CRITERIA FOR A WATER CHARGING SYSTEM
The choice of a new charging system is a commercial
decision for the water companies to make. But the unique status
of water means that the decision has considerable social and environmental
implications. The Government therefore has a proper interest in
Through OFWAT, the Government already takes
an interest in the overall level of charges to households. As
a steward of the environment, it has an interest in seeing that
there are incentives for the sensible use of water by both the
water industry and consumers. For reasons of social justice, it
also has an interest in the mix of charges between households.
There is no reason to suppose that the public
interest is necessarily or inevitably at odds with the water companies'
interest. Instead of proceeding on this basis, assuming the problem
to be an inherently adversarial one, the Government could try
to lead the water companies towards decisions that would command
political and public support.
We propose that the Government should exercise
its leadership by setting out criteria relating to the effects
of any new system of payment. The criteria we suggest are that
a system of charging should:
Be efficient in economic terms.
Sustain the environment.
Produce socially just outcomes.
There are certainly other important attributes
that any charging system should possessfor example, to
be understandable to usersbut criteria of efficiency, sustainability
and justice are likely to be fundamental determinants of the acceptability
or not of any system.
Applying the Criteria
One way of applying these criteria is to frame
a set of more specific questions to ask of any particular charging
system. In order to meet a particular criteria, a charging system
must provide a satisfactory answer to all of the questions associated
with it. For example:
|Criterion||Questions to ask to establish whether the criterion is met. Does the system:
|Economic efficiency|| Allow for water to be appropriately priced at the margin?
Provide a balance of incentives for both households and water companies
to use resources efficiently?
|Sustain environment|| Help protect the ecosystem, in terms of both the quantity and quality of
Address the strategic water problems foreseen by the water company in
Stimulate water companies to promote non-
financial measures for the saving of water?
|Social justice|| Protect households from pressure to economise on water where health
and hygiene could suffer?
Reflect consumers' ability to pay for water to meet essential needs?
Include payment options to help with budgeting and arrangements for
exemptions and rebates?
Any system put forward to solve the strategic problems should
be required to satisfy all the criteria and not just some.
Current Charging SystemsThe Two Extremes
There are two extreme forms of water charging system. One
is where the bill is independent of the volume of water used and
is wholly determined by the fixed charge. The other is where there
is no fixed charge and where the bill is proportional to the volume
of water used. Interestingly, these extremes are close to representing
the two systems actually in existence for households in England
and Wales at the moment:
Most households currently pay for water via a
fixed charge only, set according to rateable values (see diagram
The minority of households who are now metered
pay according to the volume of water they use, plus a small fixed
charge (see diagram below).
Clearly, it is possible to "mix and match" the
charges with a combination of fixed charge and volumetric charge.
Two possible examples are:
A tariff structure that combines a standing charge
with a volumetric charge that only starts to apply above a given
level of "basic" water usage.
A block tariff structure, where the amount paid
still depends on the volume of water used but does not vary continuously
This analysis highlights the observation that any water charging
system combines a level of fixed charge with one or more volumetric
charges for differing volumes of water usage. The practical questions
in devising a particular tariff structure then concern:
The relationship between the fixed charge and
the volumetric charge(s).
Whether any of them should vary between households.
How the information necessary to set a particular
household's tariff should be obtained.
If the marginal price (which corresponds to the slope of
the line in the diagrams above) is too low, then the consumer
has little incentive to economise on usage. Conversely, if the
marginal price is too high, then the supplier has little incentive
to encourage its consumers to economise on usage. Theories of
economic efficiency suggest that, over time, the price paid by
the consumer for an extra litre of water at the margin should
equal the cost incurred by the water company in providing that
additional water (plus, perhaps, the environmental costs).
Note that economic efficiency is only concerned with the
cost at relatively high levels of usage (where the consumer is
faced with a decision whether or not to use water) and not at
lower levels of usage (where the consumer will use the water anyway).
So any charging system where payment according to the volume used
starts to apply above a certain level of consumption is in principle
capable of satisfying this efficiency criterion.
Like economic efficiency, environmental sustainability may
also depend on the marginal price because any element of charging
for water according to volume used creates financial incentives
for households to economise. But, as there is no reason to suppose
that households will respond only to price incentives, it is important
that water companies also have the incentive to encourage such
economy by other, non-financial means. This requires that the
marginal price paid by households be no greater than the marginal
Social justice on the other hand depends much more on the
total bill (both volumetric and fixed charges). So, for example,
the fixed charge should be such that it is affordable for poor
families and the costs at low levels of usage should be such that
no household is unable to afford the water for ordinary domestic
usage that it needs for essential purposes.
Assessment of the Current Schemes
Applying these principles shows that none of the present
charging systems is adequate:
Flat rate charging systems, such as the present
ones based on rateable values or council tax bands, cannot satisfy
either the economic or the environmental criteria because the
marginal price of water is zero. On the other hand, the present
flat rate systems are to some extent a proxy for the ability to
pay, and may therefore meet the criterion of social justice.
The present tariff for metered customers also
seems to fail to satisfy the economic criterion, but for the different
reason that its marginal (volumetric) price is arguably too high
compared with the future long run marginal cost. As a result,
the tariff structure does not provide a proper balance of financial
incentives as it leaves water companies with little or no financial
interest in households saving water. Moreover, as the fixed charge
element is levied as a uniform fee per household, it also cannot
meet the social justice criterion, as water bills are unrelated
to customers' ability to pay.
Assessment of a Hybrid Scheme
Although the present metered tariff does not meet the criteria,
it is possible to see how it could be altered to ensure that it
did. For example:
First, if the volumetric charge for water were
reduced to bring it into line with a revised view of the long
run marginal cost of water, both the economic and the environmental
criteria could be met.
Second, if volumetric charging were only to begin
once a household exceeded its "basic usage" (set to
reflect essential water needs), this would contribute to the social
justice criterion being met.
Third, the fixed charge would need to be raised
to offset the fall in the water companies' income resulting from
the two changes above. But if this higher standing charge were
allocated among households according to some proxy for the ability
to pay, for example, council tax banding, then the social justice
criteria could still be met.
We conclude that charging systems can be found that satisfy
the multiple criteria of economic efficiency, environmental sustainability
and social justice. But they have to be sophisticated systems.
Whilst this implies widespread metering, the accompanying tariff
must reflect social justice concerns in a way that the present
metered tariff does not.
Opposition to Metering
There is continuing opposition to metering itself, usually
from bodies representing the interests of consumers, whether in
the water industry or more generally.
We acknowledgeindeed we emphasisethat there
are serious objections to an extension of metering on the present
tariff, objections economic, environmental and social. But the
fundamental fault lies with the tariff structure and the principles
on which it has been constructed by the water companies, at the
behest of the last Government and OFWAT. We believe it is vital
to distinguish between metering and the tariff structure, directing
criticisms at the latter, because metering itself provides information
on usage that will help manage society's use of water in the coming
Practicalities of Sophisticated Charging Systems
There are also a number of problems which arise from the
sophisticated tariff structure needed to meet multiple criteria.
The cost implications of gathering additional
information and administering the system.
The setting of household-specific thresholds (eg
for basic usage).
Concerns arising from the confidentiality of some
of the information required.
We recognise all of these as important issues which need
to be addressed in any fully fledged solution. However, they should
not be insuperable, given additional research, a realistic timescale
for implementation and appropriate co-operation between the water
companies and local authorities, who may have a significant role
to play in overcoming some of these obstacles.
Edited extracts from Fair and Sustainable: Paying for Water,
New Policy Institute, 1997. Back