Reflections on Water Pricing and Tariff Design Prof. Dale Whittington University of North Carolina at Chapel Hill Prof. John Boland The Johns Hopkins University April 3, 2001
Mar 30, 2015
Reflections on Water Pricing and Tariff Design
Prof. Dale WhittingtonUniversity of North Carolina at Chapel Hill
Prof. John BolandThe Johns Hopkins University
April 3, 2001
Outline of Presentation Objectives of water pricing and tariff
design Alternative Tariff Structures -
Definitions Observations on Increasing Block
Tariffs (IBTs)
Water Tariff The set of prices, charges and taxes
used to generate revenue and The rules and regulations which
govern their use
Average Residential Water Tariffs - Selected Asian Cities (US$ / m3 ,1997)
0.00
Price US$/m3 Cities
0.70
0.20
0.50
Calcutta, Delhi, Beijing, Mumbai, Shanghai, Karachi, Dhaka
Ho Chi Minh, Colombo, Lahore
Manila, Seoul
Bangkok, Kuala Lumpur, Taipei
Singapore, Hong Kong
Jakarta
Functions of the Tariff Determines level and pattern of revenue Contributes to ability to attract capital Creates incentives affecting the
production and use of services Influences the value of the services
received and the total cost of production Allocates cost among customers, groups
of customers, and over time
Purposes of the Tariff Economic Efficiency Fairness (a perception) Equity (a testable hypothesis) Revenue sufficiency Net revenue stability Simplicity and understandability Resource conservation
Additional Considerations in Tariff Design Public acceptability Political acceptability Ease of implementation Enhancement of credit rating
Criteria versus Average Tariff
0.00
US$0.05/m3
US$0.50/m3
US$1.00/m3
% who can afford a private water connection
Low
Medium
High
Very High
Water consumption by hh’s with private water connection
Low
Medium
High
Very High
Low
Medium
High
Very High
Economic benefits received by hh’s with private water connection
Criteria versus Average Tariff
0.00
US$0.05/m3
US$0.50/m3
US$1.00/m3
Revenues received by water utility
Medium
High
Low
Zero
Costs to water utility to deliver water supply
Low
Medium
High
Very High
Low (None?)
Low (None?)
High
Very High
Economic costs paid by others (e.g., subsidies needed by water utility)
Hierarchy of Objectives
Most restrictive
Least restrictive
Economic Efficiency Equity Simplicity,
transparency Fairness Resource
conservation Net revenue stability Revenue sufficiency
Service Quality vs. Cost Recovery
Asian Water Utilities Handbook,1997
Good Service Poor Service
Costs Recovered
Kuala Lumpur
Seoul
Singapore
Taipei
Colombo
Hanoi
Jakarta
Lahore
Costs Not Recovered
Beijing
Hong Kong
Shanghai
Kathmandu
Dhaka
Manila
Some Basic Tariff Options Single part tariff, consists of either:
Fixed charge (not based on measured water use)
Volumetric charge (based on measured water use)
Two part tariff, includes both fixed and volumetric charges
Volumetric Charges Uniform price - all units of water billed at
same price Block-type structures - two or more
prices, each applies to use within a defined segment (block) of monthly use Decreasing block - block price falls as use
rises Increasing block (IBT) - block price rises as use
rises [Note: first block price usually set below cost]
Tariff Design - Uniform Price Periodic fixed (“service”) charge,
e.g., US$/month/connection Single commodity price, e.g., $/m3
Example (in US$):$5.00/month for residential
connection, plus$1.00/m3 for all water use
Tariff Design - Decreasing Block Periodic fixed (“service”) charge Two or more commodity prices
($/m3), decreasing with use:$5.00/month for residential connection, plus$1.50/m3 for all water used up to 15
m3/month$1.00/m3 for all water used in excess of 15
m3/month, up to 30 m3/month$0.75/m3 for all water used in excess of 30
m3/month
Tariff Design - Increasing Block (IBT) Periodic fixed (“service”) charge Two or more commodity prices
($/m3), increasing with use:$5.00/month for residential connection, plus$0.75/m3 for all water used up to 15
m3/month$1.00/m3 for all water used in excess of of
15 m3/month, up to 30 m3/month$1.50/m3 for all water used in excess of 30
m3/month
Tariff Design - Variants Increasing rate designs Combination block designs Free service allowances (form of
increasing block) Seasonal water tariffs Seasonal sewer tariffs Lifeline rates
U.S. Water/Sewer Agencies 50,000+ water utilities 30,000+ wastewater utilities Urban places with 100,000+
population 300 water utilities 200 wastewater utilities
U.S. Government-Owned Water Utilities 80 percent of total 85-90 percent of large systems Very few subject to tariff regulation
by State Only 12 of 50 states with laws
restricting pricing practices
U.S. Investor-Owned Water Utilities 10-15 percent of large systems Subject to tariff regulation by State
agency, based on rate-of-return
U.S. Water Tariffs
1982 Survey 1992 SurveyDecreasing Block 60% 45%Uniform Price 29% 37%Increasing Block 11% 18%
Commonly Overlooked Facts I Water and sewer services are
bundled commodities Users respond to the sum of water
and sewer tariffs Developing tariffs separately
according to different criteria is illogical
Commonly Overlooked Facts II Prices determine water use, not tariff
design Each user responds to his/her last block
price regardless of what other prices may be, or what other users may do.
