

Table 1
Nominal and real growth of utility charges 1991–1996 a
1991–92 1992–93 1993–94 1994–95 1995–96
Nominal growth 8.1 10.5 6.0 7.3 6.4
Inflation 2.3 2.3 1.4 2.4 1.3
Real growth 5.6 8.0 4.5 4.8 5.1
a
The figures are unweighted averages. Inflation is measured by the consumer price index. Source:
The Norwegian Association of House Owners and Statistics Norway.

Both households and businesses pay utility charges. Household charges are not
allowed to vary with income or other social characteristics. Business charges can
be calculated in a different way than household charges, and some businesses are
able to negotiate individual contracts with the local government. As a conse-
quence, the effective charges for businesses tend to be lower than those for
households, probably reflecting competition for jobs and tax revenues. This study
analyzes utility charges paid by households.
The Norwegian Association of House Owners collected the data on utility
charges applied in this study. On the basis of information from a sample of local
governments, the association calculated the yearly utility charge for a standard
house of 110 m 2 on a 1 / 4-acre lot, with water consumption of 175 m 3 per year,
the weekly collection of a garbage can of 120 l, and a yearly cleaning of one
chimney.
The growth of utility charges during the first half of the 1990s is documented in
Table 1. From 1991 to 1996 the nominal growth of utility charges was 45%. In the
same period the rise in the general price level was 10%, implying that utility
charges grew more than four times as fast as the general price level. The real
annual growth rate was 5.6% on average.
In 1996 the average utility charge for a standard house was nearly 5000 NOK
(Norwegian kroner) or around 650 USD. The variation across the 120 communities
in the sample is substantial (see Table 2), from a minimum of 2904 NOK to a
maximum of 8230 NOK. Evaluated at average household income, this difference
is equivalent to an income tax rate differential of 2–2.5 percentage-points.

Table 2
Cross-section variation in utility charges 1996 a
Min 1st quartile Median 3rd quartile Max
User charge (NOK) 2904 3976 4854 5712 8230
a
Source: The Norwegian Association of House Owners.
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 707

3. Theoretical background: the determinants of user charges

To economists, the basic rule for public sector pricing is to set the price or the
user charge equal to marginal cost, see e.g., Bos¨ (1985). This rule relies on strong
assumptions: perfect lump-sum taxation must be possible, there should be no
externalities associated with the publicly provided good, and there must be perfect
competition in the private sector. Then there is no reason to let the price depart
from marginal cost in order to raise public sector revenue, to redistribute income
among individuals, to encourage or discourage the consumption of the publicly
provided good, or to improve efficiency in the private sector.
In an analysis of Norwegian local governments it is particularly important to
take account of the centralized system of financing, see Section 2. When the range
of tax instruments is severely restricted, user charges will most likely be fiscally
motivated since they represent important local discretion to influence current
revenues. In this paper user charges are considered to be the main local tax
instruments.
In empirical local public finance the median voter model is widely used to
analyze tax and expenditure decisions (see the surveys by Inman, 1979a;
Rubinfeld, 1987). The median voter model is an example of the so-called demand
approach where tax and expenditure decisions are determined by the voters’
demand for local public services. Such a demand approach, extended to take
account of political factors, is the theoretical background for our empirical
analysis.
The point of departure is that available resources, the costs of producing local
public services, and characteristics of the population that affect ‘spending needs’,
determine the demand for local public services. Available resources are captured
by private disposable income and local government revenue in terms of lump-sum
grants and regulated income and wealth taxes. An increase in available resources
has a positive income effect that increases demand for local public services as well
as private consumption. If more resources are a result of higher private income
(PINC), utility charges are expected to increase in order to finance higher
provision of local public services. If on the other hand, more resources are a result
of higher local government revenue (REV), utility charges are expected to decline
in order to facilitate increased private consumption.
The impact of intergovernmental grants on local fiscal decisions is given much
attention in empirical local public finance (see Oates, 1999 for an updated review).
The recent US studies by Stine (1994), Gamkhar and Oates (1996) and Goodspeed
(1998) have investigated whether there are asymmetries in the response to
increases and decreases in grants. Stine and Goodspeed use panel data to analyze
the revenue response. They tend to find that local governments are more
responsive to increases in grants than to decreases in grants. Gamkhar and Oates
find no evidence of asymmetric responses in their time-series analysis of state and
708 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

