How to stop taxing water

It’s hard to know exactly how much money Americans are paying in taxes at the tap, but it’s a lot. Last time I described the variety of ways that governments collect tax revenues through water and sewer bills—sometimes overtly, sometimes covertly. Taxes on water and sanitation are terribly regressive, as these are services that everyone must have and, unlike most other kinds of taxes, they tend to collect similar revenue from rich and poor households. Water taxes also turn utilities from providers of public service into coercive agents of government.

What can and should we do differently? How can we stop taxing the tap?

Here are some policy principles to eliminate taxes on these essential services.

1 - Eliminate taxes on water and sewer utilities.

Eliminate utility users’ taxes for residential water and sewer services. States and local governments ought to get rid of business or gross revenue taxes on water or sewer services, at least for the portion of revenue collected from residential customers. It’s really that simple. Municipalities should not charge rents for “right of way” to utilities that the cities themselves operate.

Most governments don’t tax groceries or prescription drugs because they’re basic necessities of life. Many have eliminated tax on menstrual products. We shouldn’t tax tap water, either.

General purpose governments should make this change on their own, but many have come to rely on these hidden, regressive taxes, and so are unlikely to do it without prodding. state governments should strip municipalities of the power to tax water—either immediately, or over a few years’ phase-in period. The federal government should make any water/sewer utility assistance funds contingent on eliminating water utility taxes.

2 - Stop using water/sewer bills to collect money for other stuff.

Utility bills are a handy way for local governments to generate lots of money quickly and reliably since the threat of shutoff hangs over every bill. Phoenix tacks monthly fees of $1.00 for jails and $1.50 for general revenue onto its water bills. Chicago funds city employee pensions by forcing its water/sewer customers to fork over $2.51 for every 1,000 gallons they use.

Let water and sewer customers pay for water and sewer services. Nobody should have their water shut off because the city wants money for a jail or to pay a retired employee.

3 - Exempt essential water & sewer facilities from property taxes.

Taxes on property owned by utilities and used in the provision of essential water and/or sewer services ought to be exempt from taxes or payments in lieu of taxes (PILOT). The key here is essential services.

Providing water infrastructure for basic human health needs—drinking, cooking, cleaning, and sanitation—is arguably the principal reason that water and sewer utilities exist. With high fixed costs and significant economies of scale, water systems are built and operated with the capacity to meet maximum potential demands. Unlike many other kinds of goods, demand for water service reflects qualitatively different uses at different volumes. When a utility delivers water to a customer, that water can be used for essential needs like drinking, cooking, cleaning, and sanitation. It can also be used for more discretionary needs, such as car washing, filling swimming pools, and irrigating lawns. Many facilities are oversized to meet the needs of large industrial water users or firefighting.

Taxes need not apply to all of a utility’s property. In principle, the share of source of supply, treatment, storage, transmission, and distribution facilities that would be necessary to provide basic needs could be isolated and exempt from taxation or PILOT payments. For example, if 20% of a utility’s facilities are associated with such basic needs, then the utility’s property tax or PILOT liability should be reduced by 20%--with the savings passed on to customers in the form of lower fixed and volume charges.*

4 - Raise taxes honestly.

Utilities taxes come about because local governments want revenue. Personally, I’m a fan of local government and would like to see them get the money they need. I like well-funded, professional police and fire departments. I like beautiful, functional parks and libraries, safe sidewalks, and ample street lighting. Public employees should be paid fair wages.

Governments have at their disposal tools to raise revenue for these purposes. In most parts of the U.S., local governments rely mainly on some combination of property, income, or retail sales taxes. All of these revenue sources are fairer and less regressive than water/sewer taxes. They’re also more transparent to citizens. Let’s pay for general services with general taxes.

The affordability connection

Strangely, utility taxes have received scant attention in discussions over local, state, and federal efforts at water/sewer affordability. Eliminating unrelated fees and taxes from water and sewer bills would cut bills in many communities by as much as 50%.

Before launching complex, costly, and administratively burdensome assistance schemes that are unlikely to help more than a small minority of needy customers, governments ought to eliminate taxes and fees on water bills.

*Regulators might allow investor-owned utilities a lower rate of return on this tax-exempt share of essential rate base.