Block type rates permit price discrimination, individual users respond to the price in specific block(s)
Increasing Block Tariffs (IBTs)
Still actively promoted in developing countries
Water pricing is an important instrument for stimulating efficient use of water. A basic amount could be used at a relatively low rate, while water consumption beyond that amount could be charged with progressively higher rates. (Urban Water Resources Management, UN, 1993, p 19).
Widely used in OECD countries
IBT Example: La Paz, Bolivia
(US$/cu.m.) Domestic User Commercial User Industrial User1.19 Above 300 cu.m./mo Above 20 cu.m./mo. All use0.66 151-300 cu.m./mo. 1-20 cu.m./mo.0.44 31-150 cu.m./mo.0.22 1-30 cu.m./mo.
Examples of IBTs
What is Rationale for IBTs? Claimed to transfer income from rich to poor Claimed to transfer income from firms to
poor HHs Very high prices in top blocks claimed to
discourage “extravagant” and “wasteful” use
IBTs are said to implement marginal cost pricing principles
IBTs are said to reflect assumed rising marginal cost curves
IBT Rationale Revisited I
Rich subsidize the poor Average price rises with HH use.
Therefore, to the extent that water use is correlated with income, subsidy occurs.
Maximum possible subsidy is small (typically US$1 to US$3 per month)
Subsidy is regressive within the lower blocks
IBT Rationale Revisited II
Firms subsidize poor households IBTS produce such a subsidy Subsidy is regressive within the lower
blocks If subsidy were desirable, it could be
achieved more easily by sectorally differentiated prices
Subsidy may not be desirable: large users may exit system, increasing average costs for residential users
IBT Rationale Revisited IIIIBTs discourage “extravagant” or “wasteful”
use No clear what “extravagant” means If “wasteful” means uses that do not justify
the resource cost of the water, then: Setting price equal to marginal cost means that
every customer pays to replace every unit of water taken, regardless of the type of use
No further incentive is necessary or desirable
IBT Rationale Revisited IVIBTs are consistent with marginal cost pricing There is only one marginal cost for a given
class of customers at a given time IBTs result in different customers within the
class paying different prices at any given time, based on their total monthly use
At most one of these prices can equal marginal cost; all others represent a divergence from marginal cost pricing principles
IBT Rationale Revisited VIBTs track rising marginal costs Marginal cost is not necessarily rising, even in
developing countries If marginal cost is rising, it rises as a function of
aggregate water use; it does not change perceptibly with changes in water use by a single HH
Prices are meant to reflect the costs imposed by additional water use by the HH. These are the same for all HHs in a given class at any given time.
Marginal cost may rise over time; then prices should also rise over time, but for all uses
Limitations of IBTs in Practice Difficulty in limiting size of the first block Difficult to provide proper economic incentives to
most customers Difficult to meet revenue target without large
departures from marginal cost Lack of transparency and difficulty of
administration In the case of shared connections, or where
connected HHs resell water to vendors, IBTs increase cost to the very poor
An Alternative to Increasing Block Tariffs Use lump-sum transfers for income
redistribution and other fairness objectives
This allows the choice of a uniform price design, preferable according to all other criteria
Lump-sum transfers can lead to negative fixed charges for some users
A Practical Alternative to IBTs: Uniform Price with Rebate (UPR)
Two-Part Tariff IBT DesignFixed Charge (US$/mo) -6.69 0.00
Minimum Charge (US$/mo) 2.50 2.50US$/cubic meter
0-15 cubic meters/month1.00 0.50
US$/cubic meter>15 cubic meters/month
1.00 1.00
Household Water Bill: UPR vs. IBT
Household’s Monthly Water Use (m3)
Uniform Price with Rebate
Increasing Block Tariff
5 US$2.50 US$2.50
10 US$3.31 US$5.00
15 US$8.31 US$7.50
20 US$13.31 US$12.50
25 US$18.31 US$17.50
Two-Part Tariff: Evaluation Both tariffs produce the same revenue Two-part tariff provides improved
incentives: More HHs face full marginal cost with a UPR
than with a IBT. Only the smallest, most price inelastic HHs face a zero incremental price
Two-part tariff more effective in transferring income: Per-HH transfer is larger Transfer is not regressive
Two-Part Tariff: Evaluation Two-part tariff is simple and
transparent Two-part tariff is more equitable Advantages of two-part tariff even
greater when compared to a multi-step IBT
Conclusions Usual rationales for employing IBTs are either
incomplete or incorrect There are significant practical difficulties with the
application of IBTs in developing countries If the purpose of an IBT is to redistribute
revenue, alternative tariff designs can do so more effectively
IBTs, on the other hand, introduce inefficiency, inequity, complexity, lack of transparency, revenue instability, and forecasting difficulties
Conclusions (cont.) Properly designed tariffs are powerful
management tools Comparisons of alternative designs can
be complex No single design fits all circumstances Increasing block designs, though widely
used, have many disadvantages Better tariff design is possible