Understanding progressive & regressive water pricing
By Antonio & Manny Teodoro
How do utilities distribute the costs of drinking water systems to their customers in their rate structures?
The answer is surprisingly complicated, and water utility pricing is often weird. There are lots of other wrinkles and variations, but the vast majority of utilities use one of three basic rate structures:
- Uniform, where customers pay the same price for every unit of water that they consume;
- Inclining block, which charge higher prices as volume increases; and
- Declining block, which charge lower prices as volume increases.
It’s easy to see that these different rate structures distribute costs differently, but how much differently isn’t immediately obvious. How do a utility’s rates apply to low-volume customers compared with high-volume customers?
The answer is important because it carries significant implications for affordability and conservation. It also speaks to risk tolerance and questions about fairness. Water is an unusual consumer good because its use is very different at different volumes. For residential customers, low volumes are mostly used for basic needs like drinking, cooking, cleaning and sanitation. Higher volumes are usually for more discretionary uses like lawn irrigation and car washing.Studies of water rate structures typically put them into the three main categories (uniform, inclining, and declining), which is fine, but can mask some important variation within the inclining and declining blocks. Consider four imaginary rate structures:
A and B are both inclining block rates, but A is more progressive than B because prices increase sharply for A as volume increases. Similarly, C and D are both declining block structures, but C is more regressive than D because C discounts higher volumes much more than D.
David Switzer developed a way to measure water rate progressivity to reflect that variation, and published a paper last year that uses regression slopes to measure relative progressivity. It’s a creative, rigorous, and smart methodology, but it’s pretty sophisticated and not the easiest approach for communicating with the general public.
In search of a valid but more intuitive way to communicate the idea of progressivity, we struck upon the idea of comparing average unit costs of water at relatively conservative and very high benchmark volumes. What would be appropriate comparative volumes? And how could we frame the measurement in an engaging way?
Enter Amy Poehler
Amy Poehler was a particularly profligate water customer. In the summer of 2015, while drought ravaged the Golden State, the Parks & Recreation star’s Beverly Hills home used 85,000 gallons a month. Meanwhile, a family of four that is fairly conservative with water uses something like 6,000 gallons per month for drinking, cooking, and sanitation.* In other words, Poehler’s home consumed in about two days enough water to comfortably supply a family of four for a month.
Shaming celebrities for bad environmental behavior is now something of a ritual in America, and it’s not clear whether exposing excess actually helps. But Poehler’s water consumption provides a convenient benchmark for excess.
The Amy Poehler Index
So to measure progressivity we calculate the total monthly water and sewer bill—including both fixed and volumetric charges—for a customer at 6,000 gallons (a conservative family) and at 85,000 gallons (Amy Poehler’s family), then divide that price by each customer’s total volume. These are average unit costs. The ratio of the two unit prices is the Amy Poehler Index (API). A value of 1.0 means that Amy Poehler and the conservative family pay exactly the same unit price for water. Values less than 1.0 indicate regressive rates (Amy Poehler pays less than a conservative family), and values greater than 1.0 indicate progressive rates (Amy Poehler pays more than a conservative family).
Let’s look at how this works for a couple of large U.S. city water systems under their 2019 rates:
In 2019 Tampa’s fixed monthly charge for water was just $1.50, with no fixed charge at all for sewer. Under Tampa’s inclined five-block rate structure, Amy Poehler would pay $617.82 monthly, while our conservative family would pay just $19.29. On a unit cost basis, those prices equal $7.27 and $3.22 per thousand gallons, respectively. The resulting API is a progressive 2.26.Meanwhile, in 2019 Philadelphia charged its customers a fixed $5.12 for water and $7.04 for sewer each month. The City of Brotherly Love then applied declining block water rates that would have charged Amy Poehler $455.69 monthly, and the conservative household $41.10—more than twice the Tampa bill for the same volume. The resulting unit costs turn out to be $5.36 for Amy Poehler and $6.85 for our conservative family, for a regressive API of .78.
The National Progressivity Picture
We used data from the Teodoro & Saywitz 2019 affordability update to calculate API for a nationally representative sample of 399 U.S. water and sewer systems. Average combined water and sewer rates were slightly regressive at .88, but ranged widely from .07 in Anchorage, AK to 3.81 in Phoenix, AZ.
API isn’t as precise as Switzer’s progressivity coefficient, but in our national dataset the two metrics correlate pretty well (ρ=.71). More importantly, the API offers an easy way to understand and improve the ways that communities distribute costs through their rate structures. That seems like the sort of thing Leslie Knope would probably dig.
to win not to lose in water utility management
Warning: strained sports metaphor coming.
