1. Reflections on Water Pricing and Tariff Design
Prof. Dale Whittington
University of North Carolina at Chapel Hill
Prof. John Boland
The Johns Hopkins University
April 3, 2001

2. Outline of Presentation
Objectives of water pricing and tariff design
Alternative Tariff Structures - Definitions
Observations on Increasing Block Tariffs (IBTs)

3. Water Tariff
The set of prices, charges and taxes used to generate revenue and
The rules and regulations which govern their use

4. Average Residential Water Tariffs - Selected Asian Cities (US$ / m3 ,1997)
Price US$/m3
Cities
0.70
Jakarta
Singapore, Hong Kong
0.50
Bangkok, Kuala Lumpur, Taipei
Manila, Seoul
0.20
Ho Chi Minh, Colombo, Lahore
Calcutta, Delhi, Beijing, Mumbai, Shanghai, Karachi, Dhaka
0.00

5. Functions of the Tariff
Determines level and pattern of revenue
Contributes to ability to attract capital
Creates incentives affecting the production and use of services
Influences the value of the services received and the total cost of production
Allocates cost among customers, groups of customers, and over time

6. Purposes of the Tariff Economic Efficiency Fairness (a perception)
Equity (a testable hypothesis)
Revenue sufficiency
Net revenue stability
Simplicity and understandability
Resource conservation

7. Additional Considerations in Tariff Design
Public acceptability
Political acceptability
Ease of implementation
Enhancement of credit rating

8. Criteria versus Average Tariff
% who can afford a private water connection
Water consumption by hh’s with private water connection
Economic benefits received by hh’s with private water connection
Low
Medium
High
Very High
Low
Medium
High
Very High
Low
Medium
High
Very High
US$1.00/m3
US$0.50/m3
US$0.05/m3
0.00

9. Criteria versus Average Tariff
Revenues received by water utility
Costs to water utility to deliver water supply
Economic costs paid by others (e.g., subsidies needed by water utility)
Medium
High
Low
Zero
Low
Medium
High
Very High
Low (None?)
High
Very High
US$1.00/m3
US$0.50/m3
US$0.05/m3
0.00

10. Hierarchy of Objectives
Most restrictive
Least restrictive
Economic Efficiency
Equity
Simplicity, transparency
Fairness
Resource conservation
Net revenue stability
Revenue sufficiency

11. Service Quality vs. Cost Recovery
Asian Water Utilities Handbook,1997
Good Service
Poor Service
Costs Recovered
Kuala Lumpur
Seoul
Singapore
Taipei
Colombo
Hanoi
Jakarta
Lahore
Costs Not Recovered
Beijing
Hong Kong
Shanghai
Kathmandu
Dhaka
Manila

12. Some Basic Tariff Options
Single part tariff, consists of either:
Fixed charge (not based on measured water use)
Volumetric charge (based on measured water use)
Two part tariff, includes both fixed and volumetric charges

13. Volumetric Charges
Uniform price - all units of water billed at same price
Block-type structures - two or more prices, each applies to use within a defined segment (block) of monthly use
Decreasing block - block price falls as use rises
Increasing block (IBT) - block price rises as use rises [Note: first block price usually set below cost]

14. Tariff Design - Uniform Price
Periodic fixed (“service”) charge, e.g., US$/month/connection
Single commodity price, e.g., $/m3
Example (in US$):
$5.00/month for residential connection, plus
$1.00/m3 for all water use

15. Tariff Design - Decreasing Block
Periodic fixed (“service”) charge
Two or more commodity prices ($/m3), decreasing with use:
$5.00/month for residential connection, plus
$1.50/m3 for all water used up to 15 m3/month
$1.00/m3 for all water used in excess of 15 m3/month, up to 30 m3/month
$0.75/m3 for all water used in excess of 30 m3/month

16. Tariff Design - Increasing Block (IBT)
Periodic fixed (“service”) charge
Two or more commodity prices ($/m3), increasing with use:
$5.00/month for residential connection, plus
$0.75/m3 for all water used up to 15 m3/month
$1.00/m3 for all water used in excess of of 15 m3/month, up to 30 m3/month
$1.50/m3 for all water used in excess of 30 m3/month

17. Tariff Design - Variants
Increasing rate designs
Combination block designs
Free service allowances (form of increasing block)
Seasonal water tariffs
Seasonal sewer tariffs
Lifeline rates

18. U.S. Water/Sewer Agencies
50,000+ water utilities
30,000+ wastewater utilities
Urban places with 100,000+ population
300 water utilities
200 wastewater utilities

19. U.S. Government-Owned Water Utilities
80 percent of total
85-90 percent of large systems
Very few subject to tariff regulation by State
Only 12 of 50 states with laws restricting pricing practices

20. U.S. Investor-Owned Water Utilities
10-15 percent of large systems
Subject to tariff regulation by State agency, based on rate-of-return

