A Theory of User-Fee Competition

We develop a two-region model where the decentralized provision of spillover goods can be financed by means of taxes or user fees. In order to enforce the fees regions have to invest in exclusion. We show that a decentralized solution tends to be inefficient. There will be over-investment in exclusion and an underprovision of the spillover goods compared to a centralized solution. In addition the regions have strategic incentives to set user charges. If the regional spillover goods are substitutes user fees tend to be inefficiently low, whereas they tend to be inefficiently high if the spillover goods are complements.