It’s late January, and the National Football League season soon reaches its climax with the Super Bowl. Both of last weekend’s conference championship games saw a high-octane home team take the lead. By late in the game, the winning teams’ strategies shifted from trying to score to trying to run out the clock. That meant lots of prevent defense, a tactic familiar to any reasonably attentive American football fan.
Prevent defense is an ultra-conservative strategy, designed to use up time and avoid disastrous, long passing plays—the goal is not really to stop the opposing team, but rather to manage moderate losses. A coach who deploys a prevent defense isn’t so much trying to win as he is trying to avoid losing. That works fine when the team that’s ahead has a comfortable lead. But when the lead is tenuous, prevent defense courts disaster because it can allow a quarterback to lead a heroic comeback. Legendary NFL coach John Madden famously declared that: “All a prevent defense does is prevent you from winning.”
Naturally, all of this makes me think about water utility management.
Compliance as performance
A few years ago I took a water operator training class through Texas A&M Engineering Extension. The course covered principles of safe operations, along with the basic math, chemistry, and physics that operators need. What really stood out to me was how virtually everything about our training involved regulatory compliance. Treatment plant operations, distribution system maintenance, even safety protocols, were all framed in terms of following rules and avoiding violations.
Things don’t seem much different in utilities’ executive suites or board rooms. Although the rhetoric of excellence abounds in water management circles, real policy decisions and capital investments tend to follow regulatory requirements. Treatment plant upgrades happen when the EPA formulates a new rule. Sewer capacity expansions come when overflows become so frequent and egregious that regulators force a consent decree.
A water system’s strategic goal might be public health, environmental quality, citizen trust, and economic prosperity, but the utilities’ management tactics often boil down to regulatory compliance. The practical goal is not so much to achieve good things, but to avoid bad ones.
The main reason is money. One of the challenges of managing great water and sewer systems is that the price of a water is much more visible than quality of water. Customers—who are also voters—know for sure what they pay for it when they get the bill each month. Water systems are literally buried. Unless quality is egregiously awful, the only marker of a system’s quality is regulatory compliance. It’s hard for utilities to demonstrate their real value in terms of anything but monthly bills and disasters.
Utility leaders are thus stuck between a rate increase rock and a regulatory hard place. For many, “success” means avoiding rate increases and regulatory violations as long as possible. The folks who operate these essential systems don’t like running them to the brink of failure, but as one city utility executive told me: “It’s hard to get anything done without a regulatory boot to your backside.”
That’s a fundamentally negative way to think about performance. Is it any wonder that utility managers often run a prevent defense?
From loss avoidance to winning
There are some creative, dynamic, and courageous leaders in the water sector who have found ways to build achievement cultures in their utilities. But hoping for the serendipitous arrival of an exceptional leader isn’t really a strategy. What would it take to change the game? How can we get utility leaders to think about seeking success, rather than avoiding failure?
What’s needed is a comprehensive, independent, and visible system for monitoring and reporting water and sewer utility performance. What if there were monthly box scores for utilities? What if they received a report card and grade point average every year, with results reported publicly?
Aquam cum laude
This isn’t really a radical idea; Congress had transparency in mind when it required utilities systems to provide water quality reports, and the State of New Jersey was thinking about political accountability when it launched the Water Quality Accountability Act. Too often we forget that public information about water system performance also creates a credit-claiming opportunity. But reporting under those laws is complicated and in many ways opaque.
Anyone who has been to high school understands grades and GPAs. A simple, comprehensive report card would give a utility’s leaders a way to communicate progress. A new management team could set clear improvement targets and show how their efforts moved the system’s GPA from 2.7 to 3.5. Mayors and councilmembers could trumpet the improvements, helping to demonstrate the value of those unpleasant rate increases. Water systems that achieve and maintain consistent excellence across the board would qualify for the Dean’s List.
I’m a big believer in the power of measurement and incentives. If we keep score correctly, our utility leaders can do more than avoid disaster—they can play to win health, environmental quality, and economic prosperity for our communities.
© 2020 Manny P. Teodoro
U.S. water utilities are shifting costs to low-volume customers—good for revenue stability, but bad for affordability
Rising water and sewer prices linked to increasing capital and operating costs are driving affordability concerns across the United States, and with good reason. Studies of water rates typically measure prices at benchmark volumes that are meant to reflect “average” residential customers.* But for purposes of low-income affordability, how a utility structures its prices across levels of demand is as important as what it charges an average customer or how much total revenue it pulls in.
