Block Tariff Structure in Municipalities

A recent Water Research Commission study, led by Nelson Mandela Metropolitan University’s Professor Stephen Hosking, looking into the municipal water tariffs of 15 South African municipalities, found that the primary driver of water service tariffs is the quest to balance tariff revenues with explicit financial costs.

Given that the national government requires this balance, and it is a prudent financial practice, the question arises whether this aspect of municipal water service management is in a sound and healthy state.

The water supplied by South African municipalities may be categorised into nontariff water, water charged at average financial cost (the tariff level), and water charged to balance total revenue with total financial cost.

Nontariff water relates to all water losses and water services supplied at no charge or without national government subsidy support.

Water services are charged at their average financial cost of production to government, selected businesses, other municipalities and residents whose tariffs are paid on their behalf by national government.

The remainder of water service users are charged in a way that balances total revenue with total cost, namely full-tariff-paying residents and businesses not qualifying for average cost tariffs. Revenue, and captured consumer surplus from this group, are increased by means of price discrimination. Those who are prepared to pay more for their water are charged more for it, and the latter are targeted in terms of how much they demand. The more service demanded, the higher the unit rate charged.

South African Local Government Association water services manager William Moraka confirms that the increasing block tariff structure enjoys wide-spread support among municipalities.

Municipalities argue that it works in such a way as to recover their costs, it enables them to cross-subsidise the poor’s low water-service use with extra payments made by the rich owing to their high water-service use, and it curtails demand for water and capital to build new water infrastructure – both scarce resources.

Along with national government subsidies, this cross-subsidisation has contributed to improved water services to those previously excluded from them.

Unfortunately, not all the findings of the survey were as positive. It was also found that the financial information avail- able to calculate the water service tariffs was often inadequate, costs of provision of services were underestimated and important environmental costs were excluded. More seriously, it was found that there was widespread ignorance and, perhaps, even disregard in some cases of the demand for municipal water services.

The study concluded that the primary current influence on municipal tariff design is compliance with water and municipal governance law and policy.

For many of South Africa’s municipalities, meeting the compliance goals is challenging to the point of being almost overwhelming. The net external cost is not included in the calculation of South African municipal water service tariffs. Many municipalities use limited (if any) accounting information to determine the availability tariff.

Further, there is uncertainty within South African municipalities as to the underlying economic rationale of the water service tariff structure. The use of increasing block tariff structures is appropriate for curtailing individual user demand, but other more targeted instruments are superior for the pursuit of other goals, such as cross-subsidising the cost of providing water services to the poor.

Increasing block tariff structures may redistribute income in unintended ways.

The case studies evaluated show that the municipalities calculate water service tariffs by balancing their tariff revenue and explicit financial costs. It is a cost accounting exercise.

When municipalities pay minimal attention to demand, that is, what residents and business are able and willing to pay for, the link between the supply of and demand for water services is undermined. The main concern that this delinking gives rise to is that there may be unacceptable delays in water supply infrastructure being built, with consumer welfare being compromised as a result.

Hosking’s findings raise the question as to whether the increasing block tariff system is as economically meritorious as is commonly thought. It may well be true that a tariff hike is a cheaper way to solve the problem of excess demand than building a dam, but the question remains whether this gain exceeds the cost of consumer welfare and business opportunities lost through municipalities’ ignorance of the demand they face.

25th May 2012