Why rate structures, not assistance programs, offer the most promising path to water affordability
When discussions of water and sewer affordability turn to policy solutions, they typically focus on Customer Assistance Programs (CAPs). But a focus on CAPs bypasses a much more direct, effective, and efficient means of improving affordability: rate design. To see what I mean, consider the way we combat infectious diseases.
Therapy vs Inoculation
Clinical therapy and inoculation are both ways to fight infectious diseases. Each approach can improve health, neither is perfect, and some combination of both is useful in practice. But for the most serious diseases, inoculation is far superior to therapy.
Clinical therapy is costly. For therapy to cure a disease, a patient must recognize that (s)he is sick, be aware that treatment is available, seek treatment, and then follow a course of treatment and hope that it works. For health care providers, therapy requires highly skilled employees, careful diagnostic procedures, and treatment that can involve expensive drugs and equipment. Meanwhile, the broader community bears the costs of people who go untreated or carry the disease without symptoms.
Inoculation is comparatively inexpensive. Inoculation requires little time or sophistication from patients, and it is quick and easy for health care providers. A tiny minority might suffer adverse effects, but the community benefits from widespread immunization, which can sometimes effectively eradicate a disease from an entire population.
Customer assistance programs as clinical therapy
CAPs seek to ameliorate affordability problems caused in part by water and sewer rates. CAPs come in lots of shapes and sizes. Some are as simple as shut-off forbearance and budget billing; others involve income-qualified rate discounts or bill forgiveness plans; still others provide high-efficiency fixtures or appliances for low-income households.
Like clinical therapy, CAPs are costly. CAPs have obvious direct costs to the utility, like revenue lost through discounts or the direct cost of installing retrofits. CAPs can also have significant administrative costs: someone must determine which customers qualify, keep records of who receives or is denied assistance, and keep track of those who lose eligibility over time. Utilities sometimes coordinate assistance with other agencies to administer these programs more efficiently, but that only reduces administrative costs, it doesn’t avoid them. CAPs can be politically and legally risky, too, since they are explicit transfers from one group to another. In many states utilities are legally constrained from such transfers.
Less obviously, CAPs are also costly for their recipients. In order to participate in a CAP, a water customer must:
- Learn that the program exists;
- Find out if (s)he is eligible;
- Apply for the program; and
- Follow up with program administrators as necessary to maintain eligibility.
Each of these steps imposes a transaction cost of time and effort on working-class families. If participation requires an in-person visit, then transportation and child care add to those costs. Language barriers and distrust of government can raise transaction costs even further. There are good reasons to believe that many people who are eligible for and badly need CAPs never apply for them.
Rate design as inoculation
Some key elements of rate design can improve affordability directly, without the need for CAPs, by maintaining low prices for essential household water and sanitation. Specifically, affordability-friendly rate structures feature:
- Low fixed charges;
- Volumetric sewer prices based on indoor flows;
- Low volumetric water prices for essential household water use; and
- Steeply escalating volumetric prices for demand beyond essential use.
Like inoculation, rate design is a solution with low administrative burdens. Affordability-friendly rate designs create no additional transaction costs for utilities or customers. Since rate structures apply to everyone, there’s no need to determine or track income eligibility, and there’s no worry that eligible customers are failing to sign up. Customers do not need to learn about, apply for, or document their eligibility. Rate design isn’t an affordability cure-all, but it can go an awfully long way toward immunizing a population against unaffordable water and sewer service.
So why don’t more utilities use rate design to address affordability?
Ordinary organizational inertia is one reason, of course. There’s also a widespread misperception in ratemaking circles that affordability contravenes goals like cost-of-service equity, full-cost pricing, and/or conservation. Happily, affordability-friendly rate design can exist in harmony with all of these principles—I’ll tackle that topic in a future post.
But the greatest barrier to more affordability-through-rate design is probably revenue stability. High fixed charges generate revenue reliably. Revenue from volumetric charges fluctuate with water sales, which 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. That can leave the utility in tough financial shape, because the utility’s capital and operating costs are mostly fixed. Some utilities have responded to falling average water demand by raising their fixed charges, in large part to manage revenue volatility. That’s bad news for affordability.
So a key to more affordable rate design is developing mechanisms that manage utilities’ revenue risks. Adequately insulated from those risks, utilities can price water more equitably, efficiently, and affordably.
Many California communities restricted outdoor irrigation during the recent drought. Did enforcement matter?
Faced with water scarcity, communities sometimes restrict residential outdoor water use, such as car washing and especially lawn/garden irrigation. These water restrictions are effective in driving water conservation, and many California communities adopted them during that state’s recent drought (I’ve blogged about them before). The severity of those restrictions varied considerably, with some utilities allowing unlimited irrigation, some allowing irrigation just one or two days per week, and a few banning outdoor irrigation altogether.
Enforcement of those restrictions was up to individual utilities, and enforcement actions varied considerably. Youlang Zhang and I have been analyzing those enforcement actions and how they correlated with conservation outcomes; we’ll present our first results at the APSA Conference in Boston next week. How did California utilities enforce water restrictions? Did enforcement actions affect water consumption?