local spending. We will, as Stine and Goodspeed, investigate the local revenue
response to increases and decreases in grants (and regulated taxes).
A higher unit cost in the production of local public services will reduce the
provision of services, and the effect on utility charges will depend on the demand
response.1 If demand is inelastic with respect to costs, local public expenditure
increases. And when user charges are considered to be the main tax instruments,
higher utility charges may be necessary to finance the higher expenditures. On the
other hand, increased production costs will lead to lower utility charges if demand
is elastic with respect to costs. As summarized by Oates (1986), demand for local
public services tend to be inelastic, which points to a positive relationship between
utility charges and the costs of providing local public services.
Data on the unit cost in the production of local public services are not available,
and in the empirical analysis we use proxy variables capturing population size
(POP), the share of the population living in rural areas (RURAL) and regional tax
differentials. First, we expect that small and sparsely populated communities have
a cost-disadvantage in provision of local public services. Second, there is
substantial regional variation in the payroll tax (t ). Whereas public and private
employers in urban areas paid 14.1% payroll tax in 1996, employers in the most
Northern part of the country are exempted from payroll tax. And given that local
governments use a common wage scale (determined in national negotiations) with
little room for local adjustments, the payroll tax is the most important source of
differences in unit labor costs across local governments.
Kindergartens, primary and lower secondary education, and care for the elderly
are important welfare services provided by Norwegian local governments. These
services are directed towards specific age groups of the population, and previous
studies (e.g., Borge and Rattsø, 1995) have found that the age composition of the
population is an important determinant of spending on these services. In this study
such ‘spending needs’ are captured by the fraction of the population below 7 years
of age (CH0]6), the fraction of the population between 7 and 15 years of age
(YO7]15), and the fraction of the population 80 years and above (EL80). We
expect that higher ‘spending needs’, i.e., a higher share of the population in these
age groups, will lead to higher utility charges.
Starting with Roubini and Sachs (1989a,b) and Inman and Fitts (1990), an
increasing number of empirical studies of government behavior have emphasized
the importance of political strength. Analyses of Norwegian local governments
have shown that a strong political leadership contributes to lower user charge
revenue (Borge, 1995), to lower budget deficits (Borge, 1997), and to lower
administrative spending (Kalseth and Rattsø, 1998). The general idea is that a

1
In this context the demand response refers to the effect of higher costs on the provision of local
public services in general, and not to the households’ response to higher utility charges.
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 709

strong political leadership has an advantage in opposing pressure from special

interests. In our context, an advantage in opposing pressure to increase local public
spending facilitates lower utility charges.
Two measures of political strength are applied in the empirical analysis. The
first is a traditional Herfindahl-index (HERF) measuring the party fragmentation in
the local council:

O SH
P
2
HERF 5 p (1)
p51

The share of representatives held by party p is denoted SH p . The index varies

from 1 /P (the seats are equally divided among the P parties) to unity (all seats are
held by a single party), and is inversely related to party fragmentation and
positively related to political strength.
The second measure of political strength is based on a classification of political
regimes developed by Kalseth and Rattsø (1998). It captures information about the
number of parties in the ruling coalition and its numerical strength, and is similar
to the index applied by Roubini and Sachs (1989a,b). By utilizing information
about the party affiliation of the mayor and the deputy mayor as well as the party
composition of the local council, the following variable (denoted POW) can be
constructed:

1. The mayor and the deputy mayor are from different parties and, when
combined, their parties are in a minority position.
2. The mayor and the deputy mayor are from the same party and their party is in a
minority position.
3. The mayor and the deputy mayor are from different parties and, when
combined, their parties are in a majority position.
4. The mayor and the deputy mayor are from the same party and their party is in a
majority position.

As the Herfindahl-index, POW is positively related to political strength.

Finally, a second dimension of the local political system, ideology, is included
in the empirical analysis. It is often assumed that preferences for public spending
depend on the ideological orientation of the individual. Socialists are expected to
prefer a higher level of public spending than non-socialists. Norwegian studies
using opinion surveys of voters (Rongen, 1995) and local politicians (Sørensen,
1995) tend to support this hypothesis. And given that user charges are the main
local tax instruments, it is reasonable to expect that increased socialist influence
lead to higher utility charges. In the empirical analysis we use the share of socialist
representatives in the local council as a measure of socialist influence.
710 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

