Select Committee on Environment, Transport and Regional Affairs Memoranda




  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 the matter.

  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 possess—for example, to be understandable to users—but 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:

CriterionQuestions 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
its region?

— 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 Systems—The 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 below).

    —  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).

Intermediate Examples

  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 with it.

  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.


Some Principles

  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 cost.

  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 acknowledge—indeed we emphasise—that 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 decades.

Practicalities of Sophisticated Charging Systems

  There are also a number of problems which arise from the sophisticated tariff structure needed to meet multiple criteria. These include:

    —  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.

19   Edited extracts from Fair and Sustainable: Paying for Water, New Policy Institute, 1997. Back

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Prepared 29 January 2001