A decoupling drama plays out in San Jose
Over the past year I’ve blogged about my research with Youlang Zhang and David Switzer on public and private water utilities’ responses to the drought that gripped California from 2014-2017. One of our most interesting findings was that California’s private, investor-owned utilities conserved significantly more water than government utilities. We argued that a main reason for the difference was politics and California law, which allows rate decoupling for private water utilities.*
The timing of the San Jose story was uncanny: I wrote my 2018 water conservation update just as SJWC was filing its request for the rate increase. The story of conservation and rates in San Jose is a useful illustration of why decoupling is so economically effective but politically perilous.
One city, three water systems
San Jose is unusual among large American cities in that three separate utilities provide drinking water service to its residents. The San Jose Municipal Water System (SJ Muni) is governed by the San Jose City Council, which sets the utility’s investment, operating, and financial policies. Two private water systems also serve San Jose: Great Oaks Water Company and San Jose Water Company (SJWC). Corporate boards and executives make investment and management decisions for these systems. Serving a population of more than a million, SJWC is the giant of the trio; but SJ Muni and Great Oaks are also large, each serve populations of around 100,000.
Importantly, very different processes govern price-setting for the three systems. San Jose’s elected City Council sets rates for SJ Muni. As investor-owned systems, SJWC and Great Oaks set their rates through the California Public Utilities Commission, whose members are appointed by the governor. That means San Jose voters can influence SJ Muni’s rates through their elected councilmembers. Rate-setting for SJWC and Great Oaks is a more technocratic affair, with the process handled mostly by lawyers, engineers, and economists at the CPUC.
All three systems charge fixed monthly service fees plus volumetric prices. However, their volumetric rate structures differ in subtle but important ways. The two private utilities employ inclining block rates, which charge progressively higher unit prices as volume increases. For example, SJWC customers pay $3.20 per hundred cubic feet (ccf) for the first three ccf; prices jump to $4.80/ccf for the next 15 ccf, and then to $6.40/ccf for volume beyond 18 ccf per month. Great Oaks uses a similar three-block rate structure, although its rates are considerably less progressive. SJ Muni uses a flat rate: customers pay the same unit price for all water, regardless of how much they use.† Here’s how these prices translate into bills for demand ranging from 0-30 ccf per month:
Great Oaks’ prices are lowest overall. SJ Muni’s and SJWC’s prices are similar at low volumes, with the private company’s total prices about $7-10 higher through the first 15 ccf. Without detailed financial, operational, and customer data, it’s impossible to say whether that gap is justified. We can say that the gap widens at higher volumes due to SJWC’s more progressive pricing: at 40 ccf/month a SJWC customer pays $52.09 more than a SJ Muni customer. That means SJWC likely gets significantly more of its revenue from the high-volume customers who pay high prices for water.
Is water consumption in San Jose consistent with those differences in pricing? This chart shows SJ Muni’s water conservation from 2015-2018, and population-weighted conservation for SJWC and Great Oaks for the same period, compared with the same month in 2013:
Notice how the green (private) line is close to but usually slightly above the blue (SJ municipal) line? Overall conservation tracks pretty closely for public vs. private over the four-year period, but San Jose’s private systems have averaged about 1% more savings.
The difference in per capita water use is much more noticeable; here’s residential gallons per capita per day in 2018:
San Jose’s private utility customers are much more conservative with water than are SJ Muni’s customers, using about eight gallons per person less water on average. The disparity is greatest during the seasonal peak period when supply stresses are also greatest.
Decoupling to the (utility’s) rescue!
In 2018, SJWC’s water customers were so conservative that the utility had a $9 million shortfall in sales revenue. California’s policy of rate decoupling allows the company to make up that shortfall with a rate increase in 2019. San Jose residents and lawmakers are angry that their reward for conservation success is a rate hike. Flat rates help keep SJ Muni’s revenues steadier and so spare the city council from the citizen wrath that such a rate increase might unleash.
Lots of things cause people to use more or less water, and so we can’t say for certain that prices drove the conservation patterns we see in San Jose without detailed customer-level data and a carefully-designed study. But it’s fair to say that San Jose’s experience is consistent with the public-private differences we see in the rest of California. Without decoupling, it’s unlikely that private utilities would use progressive pricing and risk the kinds of revenue losses that they experienced in 2018.
Economics is supposed to be the dismal science and politics the art of the possible. But for California water, the opposite seems to hold: decoupling makes conservation economically viable for private firms, while politics forces governments into difficult choices that can mean financial success at an environmental cost.
† SJ Muni’s flat water rates vary by geographic zone. The graph here uses a simple average of those rates.
A California surprise: update
California has been enjoying a great deal of rain and snow over the past several months—a pleasant rebound in precipitation after the brutal drought that plagued the state from 2011-2017. It’s now early 2019, reservoirs are full, the mountain snowpack is deep, and water managers in the Golden State are breathing easier than they have in a long time. Though water use has crept up since the end of the drought, overall water consumption remains lower than its pre-drought levels.
A California surprise
A surprising finding emerged from my analysis of California’s drought data with Youlang Zhang and David Switzer: the state’s private, investor-owned utilities conserved significantly more water than did local government utilities during the crisis. We linked the difference in drought response to the institutions that govern water finance. Nerds interested readers can read the full study in Policy Studies Journal for the details.
In a blog post last summer, I observed that a public-private conservation gap of 2-3% persisted in 2017 even after the drought ended, and wrote that financial imperatives would likely cause the trend to continue:
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.
