From Finance

Garden Badger

Water Sector Reform #2:
Regulatory Transparency & Fairness

Bringing together the best of both states

With a major federal investment in water infrastructure possibly on the horizon, the United States has a once-in-a-generation opportunity to leverage that money into transformational, institutional solutions for America’s water sector. This is the second in a series of five posts outlining five broad ideas to reform the management, governance, and regulation of U.S. drinking water, sewer, and stormwater systems. The first proposed reform was consolidation of water utilities.

The second proposed reform is an overhaul of the processes and institutions that regulate water system finance using regulatory models from New Jersey and Wisconsin. The goal of this reform is not to regulate water quality directly, but rather to change the incentives for the organizations that operate water systems.

The need for regulatory reforms follow from the ownership structure of the U.S. water sector.

Infrastructure ownership

Another important way in which water is different from energy and other utilities is ownership. The overwhelming majority of Americans get their electricity and/or gas from a private, investor-owned firm, with small minorities receiving service from government utilities. But water is a different story: about 88% of Americans get their drinking water service from a local government, with about 12% served by private firms.

Source: US Dept of Energy, US Dept of Transportation, US Environmental Protection Agency

Ownership is crucial because different institutions govern private and public systems, creating different incentives for infrastructure investment.

Public Utilities Commissions

Let’s start with the private sector. The profit motive, constrained by regulation, drives management of investor-owned utilities.

Private utilities of all kinds—water, energy, telecom, whatever—are operated by corporate managers in the interests of their shareholders. But utilities are natural monopolies, and so we can’t count on free markets to guide investment and pricing. Instead, prices are not set by the companies themselves, but rather by the state Public Utilities Commissions (PUCs). The PUCs require utilities to report publicly their asset management plans and financial records in order to justify their pricing. PUC-regulated systems must also report a variety of performance data, which commissioners scrutinize to ensure that utilities are maintaining adequate service.

PUCs allow private utilities to set prices based on the amount of capital they invest in the system: the more capital invested, the more revenue they earn. That can create an incentive for private utilities to over-invest in infrastructure because those investments allow them to raise rates—a problem known as the Averch-Johnson Effect. Much of what the PUCs do is scrutinize all those investments to ensure that they’re justified and that utilities aren’t gold-plating their systems. In other words, PUCs act to prevent over-investment in utility capital.

But remember, that’s only about 12% of the water sector.

Local governments

The overwhelming majority of water service is provided by local governments—usually cities, counties, towns, villages, authorities, and special districts. These systems are managed by local bureaucrats, with investment and pricing decisions made by local elected officials. For all the talk about federal funding, U.S. water infrastructure investment is mainly a function of local politics.

Local politics are unkind to water infrastructure because the price of water is much more visible than the quality of water. As in all things, people generally like high quality and low prices. Thing is, most contaminants in water are invisible. Unless my water is so bad that I can smell or taste it, unless there are frequent an ongoing outages and main breaks, I really have no idea how good my water system is. Unlike roads and bridges, water systems are literally buried.

But the price of water is easily observable. Voters may not know what contaminants are in the water, but they know for sure what they pay for it when they get the bill each month.

Now suppose I’m an elected official who wants to please my voters. If I make decisions that maintain or improve water quality, that’s good! Alas, my voters may not recognize the improvement. But quality improvement might cause prices to increase, which is bad because higher prices are immediately visible to voters.

No mayor wants to roll into the office & find these folks waiting

But blame avoidance isn’t good for infrastructure investment. That’s a big part of why all those facilities built back in the 1970s and 80s are crumbling today. Back when the CWA and SDWA sent hundreds of billions of dollars to local governments, the idea was never for the US government to own and operate water systems. The goal was for ​Uncle Sam to help get those systems up and running in compliance with the new environmental laws. Local governments were then supposed to take over responsibility for those systems. In too many cases political forces have led local officials to run those systems to failure. Local politicians don’t neglect water infrastructure because they’re stupid​; they do it because they’re responsive to voters.

Jersey to the Rescue?

In 2017 New Jersey passed the Water Quality Accountability Act (WQAA), which requires all water utilities—both government and investor-owned—to develop asset management plans, report on infrastructure conditions, and reinvest adequately in their systems. Rule-making to implement the new law is still under way, but what the WQAA requires of all water systems is similar to what PUCs already require of investor-owned utilities: transparency about infrastructure conditions, evidence that they are managing assets responsibly, and evidence of system performance.

Making all that system information transparent can make water’s quality as visible at its price. We can make water infrastructure a credit-claiming opportunity for local officials, not just a blame-avoidance game. Mayors seeking reelection should point at their cities’ water system performance with pride, not merely seek to duck responsibility for rate increases.

