An Assessment of the Widespread Use of Increasing Block Tariffs in the Municipal Water Supply Sector
An Assessment of the Widespread Use of Increasing Block Tariffs in the Municipal Water Supply Sector
- Dale WhittingtonDale WhittingtonGillings School of Global Public Health, University of North Carolina at Chapel Hill
- and Céline NaugesCéline NaugesToulouse School of Economics and French Institute for Research in Agriculture
The design of municipal water tariffs requires balancing multiple criteria such as financial self-sufficiency for the service provider, equity among customers, and economic efficiency for society. Globally, various forms of water tariffs are in use (e.g., tariffs based on fixed or volumetric charges, single and two-part tariffs, and increasing or decreasing block tariffs) but increasing block tariffs (IBTs) have become popular worldwide over the last few decades for two main reasons. Apart from the fact that IBTs incentivize households to save water by charging large volumes at a higher price, there is a widespread belief that IBTs are pro-poor. The latter would be the consequence of providing all households with a minimum amount of water at a low (subsidized) price while large water users pay higher prices. However cross-subsidization between wealthy and poor households will occur only if poor households’ consumption falls in the low (subsidized) block and if rich households consume in the higher block and pay a price that is above the average cost of supply. These two conditions are rarely met in reality and IBTs often fail to allocate subsidies to the poor effectively. There are a few examples of water utilities making adjustments to the tariff to take into account that poor households with large families are likely to be adversely affected by IBTs. However, the provision of a minimum amount of water for free (as in South Africa), the design of household-specific low-cost water allowances (as in California), or tariffs being adjusted based on household size do not usually improve the targeting of subsidies to the poorest households. The widespread use of IBTs is difficult to rationalize, in particular while knowing that the use of a (simple) uniform volumetric tariff where water provision is charged at its full cost could improve social welfare by removing price distortions and would be easier for households to understand than IBTs. This simple tariff could be combined with some consumer assistance programs to help the poorest households pay their bills.
- Public Health Policy and Governance
Various tariff structures are used in the water sector but increasing block tariffs (IBTs), that is, stepwise tariffs in which the unit price of water increases as the volume of water use increases, are becoming by far the most popular. In the United States, for example, the share of water utilities using IBTs increased from only 4% in 1982 to 36% in 2004 (Dahan & Nisan, 2007). Since the early 21st century, IBTs have been used by most utilities in Asia Pacific and Latin America (Global Water Intelligence, 2019).
There are two main reasons that IBTs are so popular. First, there is a widespread belief that IBTs are pro-poor since they provide all households with a minimum amount of water at a low (subsidized) price while large water users pay higher prices. It is widely believed that large water users cross-subsidize small water users. Second, by charging higher volumes at a higher unit price, IBTs are also considered the appropriate instrument to promote water conservation.
Decision makers and water utility managers often overlook that the following set of conditions needs to be fulfilled for IBTs to perform as expected: (i) poor households, in order to benefit from the subsidized price of water services, need to have a connection to the water supply network; (ii) poor households need to consume low amounts of water so that their use does not fall into the higher-priced blocks (but note that if they have large families and/or share a connection with other households then their consumption is likely to fall in the higher blocks); and (iii) the size of the first subsidized block should not be too large and the price in the higher blocks should be above the average cost of supply. The above conditions are rarely met in studies in the scientific literature. As a result, IBTs are rarely pro-poor.
In the section “Objectives of Tariff Design,” we review the objectives that water tariffs should ideally achieve. In the section “Different Forms of Water Tariffs,” we discuss the various forms of water tariffs that can be used to calculate customers’ water bills, in addition to IBTs. We provide an assessment of IBTs in the section “Assessment of IBTs’ Performance,” combining factual evidence and evidence from the scientific (empirical) literature, and we offer some recommendations.
Objectives of Tariff Design
Policymakers must often balance economic, financial, and social objectives when deciding on a tariff structure and tariff levels (prices). Tariff design involves balancing different objectives that may conflict with each other. Judgment is required to make the right trade-offs between competing objectives at a particular time and location.
