Economics of water pricing

California is experiencing a drought and naturally water is a scarce commodity. The Governor has even asked citizens to prepare for water rationing. It is in this context that George Mason University economist, David Zetland has come up with a new water tariff plan for California.

Zetland argues that the problem in California and many other places is a demand-supply mismatch, arising out of inefficiently structured tariffs, which under-price water. He therefore, proposes a tariff structure that assures a basic minimum of supply at the lowest cost, and then increasing the tariff progressively for higher consumption. Many South African cities like Durban, go one step further and provide a minimum quantity free of cost and then charges progressively higher tariffs for higher consumption.

He writes, "As it stands, Los Angeles households pay $2.80 for the first 885 gallons they use per day. That's enough water to fill 18 bathtubs. The next 18 tubs cost $3.40, which is only 20% more. Most L.A. households don't even see this price increase, since the average household of three uses just 350 gallons - about seven bathtubs - each day. For that water, the household pays only $35 a month. If they use twice the amount, the bill merely doubles. I propose a system where every person gets the first 75 gallons, or 1.5 bathtubs, per day for free but pays $5.60 for each 75 gallons after that. Under my system, the monthly bill for the average household of three would come to $95."



While providing a basic quantity of water free of cost is a good option, its financial viability depends on the consumer mix. If there is a sufficiently large enough bulk or high consumption users, as in Durban, then it becomes an appropriate strategy. The higher value consumers end up cross-subsidizing the minimum free quantity. But in most Indian cities, where the numbers of high value consumers are small and that of low quantity consumers are huge, this model may not work out. Further, though the average per capita supply is large (150-200 lpcd) in many Indian cities, the high Non Revenue Water (NRW) component ensures that actual water availability for the middle class is far less.

A similar proposal was considered by the Vijayawada Municipal Corporation (VMC) and was found not financially viable. Of the 164 MLD supplied to a population of 1 million and 75000 connections, only 66 MLD was being billed. It was proposed that 10 kl be provided free of cost, and then the tariff go up progressively from Rs 8.50 per kl from 10kl to 25 kl, and Rs 12 per kl from 25kl-50kl, and Rs 15.50 per kl beyond 50 kl. It was found that only 35% of consumers would fall into the paying bracket, and of them too only 5% were those consuming more than 50 kl.

Hat tip : Freakonomics