Meanwhile, in Madison…

A thousand miles away, Wisconsin employs a unique regulatory system that’s a perfect complement to New Jersey’s new law. All fifty states and the District of Columbia have Public Utilities Commissions, but Wisconsin is the only state where all systems—public and private—are subject to PUC financial regulation. That is, Wisconsin local governments must get approval of their rates from the PUC (or the Public Services Commission, as they call it there).

expected a cheesier logo

As with other utilities commissions, the traditional role of the Wisconsin PSC with respect to rates is to guard against over-pricing by private monopolies. But in the case of local government utilities, the PSC’s authority could include New Jersey-style asset management requirements and a guard against underpricing due to inadequate reinvestment. At the same time, the PSC provides something of a shield for local leaders. As a 2012 Alliance for Water Efficiency report observed:

“The Wisconsin Public Service Commission regulates both public and private water systems, and assumes the responsibility for approving all changes to water rate-making in the state. Thus, the political ‘heat’ is off at the local level and water systems can more easily approach the PSC for needed changes to their revenue structures.”

In theory, if a utility isn’t adequately investing in maintenance and upgrades, the Wisconsin PSC might actually be able to compel rate increases. (I’m not sure that’s ever actually happened).

Regulatory overhaul

Together, the Garden State’s new WQAA and the Badger State’s PSC authority over local governments would be a potent regulatory combination. So my second proposed reform is to require comprehensive asset management and performance reporting for all water utilities (as in New Jersey), and to extend PUC pricing regulation to government utilities (as in Wisconsin). The idea is broadly consistent with Australia’s model for urban water price regulation. As with my other proposed reforms, achieving such a significant overhaul to the nation’s regulatory institutions will require federal leverage.

The great promise of the regulatory regimes pioneered in New Jersey and Wisconsin is that transparency and fairness can make buried infrastructure more visible, and so shift the political incentives for sound management of water systems.

Golden Opportunity

What the Cuyahoga River Fire says about the past, and maybe the future

Cleveland, 1969

Fifty years ago this week the Cuyahoga River caught fire in downtown Cleveland.

Observers of U.S. water policy and environmentalism more generally have been celebrating the fire’s golden anniversary all year, because three years after the Cuyahoga River burned, Congress passed the Clean Water Act. The Safe Drinking Water Act followed two years later. The Cuyahoga River Fire is a textbook example of what political scientists call focusing events: high-profile occurrences that suddenly put previously obscure issues onto the public policy agenda.

The 1969 fire is rightly iconic today, but many forget that it was the twelfth time that the river burned. Why did the 1969 fire catch the public imagination? The truth is that nobody knows. But it did, and it changed the way Americans think about water pollution. The fire presaged a series of laws that fundamentally changed the regulation of water pollution in the United States, invested hundreds of billions in infrastructure, catalyzed new technology, and built a generation of professionals dedicated to protection of the nation’s waters.

A new focus

A year ago I called the Flint Water Crisis the Cuyahoga River Fire of our generation. Flint has changed the way that Americans everywhere think about water infrastructure. As with the 1969 Cuyahoga River Fire, Flint wasn’t the first, wasn’t the worst, and wasn’t the biggest drinking water disaster in recent U.S. history, but it’s the one that caught the public imagination.

The Flint story wasn’t just about water chemistry and failing infrastructure—it was also about bureaucratic organizations and partisan politics. And it was about poverty and race: Flint showed America that water infrastructure is an environmental justice issue. That’s expanded the political coalition focused on water infrastructure. There’s a growing consensus that existing infrastructure funding arrangements are failing.

I’ve worked on water system management, regulation, and finance for more than 20 years and have never seen this kind of public attention to the issue. As recently as two years ago I dismissed the idea of a trillion-dollar federal program for water infrastructure as politically unviable. But something has shifted. Last month Congressional leaders and the president began sketching out a $2 trillion infrastructure package—with potentially hundreds of billions for water, sewer, and stormwater systems.

Those talks have broken down, but the fact that they were even happening suggest that we may be an election away from a major federal investment in infrastructure. Whether it’s next year or two years from now, it looks like Washington may soon be raining infrastructure money. That’s music to the ears of lots of activists who cry out that an injection of federal money is needed to fix America’s water systems.

Recovery & reform

Today people paddle their kayaks on the Cleveland riverfront and safely eat the fish they catch there. If the problems weren’t too big then, they surely aren’t too big today.

River paddling in Cleveland has gained popularity with the decline in fires and toxic waste (Jim Ridge, Share the River)

To be honest, I was a little relieved when negotiations between the White House and Congress faltered last month, because the breakdown gives us a chance to pause, take a deep breath, and think systemically. Today, the principal barriers to progress in the water sector are not environmental or technological—they are political, social, and economic. Accordingly, a big federal funding package can and should be used as leverage to reform the institutions that govern water in the United States.