If financial and political considerations are really behind the public-private differences in conservation, then it stands to reason that the greatest differences would come during summer months, when water demand–and therefore rate revenue–fluctuations are greatest.
Now that full 2018 data are posted, it’s time to revisit conservation performance for the Golden State’s water utilities. Was the forecast valid? Did private systems conserve more than public systems again last year?
Are my water conservation predictions any better than my NCAA Tournament picks?*
Overall urban water use remained significantly lower in 2018, with average monthly conservation of about 14% compared with 2013. The public-private disparity in overall conservation also persisted. This graph plots average conservation (relative to the same month in 2013) for public and private utilities from January-December 2018:
As you can see, public and private conservation moved in pretty close parallel through 2018, but private utility conservation was consistently higher than public. The difference was negligible during winter months, but during the May-September peak demand season, California’s investor-owned utilities saved an average of 2.3% more than their local government counterparts.
As always when discussing water, it’s important to give percentages some context. Had public utilities saved at the same rate as private utilities in 2018, the difference would have been about 27 billion gallons—more water than San Francisco uses in a year.
Decoupling, man. Decoupling.
The persistent seasonal swing in public-private water conservation suggests that the difference is due to differences in outdoor irrigation behavior. That the pattern is now consistent over three years adds to the mounting evidence that rate decoupling encourages conservation for investor-owned water systems.
This isn’t a story of environmental angels or devils, it’s about governance institutions and the incentives that they create. In light of the political challenges of managing local government water finance, it’s impressive that public utilities have continued to conserve as much as they have—a testament to local water managers’ commitment to efficiency in the face of political headwinds.
*They could hardly be worse. I didn’t get a single Final Four team right.
Devils (and angels) in the details, Part 5
In early January the California Water Board (SWRCB) published its long-anticipated draft proposal for a statewide low-income water bill assistance program. I’ve blogged about it over the past few weeks*; in this final (I think) post on the proposal, I’ll look at how the SWRCB proposes to pay for the estimated $606 million annual program.
How to raise 600 million dollars
The SWRCB recommends paying for the new water assistance program through “progressive revenue sources… in order not to burden some of the residents that the program seeks to serve.” To that laudable end, the proposal calls for two new taxes:
- A .25% tax on personal incomes over $1 million; and
- A sales tax on bottled water.
The income tax would generate an estimated $466 million annually, while the bottled water tax would generate $154 million. Under California’s Byzantine pubic finance laws both taxes would require supermajorities in the state legislature. The bottled water tax would also have to pass a ballot referendum.
Progressive taxation is crucial to any low-income assistance program, since the whole point is to transfer resources to people who are short on them. A millionaire’s tax makes sense from that perspective; a person whose income tops $1 million annually likely has little difficulty paying his/her water bill, and it’s doubtful that an additional 0.25% tax will much constrain productivity or lifestyle for people with seven-figure incomes.
The bottled water tax is thornier.
It’s common for those of us who work on American drinking water issues to think of bottled water as a luxury good. Bottled water is orders of magnitude more expensive than tap water, after all. It also carries some severe negative externalities: it’s lightly regulated, uses lots of energy to produce and transport, and empty bottles create a huge solid waste problem. For all those reasons, taxing bottled water would be progressive, in theory.
In practice, the progressivity of a bottled water tax isn’t so clear. Counterintuitively, in America bottled water consumption is negatively correlated with income—that is, poor and working-class Americans drink much more bottled water than do middle-class and wealthier Americans. Study after study after study show that low-income people and members of racial/ethnic minorities are much more likely to drink bottled water.
Why do lower-income people pay orders of magnitude more for bottled water, when affordable tap water is available? From a health and efficiency perspective, that isn’t rational behavior. It might be cultural, it might be taste/odor preferences, it might be about distrust in government, or it might be something else entirely. In some cases, people served by the smallest, poorest communities that suffer from poor water quality might need bottled drinking water. Raising the cost of bottled water might have the perverse effect of pushing low-income households to drink more soda and sugary beverages.
Whatever the reason for the income-bottled water relationship, the distributional effect of the SWRCB’s proposed tax is clear: the poor will bear a disproportionate burden of any bottled water tax. When you consider that a significant proportion of eligible households will never actually participate in the assistance program, a bottled water tax becomes doubly regressive.
So where do we get the other $150 million?
There’s an intuitive political appeal to using a water-related tax to raise money for water bill assistance.† What kinds of water taxes could be progressive? Here are a couple of half-baked ideas (I don’t have the time or data to bake ’em).
- A tax on “luxury” bottled water. Poor folks aren’t buying $5.00 bottles of FijiWater; they’re buying $9.99 cases of Ozarka at Walmart. A sales tax on water that retails for more than $1.00 per liter would spare the lowest-income households, and probably wouldn’t push them into drinking sugary beverages.
- A tax on residential tap water consumption over 12,000 gallons per month. At 50 gallons per capita per day (reasonably efficient indoor use), a family of four uses about 6,000 gallons per month. In the vast majority of situations, residential water consumption beyond 12,000 gallons a month is for discretionary outdoor use. A main drawback to this kind of tax is that it would irritate water utility managers, who don’t want to act as the state’s tax collectors.
A combination of these two taxes could generate significant revenue without putting the revenue burden of low-income assistance onto the people that it’s intended to help.
*In the past few posts, I’ve summarized the proposal, discussed its potentially perverse incentives for ratemaking, pondered its implications for struggling small systems, and options for administering assistance.
†The SWRCB’s carefully avoids alluding to political appeal, but does note that “fees on bottled water or alcohol would have a nexus to water use.”