4. Empirical specification

The empirical analysis is based on an unbalanced panel data set for a sample of
Norwegian local governments over the years 1992–1996. The time series of utility
charges starts in 1991, but the year 1991 is excluded from the analysis for two
reasons. First, according to the Norwegian Association of House Owners, the data
for 1991 are less reliable than the data for later years. Second, the 1991 figures for
grants and private income cannot be compared to those of later years because of a
major shift in the functional responsibility between the local governments and the
counties (grants) and a tax reform (private income).
The number of cross-section units varies from 87 in 1992 to 120 in 1994–96,2
and the total number of observations is 542. The sample is not a representative
one. First and foremost there is overrepresentation of larger urban communities.
Whereas the 120 communities in the sample has an average population size
slightly above 22 000, the average community size in the country is 10 000.
The empirical analysis is based on the following specification:

log UCH it 5 b1 log PINC it 1 b2 log REVit 1 b3 log(1 1 tit ) 1 b4 RURAL i

1 b5 log POPit 1 b6 CH0]6 it 1 b7 YO7]15 it 1 b8 EL80 it 1 b9 SOC it
1 b10 HERF it 1 b11 POW2 it 1 b12 POW3 it 1 b13 POW4 it 1 ai 1 u it (2)

UCH it is the utility charge in community i in year t, etc. ai is a community-

specific term and u it an error term. The utility charge and private income is
deflated by the consumer price index. Private income is measured net of income
and wealth taxes to local, county and national government. Local government
revenue in terms of lump-sum grants and regulated income and wealth taxes, is
deflated by the national account’s price index for local public consumption and
adjusted for minor changes in the functional responsibility between local govern-
ments and other levels of government. We use a dummy formulation of the POW
index as suggested by Edin and Ohlsson (1991).3 The category ‘different parties /
minority’ is used as reference. Sample averages and standard deviations of the
variables are reported in Table 3.
As discussed in the previous section, we will analyze whether there are
asymmetries in the response to increases and decreases in lump-sum grants and
regulated taxes (REV). The data set is well suited for this task since revenues are
decreasing for about 55% of the observations. The test for asymmetric response is
conducted by extending the basic equation in two different ways. In the first
extension REV is interacted with a dummy variable that equals unity if the
revenue growth is positive. Goodspeed (1998) uses the same formulation. In the

2
The total number of local governments is 435.
3
POWZ is a dummy variable that equals unity if POW5Z.
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 711

Table 3
Data description and descriptive statistics
Variable Description Mean (S.D.)
Utility charge (UCH) The sum of charges for water supply, discharge of 4619
sewage, garbage collection and chimney sweep (1185)
for a standard house, deflated by the consumer
price index, NOK 1996 prices
Private disposable income Taxable income minus income and wealth taxes to 64 633
(PINC) local, county and central government, measured per (7432)
capita and deflated by the consumer price index,
NOK 1996 prices
Exogenous local government The sum of lump-sum grants from the central 16 085
revenue (REV) government and regulated income and wealth (2273)
taxes, measured per capita and deflated by a price
index for local government purchases and adjusted
for minor changes in the functional responsibility,
NOK 1996 prices
Payroll tax (t ) Tax on wage expenditures paid by private and 0.127
public employers (0.040)
Settlement pattern (RURAL) The share of the population living in rural areas 0.294
(1990) (0.219)
Population size (POP) Total population, January 1 23 007
(27 547)
The share of children The share of the population 0–6 years, January 1 0.097
(CH0 6) (0.012)
]
The share of youths The share of the population 7–15 years, 0.115
(YO7 15) January 1 (0.014)
]
The share of elderly (EL80) The share of the population 80 years and above, 0.036
January 1 (0.012)
The share of socialists (SOC) The share of socialist representatives in the local 0.451
council (0.134)
Party fragmentation (HERF) Herfindahl-index measuring the party fragmentation 0.243
of the local council (0.058)
Political leadership (POW) Index capturing the party affiliation of the mayor 1.899
and the deputy mayor, and the share of seats in the (0.976)
local council held by their parties
4 — same party, majority
3 — different parties, majority
2 — same party, minority
1 — different parties, minority

second extension REV is interacted with the percentage growth in revenues. If

these interaction terms come out as significant, there is evidence of an asymmetric
response.
For several of the explanatory variables the time-series variation is limited,
whereas the cross-section variation is substantial. We therefore find it necessary to
use different estimation methods that utilize the variation in the data in different
ways. To make use of the cross-section variation in the data we start out by
712 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

estimating the model by ordinary least squares, and in most cases 18 county
dummies are included. The model is also estimated with community-specific
fixed-effects, a method which only makes use of the time-series variation in the
data. In both cases the reported t-statistics are based on standard errors that are
robust to general serial correlation and heteroskedasticity.4