Bonbright (1961) presented an early list of tariff objectives: (a) revenue sufficiency, (b) revenue stability, (c) rate (price) stability, (d) economic efficiency, (e) equitable cost allocation, (f) simplicity, (g) public acceptability, and (h) avoidance of undue rate discrimination. Experience has shown that four objectives are usually of central importance in the tariff setting process.
The first is cost recovery through sufficient revenue generation. If tariffs are too low, water utilities will not have sufficient cash to cover their costs and provide high-quality services. Water tariffs determine the level of cost recovery that a water utility achieves. When the total revenue generated falls short of total financial costs, subsidies are required in the form of financial transfers from the government (e.g., taxpayers) or from international donors, or by deferring maintenance and capital investment and running down the existing capital stock. Sufficient revenues facilitate long-term financial and capital planning and a utility’s ability to obtain financing and reduce its cost of capital (Whittington, 2011). From the perspective of water utility management, revenue generation is usually the primary objective of the tariff.
A second important objective is economic efficiency. The tariff structure should send a signal to customers to use water wisely. Thus, tariffs provide incentives to balance the costs of supply with the benefits that customers receive. An economically efficient tariff ensures that customers do not use water that is worth less to them than the full social costs of provision (and that the customers do not miss out on using water when their valuation is greater than the marginal cost of supply). An economically efficient water tariff also provides an incentive to the water utility to use capital wisely and expand the capacity of the water supply system optimally (Hanemann, 1997). To achieve economic efficiency, a tariff must also be relatively simple and transparent so that customers understand the price signal they are receiving.
Economic efficiency is sometimes associated with the objective of water conservation. When tariffs are too low and many customers are using water that has a lower economic value to them than the actual full costs of providing these services, water use is inefficient (“wasteful”), and prices that promote “water conservation” are called for. But from an economic efficiency perspective, water conservation is not itself an objective of water tariff design. There are many situations, especially in developing countries, where household water use needs to increase because the economic benefits to households of increased water use are greater than the costs of providing increased water supplies. In such cases, policies to promote water conservation would be economically inefficient and counterproductive.
A third objective is cost-of-service equity, or equitable cost allocation. Tariffs determine the water bills that the utility’s customers pay and thus the proportion of the costs paid by different groups or classes of customers. The idea of cost-of-service equity is that customer classes should pay for the costs of service that they impose on the water system. From a cost-of-service equity perspective, classes of customers that impose high costs for the water utility should pay more for water than customers who impose lower costs. For example, it will typically cost the water utility more to serve households that are located on the outer periphery of a city at higher elevations, and from a cost-of-service-equity perspective, it would be “equitable” for such households to pay more for their water services. Designing a rate structure that ensures an equitable cost allocation between customer classes has long been a central concern of rate analysts in the United States (Hazen, 1917).
The fourth main objective is the affordability of the water and sanitation services. A tariff may result in water bills that are too high (unaffordable) for some poor households to pay. Governments may decide that the provision of piped water and sanitation services is a merit good, or a human right, and should be provided to everyone as a matter of social justice, regardless of their ability to pay. Such a determination raises the question of precisely how this objective of affordability is to be achieved. One option is to provide water free or to adopt very low tariffs for piped water services. Such a policy would make the services affordable for everyone, but this approach conflicts with the objectives of revenue generation, economic efficiency, and cost-of-service equity. Tariff designers may also tinker with the tariff to try to find a way to create low water bills for poor households and higher water bills for non-poor households. Evidence shows that such adjustments are usually unsuccessful (Fuente et al., 2016; Nauges & Whittington, 2017).
Another approach to ensuring that piped water services are affordable for poor households is to directly provide them with financial assistance to pay their water bills. There are a variety of ways to design such customer assistance programs, but the key insight is to address the affordability issue not by changing the tariff but rather by targeting subsidies and other forms of assistance to poor households to ensure that they have access to piped water and sanitation services (CH2M-CVM, 2018; Gómez-Lobo & Contreras, 2003).