Over the past year I’ve been working with Texas A&M graduate student Robin Saywitz to analyze 2019 water and sewer rates data.† Among other things, we’re comparing our recent dataset with similar data from 2017. Although it’s difficult to infer trends from just two time periods, we’re seeing a troubling pattern in U.S. water and sewer rates: not only are prices increasing overall, average prices are rising much faster for low volumes than for high volumes.
That’s very bad news for affordability. Why are utilities squeezing their low-volume customers with higher prices?
The answer starts with two broad water sector trends that have converged to drive water prices to their present point. First, long-deferred capital maintenance and upgrade costs are finally coming due, and long-deferred water and sewer revenue needs are rising accordingly. Utilities need more money to pay for pipes and people. Emerging challenges like lead service line replacement and new contaminants like PFAS only make things more expensive.
At the same time, average urban water demands have been falling steadily over the past twenty years. Back in the 1990s when I first got into the water business it was an article of faith that long-term water demand increased with economic and demographic growth, and long-term supply adequacy was a paramount concern in many parts of the U.S. The water sector responded with a widespread push for conservation. Thanks to organizations like the Alliance for Water Efficiency, we’ve seen an astonishing decline in average water demand—especially for essential indoor use. For the first time, America has seen sustained urban growth with steady or even declining overall water consumption. That’s an extraordinary accomplishment, and it’s rightfully celebrated.
But the combination of rising costs with declining average demand creates a revenue problem for water utilities. Declining total demand means that the average price of water must increase steeply in order to generate needed revenue.
Perils of progressive pricing
For years, utilities have been pushing for progressive water rate structures to distribute costs equitably and to encourage conservation. Indeed, progressive pricing is part of why we’ve seen declining demand. As I’ve observed before, water service is unusual in that its use varies considerably at different levels of demand. For residential customers, low volumes reflect essential uses like drinking, cooking, cleaning, and sanitation. Higher volumes are typically associated with discretionary uses like car washing and outdoor lawn irrigation. So progressive rate structures that charge relatively low prices for low water use, steeply higher marginal prices for high volume use, and volumetric sewer charges generally result in better affordability. What’s more, good rate design helps affordability without the transaction costs, administrative burdens, and social stigma that come with means-tested assistance programs.
But progressive rate structures raise utilities’ revenue risk. Revenues from volumetric charges fluctuate vary seasonally and can skyrocket or plummet depending on the weather. A utility doesn’t sell much high-priced, high-volume water if it rains all summer and nobody waters their lawn. Even worse, sales can fall sharply during drought emergencies when customers conserve water. That can leave the utility in tough financial shape, because the utility’s capital and operating costs are mostly fixed. Progressive pricing can put the squeeze on utilities’ revenue needs.
So utilities are, in turn, putting the squeeze on their most conservative customers with more regressive pricing.
The first gallon price of water and sewer service is a useful touchstone to understand the real impact of rate structure changes.
The first gallon price is the price a customer pays for using any water at all: any fixed charges plus the price of the first unit of water or sewer service. For example, if there is a $20 monthly fixed charge for water service and the first thousand gallons of water is $2.00, then the first gallon price for water service is $22.00. Here are the weighted average prices of water and sewer service in 2017 and 2019 at one gallon, 6,000 gallons, 12,000 gallons, and 20,000 gallons:
Unsurprisingly, the first gallon price increased from $35.80 to $40.89 over the two-year period, and average prices went up at each volume level. If prices were simply going up across-the-board, we’d see roughly equal increases in prices at every volume. But the 2019 data show that price increases were uneven in percentage terms:
At 20,000 gallons monthly, average prices went up by 8%, but the first gallon price increased by more than 14%. As prices have increased, low-volume customers have on average borne a much larger share of utilities’ rising revenue burdens than their more profligate neighbors.
The financial challenges associated with equitable, affordable, progressive pricing are real: utilities can’t survive without revenue, and falling or fluctuating demand creates real risks for sustainable utility management. But there are better ways to manage risk than squeezing the most conservative customers.
A rate structure that provides basic volume allowances at low fixed prices with steeply inclined prices at higher volumes is one good option. As I’ve observed before, consolidation can help maintain progressive pricing because larger customer bases can withstand revenue shocks more easily than small systems. Utilities should also use larger cash reserves to stabilize revenues across seasons and years—and governments should keep their hands off those reserves! More creative approaches could include regional water revenue banks or development of a secondary market for utility revenue risk.
*A lot of studies claim to measure “average bills,” but are really measuring bills at specific volumes that are assumed to reflect an average customer. Studying true average bills across large numbers of utilities is hard because there’s no reliable source of data on average consumption across utilities.
†An initial working paper reports the full methodology and descriptive findings in detail.
© 2019 Manny P. Teodoro