Recently I was asked to speak about water infrastructure at the University of Rhode Island’s Metcalf Institute. With the Cuyahoga River Fire’s golden anniversary on my mind, I proposed five broad reforms to the U.S. water sector that ought to accompany any big federal program. They are:

  1. Consolidation / Regionalization
  2. Regulatory Equality & Transparency
  3. Technological Investment
  4. Human Capital
  5. Water Equity

Later this week I’ll start a series of posts elaborating on these to help get a deeper conversation going. Since this is a blog, I’m going to breeze by a great deal of detail and keep things at a 30,000-foot level. But each proposal is rooted in empirical research, each part is ambitious, but also technically and politically feasible. Over the next 2-3 years we have a once-in-a-generation opportunity to rebuild and reform water governance. Let’s make the most of it.

Making it Work

A Kansas water utility gets affordability measurement right

And lo, there arose from the Kansas City suburbs a mighty measurement

Recently we’ve seen progress in affordability measurement, as more water utilities are using better metrics when evaluating affordability.* Last year I published a new methodology for measuring water and sewer utility affordability (AR20and HM), and followed that up with a national assessment using those metrics. AR20  is the Affordability Ratio of basic water and sewer service price divided by disposable income at the 20th percentile household income. HM  is basic water and sewer service expressed in Hours of labor at Minimum wage.These metrics seek to capture the trade-offs that low-income households must make in paying for water and sewer services. Utilities have begun to use these and other improved metrics, which is encouraging!

Too hard?

The main objection I’ve seen to the real-world use of AR20 is that it can seem too complicated. You need to know the community’s 20th percentile income and essential non-water/sewer costs of living in order to calculate AR20. But there’s no convenient, off-the-shelf source for those numbers. You have to think about economic conditions in your community.

I usually include housing, health care, taxes, food,and home energy as essential non-water/sewer costs, and I use statistical models to estimate those expenses. Statistical models are important in my research because I’m analyzing affordability across hundreds of communities.  Apparently that’s led some to think that regression models of consumer data are the only way to estimate AR20,  which can seem impossibly difficult.

Fortunately, it’s not really that hard. Since publishing my 2018 article, I’ve heard from folks in utilities large and small about efforts to use these metrics exactly as they were intended: adapting AR20  to fit local needs, calculating it with local data, and using it to shape local decisions.

WaterOne’s excellent measurement adventure

An especially encouraging case is WaterOne, a special district that provides drinking water to a population of about 425,000 in the Johnson County suburbs southwest of Kansas City. As in plenty of other utilities, WaterOne’s leaders have long been interested in the affordability of their service, but had also long used the conventional 2%MHI to gauge affordability. Dissatisfied with that nonsensical number, WaterOne’s financial planning team decided to use AR20  to assess affordability and help guide policy for their own system.

Local calibration

From WaterOne’s Affordability Ratio paper

Making AR20 work for WaterOne required adapting it to local preferences and conditions in a few ways. First, the original AR20 was calculated for water and sewer combined; since WaterOne provides only drinking water, its AR20 calculation included only water rates, not sewer rates. Second, WaterOne analyzed its own customer data and decided that 45 gallons per capita per day and a 2.6-person household were the appropriate basic water consumption level for its customers (my published studies assume a 4-person household at 50 gpcd). Third, WaterOne chose to exclude home energy from their calculation of essential non-water/sewer costs. Rather than constructing an econometric model to estimate essential non-water costs, WaterOne’s finance team used available data and guidelines from the Census, IRS, USDA, and Bureau of Labor Statistics to estimate appropriate costs for its service area.

The result was a WaterOne-specific AR20 that showed the remarkable difference between the conventional %MHI method and the more meaningful AR20. After they’d done all that work, WaterOne staff contacted me to ask for feedback. We had a terrific phone call with WaterOne managers where I offered some comments on their execution, but I didn’t have much of a critique to give—they pretty much got it right.

From analysis to decision

The results were reported with the district’s 2019 budget and written up in a white paper for WaterOne’s governing board. Crucially, the paper uses the affordability metrics to frame a discussion of goals and guidelines, not to declare WaterOne’s rates “affordable” or “unaffordable” according to some arbitrary threshold. They also warned against comparing AR20 values to my published works and to other systems’ AR20 values, since WaterOne’s AR20 is based on different assumptions and WaterOne’s values may not align with others.’

Measurement principles in practice

Complexity isn’t an excuse for crummy measurement; it’s a reason to be careful with measurement. A modicum of creativity can get you there. Want to know what low-income families pay for health insurance locally? Go to healthcare.gov. Need an estimate for local low-income housing costs? Check craigslist.org. Ask local charitable organizations what low-income families pay for food or home energy. You don’t need a PhD or advanced econometric skill to do sound affordability analysis.

WaterOne answered the affordability measurement challenge with a thoughtful, nuanced analysis that applied community values to the best available data. Adapting AR20 for  WaterOne—WOAR20?—is a fine example of how utilities can put measurement principles into practice.


*The conventional approach to water affordability measurement (average bill as a percentage of Median Household Income (%MHI) is deeply flawed, as I’ve blogged previously. Despite its well-document problems,use of %MHI remains widespread, mainly because it’s easy and familiar.

My estimates use publicly-available Consumer Expenditure Survey data and Ordinary Least Squares regression. They’re not especially sophisticated.