Different Forms of Water Tariffs
A tariff structure is a set of procedural rules used to determine the bills of a water utility’s customers. Globally the most popular tariff structure is the IBT, but there are in fact many other tariff structures also in use (GWI, 2019). Tariff structures used in the municipal water supply sector can be categorized as two main types: (a) a single-part tariff and (b) a two-part tariff. Within each of these two types of tariff structure, there are many variations that a water utility can use to influence its customers’ water bills.
Single-part tariffs use a single calculation to determine a consumer’s water bill which is based either on fixed or volumetric charges.
One approach is simply to use a fixed charge. In fact, in the absence of metering, fixed charges are the only option for calculating a customer’s water bill. With a fixed charge, the consumer’s water bill is the same regardless of the volume used. Fixed charges are still widely used in some industrialized countries with plentiful water resources (e.g., Canada, Norway, and the United Kingdom). In many countries, renters in multistory apartment buildings have unmetered connections to their units and thus effectively pay a fixed charge for water (perhaps incorporated into their rent).
The water utility may decide to vary the fixed charge across different types of households or customer classes depending on characteristics of the customer. For example, historically, a common way to charge differential fixed charges was to set higher fixed charges on more valuable residential properties. This would indirectly address the affordability objective, making the water bill lower for households living in lower-cost housing units. Similarly, businesses may be assigned a different fixed charge than households, based on either a cost-of-service equity objective or an affordability objective. Positive fixed charges also raise revenue and further the revenue generation objective. Fixed charges can also vary depending on the pipe diameter of a customer’s connection. Customers with larger diameter pipes are assigned a higher fixed charge based on the assumption that they use more water. This approach contributes to both the cost-of-service equity objective, the affordability objective, and the revenue generation objective. But fixed charges do little to further the economic efficiency objective because the marginal cost to the customer of additional water use is zero, giving customers no incentive to use water wisely.
A second approach that a water utility can use to calculate a customer’s water bill with a single-part tariff is to base consumers’ water bills on the amount of water they use. This second approach requires that consumers have a metered connection and that this meter works reliably and is read on a periodic basis. There are four main formulas that water utilities deploy to calculate a water bill based on the volume of water a customer uses: (a) a uniform volumetric charge; (b) a block tariff, where the unit charge is specified over a range of water use for a specific consumer and then shifts as use increases; (c) a volume-differentiated tariff, where the unit charge for all the water a customer uses is the price in the highest block into which the customer’s usage falls; and (d) an increasing linear tariff, whereby the unit charge increases linearly as water use increases.
Uniform Volumetric Charges
With a single-part tariff and with a uniform volumetric charge, a customer’s water bill is the quantity of water used multiplied by the price per unit of water. Uniform volumetric charges are common among water utilities in the United States, Australia, and a number of European countries, and are also common for industrial and commercial customers. A uniform volumetric charge has the advantage of being easy for the customer to understand. The uniform volumetric price can be set to send a clear signal to use water wisely, thus furthering the economic efficiency objective.
There are two types of block tariffs: increasing and decreasing. If a water utility uses a single-part IBT to calculate customers’ water bills, customers pay a low volumetric per-unit charge (price) for water use up to a specified quantity (or block); for any additional water consumed, they pay a higher price up to the limit for a second block, even higher for the third, and so on. With a decreasing block tariff (DBT), on the other hand, customers pay a high volumetric charge for water use up to the specified quantity in the first block, pay less per unit for additional water up to the limit for the second block, then less still for water use in the third block, and so on. With an IBT, the first block is commonly described as the “lifeline block,” that is, it is supposed to provide a sufficient amount of water to cover the basic needs of households. The challenge faced by most utilities is to choose the amount of water that is included in the first block, knowing that households differ in size.
