Tariff cross-subsidies complicated diversions or valid route to cost recovery? Kristin Komives World Bank Water Week 2004

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1 Tariff cross-subsidies complicated diversions or valid route to cost recovery? Kristin Komives World Bank Water Week 2004

2 The problem Many water utilities are not raising enough revenue to cover costs. Raising tariffs is an option, but it is difficult in practice to set cost recovery tariffs Why? #1 Politics #2 Population served is poor #3 Water should be free (Komives and Prokopy 2000) Tariff cross-subsidies as the solution?

3 Defining tariff cross-subsidies Financial subsidy Cost of service provided minus payment Cross-subsidy for cost recovery Some users pay more than cost, and others less

4 Forms of tariff cross-subsidies Explicit (focus of this talk) differentiated volumetric tariffs by user class or geographical area (one user class subsidizes another) increasing block tariff (higher volume users subsidize lower volume users) Implicit a single tariff schedule for users who impose very different costs on the water utility flat rates for unmetered users tariff schedules without fixed charge

5 Cross-subsidies for affordability? What is affordable, and who can t afford price increases? WTP studies tell varied stories Alternative question: Can tariff cross-subsidies keep the price of water for the poor households low? Many poor households are out of the reach of crosssubsidy schemes Cross-subsidy tariffs are imprecise instruments

6 Out of reach? Explicit crosssubsidies in water tariffs only affect water prices for: Cases Santiago 1998 Lima 1991 % with connection 99% 75% % metered 99% 30% % affected by explicit cross-subs 98% 22.5% connected households Buenos Aires % 2% 1.4% with meters Abdijan % 96% 57.6% Conakry % 5% 1.9% Based on statistics cited in R. Noll, M. Shirley, and S. Cowan

7 Out of reach? Poor households are least likely to have connections Will cost recovery effort lead to service expansion? % hhs with water connection Water coverage and income Median monthly hh income (1998 US$) Based on LSMS data from 7 countries (Komives et al 2003)

8 Imprecise instruments In practice, water consumption for most connected households, not just the poor, is subsidized. Price per cubic meter (US$) La Paz/El Alto Water Tariff (1998) Industrial tariff Average cost Average cost Residential tariff Cubic meter 99% of hhs consume less than 150 cubic meters

9 Imprecise instruments Is it just a problem of poorly designed crosssubsidy tariffs? It is hard to target subsidies to the poor through tariffs because the poor are not as different from others as we might expect.

10 Geography? Colombia case Stratification of residential areas into 6 socioeconomic categories Declining subsidies for hhs living in poorest three categories Targeted population Errors of exclusion Cat 1 Cat 1 & 2 Cat 1, 2, 3 Errors of inclusion Cat 1 Cat 1 & 2 Cat 1, 2, 3 Poorest 10% 82% 31% 3% 78% 83% 88% Poorest 20% 84% 34% 3% 60% 68% 77% Poorest 30% 84% 36% 4% 39% 53% 64% Source: Gómez-Lobo & Contreras 2000

11 Consumption? Water consumption by connected hhs can be a poor indicator of relative wealth/poverty Problem for targeting power of IBTs Niamey, Niger Maturin, Venezuela Cum% Consumption Poor Rich Cum. % Poor Rich Monthly Consumption, m3/ HH Monthly Consumption, m3/hh Source: Prokopy, Komives, and Lauria 2003

12 Cross-subsidies and IBTs? Can we design an IBT in which the non-poor pay more on average than the poor, while meeting a revenue constraint? Yes, if at least one non-poor customer consumes more than the largest amount consumed by a poor customer But, large burden on few cross-subsidizers if the consumption patterns of poor and non-poor do not differ markedly Source: Prokopy, Komives, and Lauria 2003

13 An extreme example Free water for all poor households, while still achieving cost recovery? A large first block of free water with cross-subsidization through consumption in the second block Size of free water block % of total consumption exceeding free water block Price required in second block to achieve cost recovery Niamey 95 cubic meters 2% $23.00/ cubic meter Maturin 80 cubic meters 7% $2.50/ cubic meter Source: Prokopy, Komives, and Lauria 2003

14 Political and financial risk? IBTs are politically popular because most or all households benefit from the cross-subsidy But when a cross-subsidy is used in the pursuit of cost recovery, some users will see prices rise more than would otherwise be the case. Limit to political feasibility? Risk of driving cross-subsidizers off the system, undermining cost recovery goals? Price elasticity of demand in face of large price increases?

15 Tariff cross-subsidies: valid route to cost recovery? Keeping prices low is not always necessary, and may not solve problem of exclusion of poor households from water services It is difficult to target benefits of cross-subsidy to the poor Lower errors of exclusion = high errors of inclusion The greater the protection for the poor, the greater the revenue risk for the utility Lower errors of exclusion = greater burden on crosssubsidizers