5. Estimation results

The results from estimating various versions of the model by ordinary least
squares are reported in Table 4. It appears that the model explains a substantial
part of the variation in the utility charge, about 40% when the model is estimated
without county dummies and about 60% when county dummies are included.
Moreover, most estimated coefficients are consistent with the hypotheses de-
veloped in Section 3.
In column A the model is estimated without county dummies. The two variables
that capture available resources, private income and local government revenue,
come out as significant and with the expected signs. The estimated elasticity with
respect to private income is 0.7, implying that a 10% increase in private income
will increase the utility charge by 7%. There is strong evidence of revenue
substitution in the sense that local governments tend to increase the utility charge
when other sources of revenue (lump-sum grants and regulated taxes) become
more restricted. The estimated elasticity is 20.7.
There are numerous US studies on revenue substitution, and a selected review
indicates that the results are rather mixed. Inman (1979b) estimates a positive (but
insignificant) relationship between total tax revenue and grants in an analysis of
the 41 largest cities. In an extended and updated analysis (Inman, 1989) he finds
that exogenous revenue (lump-sum grants and regulated income and sales taxes
less of exogenous interest payments) has a negative impact on user charges and
property tax, but only for the property tax is the effect statistically significant.
Holtz-Eakin and Rosen (1990) find that grants have a positive (but insignificant
effect) on the property tax rate in a sample of municipal governments. Stine
(1994) and Goodspeed (1998) report that increases in grants are associated with
lower property tax revenue. Skidmore (1999) finds that grants have a significant

4
The standard errors are calculated along the lines of White (1984) and Altonji and Siow (1987).
The formula for the estimated variance-covariance matrix is

FO G FO
I

i 51
X 9i Xi
21 I

i 51
X 9i uˆ i uˆ 9i Xi GFO G
I

i 51
X 9i Xi
21

where Xi is the matrix of explanatory variables for community i, uˆ i the vector of residuals and I the
number of cross-section units. Zeldes (1989) and Shea (1995) use the same formula.
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 713

Table 4
OLS regressions a
A B C D E F
Log of private 0.713 0.564 0.599 0.598 0.585 20.019
disposable income (5.53) (3.98) (4.27) (4.34) (4.20) (20.07)
Log of local 20.693 20.701 20.685 20.673 20.650 20.509
government revenue (24.14) (23.74) (23.93) (23.75) (23.64) (22.90)
Log of 1 plus the 1.600
payroll tax (2.38)
The share of the pop. 0.455 0.324 0.319 0.308 0.322 0.242
living in rural areas (3.35) (3.26) (3.21) (3.04) (3.22) (2.36)
Log of total population 20.105 20.066 20.065 20.067 20.069 20.042
(23.15) (22.25) (22.38) (22.42) (22.49) (21.53)
The share of children 24.100 21.581 21.734 21.796 21.905 22.648
0–6 years (21.43) (20.63) (21.08) (20.72) (20.77) (21.07)
The share of youths 24.386 21.741 21.827 21.781 22.003 23.266
7–15 years (22.13) (20.95) (21.08) (21.05) (21.16) (21.87)
The share of elderly 23.833 2.323 1.993 1.882 1.783 21.073
80 years and above (21.60) (0.99) (0.86) (0.80) (0.77) (20.42)
The share of socialists 0.549 0.365 0.378 0.358 0.406 0.253
in the local council (2.61) (1.68) (1.95) (1.85) (1.98) (1.35)
Herfindahl-index 20.416 20.766 20.328
(21.13) (22.02) (20.87)
Different parties / 0.118 0.105 0.109
minority (3.69) (3.13) (3.33)
Same party / minority 20.137
(23.61)
Different parties / 20.098
majority (22.74)
Same party / majority 20.135
(22.38)
County dummies No Yes Yes Yes Yes Yes
Time dummies No No No No No Yes
R 2adj 0.396 0.578 0.597 0.596 0.597 0.612
Interaction term for test of asymmetric response:
Dummy for positive 0.001 0.000 0.001 0.000 0.000 20.000
revenue growth (0.31) (0.36) (0.43) (0.36) (0.36) (20.03)
Revenue growth 0.037 0.019 0.019 0.018 0.018 0.016
(1.36) (0.93) (0.93) (0.91) (0.91) (0.77)
a
The t-statistics in parentheses are based on standard errors that are robust to general serial
correlation and heteroskedasticity. The dependent variable is the log of the utility charge.