A variation on the IBT structure is the volume-differentiated tariff (VDT). Like an IBT, the VDT consists of a series of blocks defined by the quantity of water used, and volumetric prices increase in each subsequent block. However, with a VDT, customers are charged the volumetric price in the last block in which their usage falls for all their water use. For customers whose usage falls into a higher-priced block, their water bills can be substantially higher for a VDT than for an IBT, furthering the revenue generation objective. For example, such tariffs have been applied in Tunisia (Favre & Montginoul, 2018) and in Egypt (Nauges, Whittington, & El-Alfy, 2015).
Increasing Linear Tariffs
The increasing linear tariff structure is rarely used, but it illustrates that there are many ways that water bills can be related to the quantity of water used. In this tariff structure, the price that a consumer pays per unit increases continuously (rather than in block increments) as the quantity of water used increases. This tariff structure sends the consumer a powerful signal that increased water use is costly. Not only is each additional unit of water used sold at a higher price, but all the preceding units are sold at the last (high) price. A related but different tariff structure would require that only the last unit used would be sold at the highest price; other units would be sold at the price associated with the lower quantity. However, an increasing linear tariff does not further the economic efficiency objective because it cannot send the proper economic signal to a consumer about the marginal cost of additional water use.
A two-part tariff is a combination of a fixed charge and a volumetric charge that depends on the amount of water used. These two components of a two-part tariff can be varied in numerous ways. The fixed charge can be either positive (a flat fee) or negative (a rebate). The water use charge can be based on any kind of volumetric tariff structures, including a uniform volumetric tariff, an increasing or decreasing block tariff, or an increasing linear tariff.
Both single-part and two-part tariffs can be combined with a “minimum bill” regulation. When such a “minimum charge” regulation is in place, the water utility first calculates a customer’s water bill using the existing tariff structure. It then compares the amount of this water bill to the minimum charge. If the customer’s calculated water bill is less than the minimum charge, then the customer’s water bill is the minimum charge, not the amount that results from the application of the tariff structure. Some utilities implement a minimum charge for water and sanitation services in addition to a formal fixed charge. Though similar to a fixed charge, they are often justified or determined in different ways. For example, a minimum charge may be simply set to some arbitrary level deemed appropriate by policymakers or may be set in relation to a specified amount of water use. In the latter case, customers might be charged for a minimum amount of water use (e.g., 6m3 or 10m3 per month) regardless of how much water they use. Minimum bills have been used by water utilities in Egypt (Nauges, Whittington, & El-Alfy, 2015).
Initially, the rationale for the minimum charge was to encourage households to use sufficient amounts of water for public health purposes, that is, for them not to economize on water use so much as to jeopardize their health (Hazen, 1917). It is now often used by utilities as a means of increasing revenues (revenue generation objective).
Seasonal and Zonal Water Pricing
The costs of supplying water to customers may vary by season. For example, a community may have relatively plentiful water supplies in the rainy season but much more limited supplies in the dry season. In such cases, water tariffs can be structured to reflect these varying circumstances. The water utility can charge higher rates in the dry season and lower rates in the wet season, signaling to customers that the water supply is not constant across the seasons, and that the costs of maintaining and distributing the water supply may vary as well. The higher dry season rate also serves as a signal that each user’s consumption of water reduces the amount available for others. In locations where there are substantial differences in seasonal water use (e.g., water use is higher in summer months when temperatures and water use increase), seasonal water pricing can be especially useful to promote the economic efficiency objective because it can eliminate the need to add capacity that is only used a few months a year. However, seasonal water pricing is often perceived as unfair because it requires that prices increase when the need for water is greatest. Chile is one of the few developing countries that uses seasonal water tariffs (Chavez, 2002).
Similarly, it may cost the water utility more to deliver water to outlying communities due to, for example, increased pumping costs to reach higher elevations or more distant settlements. A zonal water-pricing structure charges users who live in such areas more for their water because it costs the utility more to serve them. Zonal prices can be used as an economic signal to users that living in such areas involves substantially higher water supply costs and that such information should be factored into customers’ locational and water-use decisions, thus furthering the economic efficiency objective as well as the cost-of-service equity objective. However, zonal tariff structures are rare, in part because they require the water supplier to collect detailed geographic data on the location of customers and match these locations to cost differences.
