Water and wastewater systems are notoriously expensive to fund; between aging infrastructure, population fluctuations, and natural disasters, operating a financially sustainable system can be difficult at best.
AWWA rate-setting best practices state that rates should be based on cost of service, which is sound advice; the intention is to promote equity by “generating revenue from each class of customer in proportion to the cost to serve each class of customer”. But rates that reflect cost of service is only one objective and may require drastic rate increases for vulnerable rate payers, which can cause public push-back and delay your funding goals even more.
Equality ≠ Equity
Smaller communities are the most at-risk for underfunded utilities. The cost of replacing pipes or building a water treatment facility is about the same as for a larger city, but unlike them, lower population communities have fewer rate payers to disperse the cost over. The higher cost per user can then become a burden, causing negative relations with public representatives and rate increases in general.
No matter the size of your community, you are likely facing political pressure to not raise rates — especially since the onset of the pandemic — as it would hurt your low-income and senior rate payers. For many communities, though, capital projects and maintenance cannot be avoided any further. Water is essential, so it’s imperative that the systems used to deliver it remain in safe, reliable and functional condition — and when they aren’t, that they are promptly and effectively replaced.
Low-income, senior, and single-occupant homes tend to be the residential users that consume the least water. With half a million households losing water service for nonpayment, a universal rate increase would disproportionately burden these low-use customers, compared to those that use excessive amounts. And this could be detrimental to their wellbeing, especially in a pandemic where water is necessary for stopping the spread of the virus thus suspending water shut offs in many areas. Although across-the-board rate increases might seem “fair” at a glance, what is equal might not be equitable. So, how can a community set sufficient rates in an equitable and affordable way? Cross-class or cross-subsidies might be your answer.
What are cross-subsidies?
If your state regulations allow it (not California, see: Proposition 218), there is opportunity to support senior citizens and other price sensitive household types, typically those within the first or second billing tiers, by subsidizing through other more affluent users within the same class but in higher tiers; this is a cross-class subsidy. Similar opportunity exists between different billing classes, say residential and agricultural; this is a cross-subsidy. Comparable views and methodologies apply to cross-class subsidies and cross-subsidies, so in some cases, the terms are discussed interchangeably.
The Division for Sustainable Development of the United Nations states, “Cross-subsidies describe a mechanism by which a group of consumers pays a price for the service higher than the cost to the utility, thereby subsidizing other groups of consumers (e.g. the poorest ones) or activities of the utility (e.g. expansion of the network). Cross-subsidies, at least in theory, have the attractive political feature that the compensation occurs within the utility and does not necessitate budget transfers from the government. However, in practice, achieving this goal supposes a careful balancing of subsidized and unsubsidized groups, so that the latter can effectively pay for the former.”
What do leading water organizations have to say about it?
The AWWA maintains, “The recommended methodology [cost-based rate-making] is aligned with industry-accepted cost of service principles that promote fair and equitable rates, discourage discriminatory pricing and cross-class subsidization, and minimize the risk of legal challenge.”
However, a Water Research Foundation study points out, “While cost-of-service ratemaking, avoidance of cross-subsidies between ratepayers, and equivalent treatment of ratepayers are time-honored principles in public utility theory, they are theoretical constructs that are intentionally blind to practical considerations that lie outside of ratemaking theory such as the real-word business problems posed to a utility by poverty.”
A key finding of a workshop held by the Consumer Council for Water was, “There is a case to be made for why cross-subsidies and social tariffs may be more appropriate and more acceptable in the water industry. Not only is water considered essential, customers have no choice of supplier.”
Water 21, magazine of the International Water Association presents an international perspective, for which the same sentiment can be applied to the municipal level. “An Independent Regulatory Commission (IRC) or national government’s incentives for making water utility rates more affordable may require some form of cross-subsidization among customer groups. […] The challenge to regulators and their governments is to address issues of rate affordability without distorting the principles of marginal cost pricing.
Cross-subsidies based on consumption levels may contain some type of lifeline rate or rising block structure, such as increasing block tariffs. The intent of such tariff structures is to protect poor households with low consumption. However, […] cross-subsidies can also affect the utility’s behavior by causing the utility to expand its network only to customers who can subsidize existing customers. Geographic areas with high-cost, low-revenue consumers will be avoided.”
How can cross-subsidies help you? Stay tuned...
Reconfiguring your rate structure may seem intimidating at first, but it’s not so difficult with the right tools. This counter-intuitive move has the opportunity to actually increase revenue, protect your most vulnerable citizens, improve conservation efforts, and promote a positive relationship between rate-payers, administration, and elected officials. Contact us to learn more.
In the next posts, we’ll dive deeper into how to define usage groups within a customer class and how rate analysis software like Waterworth allows you to model rate changes and to ensure new rates are the best fit for your community goals.