positive effect on local own-source revenues and an insignificant effect on

property taxes.
Three variables, the payroll tax, the share of the population living in rural areas
and population size, were included to capture differences in costs of producing
local public services. All three variables come out as significant and with positive
signs, clearly indicating that a cost increase leads to a higher utility charge. An
714 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

increase in the payroll tax that increases unit labor costs by 10% will increase the
utility charge by 16%. Given that the cost increase in the utility sector will be less
than 10%,5 it seems to be the case that the higher utility charge also finance cost
increases in other sectors. If the share of the population living in rural areas
increases by 10 percentage points, the predicted increase in the utility charge is
nearly 5%. The estimated elasticity with respect to population size is 20.12,
which means that a community of 50 000 inhabitants, everything else equal, will
have a utility charge that is 12% lower than a community of 25 000 inhabitants.
The results for the age composition of the population are not in accordance with
the hypothesis developed in Section 3. Contrary to our expectations, the three
variables come out with negative signs. And the share of the population 7–15
years of age is even statistically significant.
Local political institutions seem to affect the charging policy. The share of
socialist representatives in the local council is significant with the expected
positive sign. This is consistent with the view that socialists prefer a higher level
of local public spending than do non-socialists. The estimates indicate that an
increase in the share of socialists by 10 percentage-points will increase the utility
charge by 5.5%. In column A we use the Herfindahl-index as a measure of
political strength. It comes out with the expected negative sign, but is not
statistically significant.
In columns B–E the model is estimated with county dummies and with different
formulations of the variables measuring political strength. Since the county
dummies will pick up most of the variation in the payroll tax, the payroll tax is not
included in these equations.6 The main difference compared to column A is that we
now receive strong support for the hypothesis that a strong political leadership is
able to keep utility charges low. In column B the Herfindahl-index is used as a
measure of political strength, and it has a negative and significant impact on the
utility charge. An increase in the Herfindahl-index by one standard deviation will
reduce the utility charge by 4%. In column C we apply a dummy formulation of
the POW index. The weakest type of political leadership, ‘different parties /
minority’ is used as reference. It appears that the three other types of political
leadership, everything else equal, have a significant lower utility charge than the
reference category. The difference is in the range 10–14%. The estimates indicate
that ‘different parties / minority’ stand out as particularly weak, while there are no
significant differences among the three other groups. When this restriction is
imposed (column D), it appears that ‘different parties / minority’ leads to a 12%
higher utility charge than other types of political leadership. Equation D reports
the results when both measures of political strength are included in the same

5
The percentage increase in the unit cost of utility services is equal to the wage share multiplied by
the percentage increase in unit labor costs.
6
When the payroll was included in the equations with county dummies, it became insignificant. The
impact of the other variables is robust to whether the payroll tax is included or not.
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 715

equation. The dummy for ‘different parties / minority’ is still significant, whereas
the Herfindahl-index becomes insignificant.
The impact of the other variables is not much affected by the inclusion of
county dummies. The quantitative effects of private income, population density,
population size and the share of socialist representatives are somewhat reduced,
but they remain statistically significant. The effect of the share of elderly becomes
positive (but still insignificant) and the share of youths is no longer significantly
negative.
Most of the findings discussed above are robust to the inclusion of time
dummies (column F). The main modification is that the elasticity with respect to
private income becomes close to zero (and even negative). This may reflect a
problem of multicollinearity. When we regress private income on the other
explanatory variables in equation E, we get an R 2 as high as 0.85. It drops to 0.62
when the time dummies are excluded. In the case where time dummies are
included in the model, there may not be sufficient variation in the data to identify
the effect of private income.
Table 5 reports the results when the model is estimated with community-specific
fixed-effects. Both the share of the population living in rural areas and the
population size are excluded from these equations. The share of the population
living in rural areas is based on National Census data from 1990 and has no
time-series variation at all, whereas the time-series variation for the population
size is very limited during the short time period.
Equations A and B only differ with respect to the handling of the political
variables. It appears that private income and local government revenue are still
significant. The estimated elasticity with respect to private income is substantially
higher compared to Table 4 (around 1.0), whereas the revenue elasticity is
substantially reduced in absolute value (around 0.3).
The period under study does only cover two local elections. The political
variables for 1992 are based on the 1987 election, whereas the variables for
1993–1996 are based on the 1991 election.7 Given the limited time-series
variation, it is no surprise that the political variables have less impact when
community-specific effects are included. The Herfindahl-index is however, signifi-
cant at the 10% level in equation B.
When the model is estimated with both fixed-effects and time dummies (column
C), private income and local government revenue also lose their significance.
Again, there seems to be a multicollinearity problem. When we regress private
income and local government revenue on fixed-effects and time dummies, we get
an R 2 of 0.98 and 0.95, respectively.
The bottom rows of Tables 4 and 5 report the results of extending the models to
take account of possible asymmetric responses to increases and decreases in local

