Politically Feasible, Revenue Sufficient, and Economically Efficient Municipal Water Rates

Abstract

"Water rates are designed to meet multiple objectives, typically resulting in trade-offs among the objectives of economic efficiency, revenue sufficiency, and related revenue stability. Standard theory of natural monopoly is extended here to explain why long-run marginal cost (LMC) can be greater than both average cost and short-run marginal cost (SMC) for municipal water utilities. The distinctions between "benign monopoly rates" and "marginal cost rate design" favor LMC over SMC as the basis for economically efficient rate design. Taking into account conservation investments by consumers, SMC rates are economically inefficient, except during temporary shortages. The City of Los Angeles adopted economically efficient, revenue sufficient, and revenue-stable water rates at the end of a prolonged drought. After the drought ended, Los Angeles (LA) modified the rate design, making the design politically feasible during normal rainfall years. Unique features in the LA rate design determine the allocation of consumer surplus among ratepayers, making the rate design politically feasible by sharing efficiency gains among customer classes. Revenue sufficiency and stability features in the rate design minimize adverse job effects on water utility management, reducing the frequency of rate hearings with an increasing block design." ("JEL" L51, L95, Q25, Q51) Copyright (c) 2009 Western Economic Association International.

The Residential Water Demand Effect of Increasing Block Rate Water Budgets

“…Hall (2009) argues that the conservation incentives provided by water budgets are even stronger than those provided by standard IBR pricing with fixed volumetric blocks because water budgets adjust the blocks according to the size of each household. Thus both large and small households pay higher prices as consumption increases, whereas small households would rarely enter the upper blocks under a standard IBR price structure.…”

“…Thus both large and small households pay higher prices as consumption increases, whereas small households would rarely enter the upper blocks under a standard IBR price structure. Hall (2009) notes that this feature also improves the economic efficiency of water budgets because all households consume marginal water, and the marginal cost of water supply tends to be increasing. Furthermore, by more closely matching the price structure to the cost of supply, water budgets help utilities maintain fiscal balance despite potentially significant demand fluctuations.…”

“…Water budgets also can accommodate equity concerns by charging lower prices for the most essential uses of water such as drinking, cooking and cleaning (Mayer et al 2008). By keeping these prices low for every household regardless of size, water budgets tend to be more politically acceptable than standard IBR pricing (Hall 2009). Last, water budgets provide utilities with the ability to respond flexibly and immediately to evolving environmental and fiscal conditions with a price-based regulatory instrument (Mayer et al 2008).…”

Economic Principles for Water Conservation Tariffs and Incentives

“…Opportunity cost revenue, , reduces the economic fixed cost that needs to be supported by additional revenue. The amount of the net fixed cost, = − , is positive when > and zero, negative when < and zero when = (Hall 2009). When the net fixed cost is positive, the system requires an additional fixed charge to cover the remaining cost.…”

Managing California’s Water: Insights from Interviews with Water Policy Experts

“…Under such systems, water users are given a larger allocation at the lowest tier if they have larger households and larger lots, so all water users face similar incentives to improve water-use efficiency (Hall 2009). Some respondents feared that many urban water agencies could not cover their fixed costs with water conservation programs (since fixed costs need to be covered even if water use declines).…”