Zonal pricing can also be used to further the affordability objective. The prices charged to households living in poor neighborhoods or zones of a city can be lower than the prices charged to households living in middle-income or upper-income neighborhoods.
Assessment of IBTs’ Performance
IBTs are popular largely because they are politically appealing. IBTs are commonly claimed to be pro-poor because they provide a minimum amount of water to ensure that a minimum consumption level is affordable. In some circumstances, in particular if there is aversion to inequality and preference for redistribution, IBTs can also be perceived as fairer than volumetric tariffs (Meran & von Hirschhausen, 2017).
However, there is now considerable empirical evidence that IBTs do not effectively target subsidies to poor households, nor do they send the correct economic signal to households to use water wisely (see, e.g., Komives, Foster, Halpern, Wodon, & Abdullah, 2005; Nauges & Whittington, 2017; Whittington, Nauges, Fuente, & Wu, 2015). We first discuss a number of reasons why IBTs may fail to achieve equity and economic efficiency objectives. We then review papers from the scientific literature in which the authors measured the performance of IBTs based on one or several criteria and compared IBTs with other tariff structures. We conclude this section with discussion and some general recommendations.
There are multiple reasons that IBTs fail to achieve objectives of economic efficiency and equity.
First, in low- and middle-income countries, many poor households are still not connected to the piped water network and do not have direct access to the subsidized water supplies. These unconnected households, which have to rely on other, non-piped and usually less safe sources, are typically the poorest of the poor. Subsidies delivered through IBTs do not reach them and the price they pay for non-piped sources (including the cost of collection time) is often higher than the price paid by connected households.
Second, when households share a metered connection to the piped water system, the group of households sharing the connection uses more water than a household that only uses water for its own members, driving the majority of the group’s water use into the highest-priced block. In contrast, a high proportion of the water use of a household with a private connection for the exclusive use of its members is billed at the lifeline rate. Because houses sharing a connection are generally poorer than households with a private metered connection for the exclusive use of its members, poor households with shared connections commonly pay higher average prices than richer households with private connections.
Third, the argument that IBTs target subsidies effectively to poor households assumes that poor households only use small amounts of water and rich households use larger amounts. However, contrary to conventional wisdom, the correlation between household water use and income is typically low (+0.1–+0.2) (see Nauges & Whittington, 2017). Indeed, water demand is more strongly determined by household size than by income, meaning that a low-income household does not necessarily consume less water than a high-income household.
Fourth, the lifeline blocks of IBTs as commonly designed are too large, often as high as 10 m3 per month. This is equal to 83 liters per capita per day (lpcd) for a family of four (for a household with three members, this would be 111 lpcd). Average household water use in many European cities is only slightly larger than this, which means that with a lifeline rate of 10 m3 per month, many households—rich and poor—will be billed for the majority of their water use at the price in the lifeline block.
Fifth, the price of water for use in the upper blocks of IBTs as currently designed is too low. Throughout water utilities in low- and middle-income countries, the price of water in the upper blocks is still below the total average cost of water. This means that the more water a household uses, the larger the absolute value of the subsidies it receives.
Sixth, even if the volumetric price in the highest block roughly equals the marginal cost, those households whose consumption falls in the lower blocks will pay a price that is below the marginal cost of producing water, which is clearly inefficient from the point of view of resource management.
Empirical Assessments of the Effectiveness of IBTs in the Literature
In what follows, we discuss articles from the literature which provided insights on the performance of IBTs and, in some cases, proposed alternative solutions. One important observation is that the assessment of IBTs is rarely done on the basis of multiple objectives. One exception is Nauges and Whittington (2017) who studied the trade-offs between cost recovery, economic efficiency, and equity among consumers, using hypothetical data.1 Comparison between studies is also made difficult by the fact that different authors adopt different definitions of equity and fairness, and use different definitions of what is “optimal.”