7
The politicians elected in 1987 were in office most of 1991 and prepared the budget for 1992.
Similarly, the politicians elected in 1991were in office most of 1995 and prepared the budget for 1996.
716 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718

Table 5
Fixed-effects regressions a
A B C
Log of private 1.046 1.007 20.317
disposable income (6.83) (6.48) (21.29)
Log of local 20.299 20.314 20.011
government revenue (21.99) (22.12) (20.09)
The share of children 22.975 23.302 25.200
0–6 years of age (20.92) (21.01) (21.66)
The share of youths 1.137 1.278 20.271
7–15 years of age (0.46) (0.51) (20.11)
The share of elderly 0.101 0.284 26.790
80 years and above (0.02) (0.04) (21.06)
The share of socialists 20.033 0.009 0.234
in the local council (20.25) (0.07) (1.86)
Different parties / minority 0.009
(0.46)
Herfindahl-index 20.310 0.002
(21.69) (0.01)
Time dummies No No Yes
R 2adj 0.907 0.908 0.920
Interaction term for test of asymmetric response:
Dummy for positive 0.001 0.001 20.00007
revenue growth (0.61) (0.61) (20.08)
Revenue growth 0.003 0.003 20.006
(0.23) (0.23) (20.46)
a
The t-statistics in parentheses are based on standard errors that are robust to general serial
correlation and heteroskedasticity. The dependent variable is the log of the utility charge.

government revenue. The point estimates indicate that the response is strongest
when revenues are declining, which goes in the opposite direction of the findings
of Stine (1994) and Goodspeed (1998). Given that the quantitative effects are
negligible and never statistically significant, our results are in line with Gamkhar
and Oates (1996) who find no evidence of asymmetric response.

6. Concluding remarks

Although user charges have become more important in the financing of sub-
national governments during the last decades, few empirical studies of the
determinants of user charges have appeared in the literature. Most contributions
have concentrated on the efficiency potential of user charges, the revenue potential
and descriptions on how and to which extent user charges are applied for various
public services. In this paper we were able to take advantage of a new panel data
 L.-E. Borge / Regional Science and Urban Economics 30 (2000) 703 – 718 717

set on utility charges levied by Norwegian local governments, which facilitated an

empirical analysis of the economic and political determinants of user charges.
Norway has a centralized system of financing with effective tax limits where
user charges are the main local tax instruments. The empirical analysis support the
hypothesis that user charges are fiscally motivated, first and foremost because of
the strong evidence of a revenue substitution effect: When other sources of
revenue (grants and regulated taxes) become more restricted, local governments
respond by increasing the reliance on utility charges. We find no evidence of any
asymmetries in the response to increases and decreases in grants and regulated
taxes.
The charging policy is also affected by private income and local cost conditions.
Increased private income leads to higher utility charges, probably reflecting
increased demand for local public services. The cost disadvantages of small and
sparsely populated communities are reflected in higher utility charges, and local
governments that pay high payroll taxes have higher utility charges than others.
Finally, politics are shown to be important. A high share of socialist representa-
tives in the local council is associated with high utility charges, whereas a strong
political leadership is able to keep utility charges low.

Acknowledgements

The paper has been presented at the annual meetings of the European Public
Choice Society, the European Economic Association, the Econometric Society
(European Meeting) and the Norwegian Tax Forum. I am grateful for comments
from the participants, and in particular to Matz Dahlberg, Audun Langørgen and
two referees. The Norwegian Research Council (Economic Research Programme
on Taxation) has funded the research. The Norwegian Association of House
Owners and the Norwegian Social Science Data Services have provided the data
used in this study, but they bear no responsibility for analyses and conclusions.

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