21. U.S. Water Tariffs

22. Commonly Overlooked Facts I
Water and sewer services are bundled commodities
Users respond to the sum of water and sewer tariffs
Developing tariffs separately according to different criteria is illogical

23. Commonly Overlooked Facts II
Prices determine water use, not tariff design
Each user responds to his/her last block price regardless of what other prices may be, or what other users may do.
Block type rates permit price discrimination, individual users respond to the price in specific block(s)

24. Increasing Block Tariffs (IBTs)
Still actively promoted in developing countries
Water pricing is an important instrument for stimulating efficient use of water. A basic amount could be used at a relatively low rate, while water consumption beyond that amount could be charged with progressively higher rates. (Urban Water Resources Management, UN, 1993, p 19).
Widely used in OECD countries

25. IBT Example: La Paz, Bolivia

26. Examples of IBTs

27. What is Rationale for IBTs?
Claimed to transfer income from rich to poor
Claimed to transfer income from firms to poor HHs
Very high prices in top blocks claimed to discourage “extravagant” and “wasteful” use
IBTs are said to implement marginal cost pricing principles
IBTs are said to reflect assumed rising marginal cost curves

28. IBT Rationale Revisited I
Rich subsidize the poor
Average price rises with HH use. Therefore, to the extent that water use is correlated with income, subsidy occurs.
Maximum possible subsidy is small (typically US$1 to US$3 per month)
Subsidy is regressive within the lower blocks

29. IBT Rationale Revisited II
Firms subsidize poor households
IBTS produce such a subsidy
Subsidy is regressive within the lower blocks
If subsidy were desirable, it could be achieved more easily by sectorally differentiated prices
Subsidy may not be desirable: large users may exit system, increasing average costs for residential users

30. IBT Rationale Revisited III
IBTs discourage “extravagant” or “wasteful” use
No clear what “extravagant” means
If “wasteful” means uses that do not justify the resource cost of the water, then:
Setting price equal to marginal cost means that every customer pays to replace every unit of water taken, regardless of the type of use
No further incentive is necessary or desirable

31. IBT Rationale Revisited IV
IBTs are consistent with marginal cost pricing
There is only one marginal cost for a given class of customers at a given time
IBTs result in different customers within the class paying different prices at any given time, based on their total monthly use
At most one of these prices can equal marginal cost; all others represent a divergence from marginal cost pricing principles

32. IBT Rationale Revisited V
IBTs track rising marginal costs
Marginal cost is not necessarily rising, even in developing countries
If marginal cost is rising, it rises as a function of aggregate water use; it does not change perceptibly with changes in water use by a single HH
Prices are meant to reflect the costs imposed by additional water use by the HH. These are the same for all HHs in a given class at any given time.
Marginal cost may rise over time; then prices should also rise over time, but for all uses

33. Limitations of IBTs in Practice
Difficulty in limiting size of the first block
Difficult to provide proper economic incentives to most customers
Difficult to meet revenue target without large departures from marginal cost
Lack of transparency and difficulty of administration
In the case of shared connections, or where connected HHs resell water to vendors, IBTs increase cost to the very poor

34. An Alternative to Increasing Block Tariffs
Use lump-sum transfers for income redistribution and other fairness objectives
This allows the choice of a uniform price design, preferable according to all other criteria
Lump-sum transfers can lead to negative fixed charges for some users

35. A Practical Alternative to IBTs: Uniform Price with Rebate (UPR)

36. Household Water Bill: UPR vs. IBT
Household’s Monthly Water Use (m3)
Uniform Price with Rebate
Increasing Block Tariff 5
US$2.50 10
US$3.31
US$5.00 15
US$8.31
US$7.50 20
US$13.31
US$12.50 25
US$18.31
US$17.50

37. Two-Part Tariff: Evaluation
Both tariffs produce the same revenue
Two-part tariff provides improved incentives:
More HHs face full marginal cost with a UPR than with a IBT. Only the smallest, most price inelastic HHs face a zero incremental price
Two-part tariff more effective in transferring income:
Per-HH transfer is larger
Transfer is not regressive

38. Two-Part Tariff: Evaluation
Two-part tariff is simple and transparent
Two-part tariff is more equitable
Advantages of two-part tariff even greater when compared to a multi-step IBT

39. Conclusions
Usual rationales for employing IBTs are either incomplete or incorrect
There are significant practical difficulties with the application of IBTs in developing countries
If the purpose of an IBT is to redistribute revenue, alternative tariff designs can do so more effectively
IBTs, on the other hand, introduce inefficiency, inequity, complexity, lack of transparency, revenue instability, and forecasting difficulties

40. Conclusions (cont.)
Properly designed tariffs are powerful management tools
Comparisons of alternative designs can be complex
No single design fits all circumstances
Increasing block designs, though widely used, have many disadvantages
Better tariff design is possible