The fact that IBTs may fail to achieve equity objectives because water consumption is influenced more by household size than by household income is now better understood and acknowledged. In order to address this equity issue, IBTs have been modified in some places to account for household size. For example, in most of the Spanish provincial capitals, either a discount is applied to the price charged in each block or an ad hoc block tariff is designed for households above a specific size. Arbués and Barberán (2012) studied whether such tariffs led to greater equity, where equity is defined as follows: all households, regardless of their size, pay the same per capita (variable) water charge to cover their basic needs.2 In the majority of cities studied, it was found that the introduction of a special volumetric tariff for households above a specific size (rules vary by city) did not improve this equity objective.
Allocation-based rates (ABR), which are now common in California, are a type of IBT in which “the block sizes are defined based on the quantity of water that is deemed efficient for a particular consumer’s indoor and outdoor needs” (Pérez-Urdiales & Baerenklau, 2019, p. 206). The amount of water that is allocated to each household and which is charged at low cost is adjusted at each billing period based on the number of residents, the size of the irrigated area, and the weather conditions.3 Pérez-Urdiales and Baerenklau (2019) use a natural experiment involving a tariff change in a Southern Californian water district from a uniform tariff to an IBT with ABR, on households’ water use and welfare. They find evidence that the introduction of ABR induced water conservation, with a more pronounced effect on those households that were further from their “efficient threshold” before the tariff change. The impact on welfare (of moving from uniform pricing to IBT with ABR) was found to be positive overall (with an average increase of $24 per year per household), but the average welfare of households in the lower tercile of the income distribution was slightly reduced, indicating that the tariff combining an IBT and ABR is regressive (Baerenklau & Pérez-Urdiales, 2019).
Another type of IBT adjustment was the Free Basic Water Policy which was introduced in South Africa in 2001 and provided 6m3 of free water per month to households, but in this case, regardless of income or household size. Running a counterfactual analysis on a rich dataset from a low-income suburb, Szabó (2015) showed that the free water allowance (which acts as a lump-sum subsidy) does not have a large impact on water use. The author then looked for an alternative tariff, without any free water allowance, that would maximize consumers’ total expected utility while keeping the profit of the water company unchanged. Some conditions had to be imposed for the analysis to be tractable. In particular, the author assumed that the six kink points would remain the same in the hypothetical tariff. Under these constraints, the proposed tariff is a seven-block IBT with lower prices in the first three blocks and higher prices in the last four blocks. This revised (“optimal”) tariff leads to an overall increase in welfare (approximately 3.5% of the median monthly income) compared to the previous IBT. The removal of the free allowance also improves the welfare of the poorest consumers who benefit from reduced marginal prices. Finally, under the revised tariff the number of households consuming very low quantities of clean water is also reduced. This is because the price on the second block is significantly lower with the revised tariff. In the original tariff, a higher price in the second block incentivized households to consume less than the free water allowance threshold.
Several authors have studied the impact on households’ welfare of moving from an IBT to a uniform volumetric tariff. In general, comparison of various pricing models has confirmed that the first best alternative, that is, setting uniform volumetric price in which the water price is set at the marginal cost, maximizes social welfare by removing the price distortions induced by block pricing (Hajispyrou, Koundouri, & Pashardes, 2002; Ruijs, 2009; Ruijs, Zimmermann, & van den Berg, 2008).
Simulations run in Cyprus indicated that most of the benefits of moving from an IBT to a uniform volumetric pricing system would be enjoyed by the better-off households (Hajispyrou et al., 2002). This is for two main reasons: (a) average consumption increases from the low- to high-income group (six groups in total), and (b) all households under the current IBT pay an average price that is below the average supply cost. When moving from the current IBT to an (efficient) volumetric tariff, households in the lower-income groups experience the largest price increase and the largest welfare loss. However, the current IBT is quite inequitable since the largest share of the subsidies go to the better-off households which benefit from subsidized prices even in the higher blocks. Under the hypothetical efficient volumetric tariff, each household pays the same (efficient) price, and there is no longer any subsidy being distributed. Some financial assistance or rebate may have to be distributed to the low-income groups to make this new tariff equitable and politically acceptable. Moving from the current IBT to the (efficient) volumetric tariff would allow the utility to raise more revenues and to improve the cost recovery objective compared to the current IBT tariff.