Avenues of enforcement
In July 2014 the SWRCB authorized local water utilities to impose fines of up to $500 a day for violating water restrictions and invited citizens to report violations of water use restrictions through online portals and telephone hotlines. After receiving complaints or observing violations, utilities proceeded with a series of escalating enforcement steps. The first is a follow-up action, an informal intervention that typically involves sharing information with the violator with a goal of compliance through education. The second step is a formal warning, where the utility informs the violator of regulations and potential penalties. The final step is a formal penalty and fine.
A different logic underlies each of these enforcement actions Follow-up actions convey information about public policies and community values, with the expectation that greater awareness will motivate conservation. Warnings threaten violators with punishment, and so raise the prospective cost of profligacy. Penalties punish past action in hope of deterring future behavior. Over the course of the drought local utilities issued hundreds of thousands of warnings and levied tens of thousands of penalties for violating water regulations.
We analyzed monthly data from California over the 32-month drought emergency period, looking for relationships between utilities’ enforcement actions and total conservation by those utilities. Basically we were asking: does past enforcement predict present conservation?
Initial results are fascinating. Informal follow-up actions and penalties had no statistically discernible relationship with conservation. Only warnings appear to be correlated with conservation. Here are the effects, plotted graphically:
In substantive terms, these results indicate that 100 formal warnings results in about 0.1% greater conservation. Though these figures are small in percentage terms, they represent potentially large volumes of water. An average of 500 more warnings each month during the observation period would have reduced the state’s total water consumption by 29 billion gallons—enough to supply the City of San Francisco for 15 months.
So are penalties pointless?
Does that mean that penalties don’t work? Not necessarily. It’s likely that the positive effects of warnings depend on the threat of penalties. Also, a $500 penalty might be an insufficient incentive for conservation in utilities where penalties were imposed. If you’re a rich celebrity, you might not care about a $500 fine enough to stop wasting water. Without detailed data on individual violations (which we don’t have), it’s hard to say.
In any event, the effects of all enforcement actions were apparently short-lived. Enforcement actions were most influential early in the drought emergency, when climatic conditions were most severe. As the drought weakened, the influence of enforcement also declined. The effects of all three types of enforcement actions appear to be negligible in the long run.
Lessons for conservation
We need to do more work to make sure we have the analysis right and to tease out all of the temporal effects, but our findings to date suggest three preliminary takeaways:
- Formal warnings are most effective in driving overall conservation; and
- Warnings can lead to immediate conservation during an emergency; but
- Enforcement effects decline in the long run, and so probably don’t help promote conservation as a “way of life.”
A California Surprise, Part 3
California’s private utilities continued to out-conserve public utilities even after the state lifted its mandate.
In 2015 the California State Water Resources Control Board (SWRCB) ordered drinking water utilities to reduce water usage by 25% statewide. As I reported in an earlier post, something surprising happened: compared with local governments, the state’s private, investor-owned utilities imposed stricter water use regulations, were nearly twice as likely to comply with the state mandate, and conserved significantly more water overall. My last post traced this disparity to differences in the institutions that govern water rates in California and the conservation incentives that those institutions create.
In June 2016 the state declared an end to the drought emergency and lifted the mandatory conservation rules, and allowed utilities to set their own conservation targets. Somewhat to the state’s chagrin, 84% of utilities–including nearly all of the state’s private utilities–responded by setting their conservation targets at zero (so much for self-regulation!). Still, conservation has continued, with the state’s utilities still using far less water on average than they did before the drought.
But curiously, the public-private conservation disparity has persisted well after the state mandate ended and most conservation targets dropped to zero.
Even after the state lifted the rules in June 2016, private utilities continued to impose stricter irrigation restrictions on average compared with public utilities. Through February 2017, public utilities allowed an average of about one more day per week relative to private utilities. In the spring of 2017 the gap began to narrow. In June 2017 the relationship switched: since then, public utilities have been imposed tougher irrigation restrictions. The cause of that switch isn’t clear, and we haven’t really looked into it.
But the really surprising thing is the persistent disparity in overall conservation. This graph plots average conservation (relative to the same month in 2013) for public and private utilities from June 2016 through the end of calendar 2017:
As you can see, overall conservation declined for public and private alike as drought conditions eased. But the really interesting thing here is the consistent difference between public and private sectors: except for February through May 2017, private utilities conserved about 2-3% more on average than public utilities.
While the difference doesn’t seem like much in percentage terms, in a state as large as California, a few percentage points can be enormous in absolute volumes of water. Had public utilities saved at the same rate as private utilities over that period of time, the difference would have been about 52 billion gallons—more water than San Francisco uses in two years. Regression analysis in my forthcoming article coauthored with Youlang Zhang and David Switzer confirms what the graph implies: after accounting for demographics, population density, climatic conditions, source water, and other variables, we find that California’s private utilities out-conserved public utilities in the post-mandate period by a statistically significant average of 2.7%.
Decoupling is a hell of a drug
This consistent public-private difference lends greater weight to the idea that rate decoupling facilitates water conservation for private utilities, and that political constraints hamper public sector conservation. If 2018 holds to form, public and private conservation will converge in the spring and diverge again in the summer and autumn. Look for an update here in early 2019 when full 2018 data are available.