Using data from the metropolitan area of São Paulo (Brazil), Ruijs, Zimmermann, & van den Berg (2008) and Ruijs (2009) compared alternative pricing policies on the basis of water demand and welfare effects across the income distribution. Their findings show that moving from an IBT to a uniform volumetric tariff structure leads to an increase in welfare, but more so for the households in the higher-income groups. However, the authors caution that the estimates of demand and welfare effects in their simulation exercise may be biased because the parameters of the assumed demand function were estimated using aggregate data at the municipality level (39 municipalities) for water consumption combined with a regional measure of income (which covers the entire region and varies only over time). Water consumption for the five income groups (five quintiles) thus had to be extrapolated based on the parameter estimates (in particular, income elasticity). Such an extrapolation leads to a positive correlation between water use and income (since income elasticity was found to be positive), which is likely to be much higher than what is usually observed in micro-, household-level data. Simulations of tariff changes on welfare effects across the income distribution may thus be misleading when performed using averages for different income groups.
Nauges and Whittington (2017) used hypothetical household data on water consumption to study the impact of a shift from a uniform volumetric tariff to an IBT on water use and water bills, subsidy targeting (equity), and economic efficiency, while conditioning on financial cost-recovery objectives. They studied a two-block IBT and considered various sizes for the first block. The general conclusion is that IBTs perform poorly in terms of equity, since the majority of subsidies accrue to middle- and upper-income households. When the financial objective is modest (low cost recovery), the equity issue (i.e., the poor targeting) is exacerbated when the correlation between water use and household income is high. This happens because prices, even in the higher blocks, are subsidized. Their findings also confirm that IBTs decrease overall welfare by introducing price distortions, but these welfare losses are found to be relatively small, especially when households respond to average prices.
Evidence from the literature thus confirms that IBTs do not perform well in most situations in terms of subsidy targeting. One of the main arguments in favor of IBTs was that such tariffs should help the poor receive a minimum amount of water at a low price while better-off households would pay a higher price to compensate. However, the evidence suggests that these equity and cross-subsidization objectives are rarely fulfilled because poor households are not always low water users. A (high and positive) correlation between household income and water consumption is one necessary condition for IBTs to perform well, but two other conditions also need to be fulfilled: (a) the price in the upper blocks needs to be above the average cost of supply, and (b) there must be enough customers whose consumption falls in the higher blocks and who pay the higher price.
It is clear from the literature that adjustments made to the tariff, such as the provision of a minimum amount of water for free (as in South Africa), the design of household-specific low-cost water allowances (as in California), or tariffs being adjusted for households above a specific size, do not usually lead to more equitable outcomes. On the contrary, simpler uniform volumetric tariffs can improve social welfare by removing price distortions. Such tariffs are also easier for households to understand than IBTs. Since the correlation between water use and income is often low, tinkering with tariffs will almost never be sufficient to improve targeting of subsidies to the poorest households. For this reason we recommend the use of a uniform volumetric tariff where water provision is charged at its full cost, combined with some consumer assistance programs to help the poorest households pay their bills (Cook, Fuente, & Whittington, 2020a; Cook, Fuente, Matichich, & Whittington, 2020b). This is in line with recommendation by Tienbergen (1952) that separate policy instruments should be used to address different objectives. Examples of such financial assistance programs are the means-tested subsidy used in Chile and the geographically targeted subsidy used in Colombia (Gómez-Lobo & Contreras, 2003). For a comparison between an IBT and a means-tested subsidy in the city of Lima (Peru), see also Barde and Lehmann (2014).
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1. We do not discuss theoretical analyses of water tariffs. Some useful references are Monteiro and Roseta-Palma (2011), Sibly and Tooth (2014), Schoengold and Zilberman (2014), and Meran and von Hirschhausen (2017).
2. In this particular study, basic needs were defined as the average consumption in the region.
3. For this reason, ABRs are household-specific and change at every billing period.