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Key departmental publications, e.g. annual reports, budget papers and program guidelines are available in our online archive.

Much of the material listed on these archived web pages has been superseded, or served a particular purpose at a particular time. It may contain references to activities or policies that have no current application. Many archived documents may link to web pages that have moved or no longer exist, or may refer to other documents that are no longer available.

Equity and the Environment

Environmental Economics Seminar Series
Department of the Environment, Sport and Territories, 1996
ISBN 0 642 24878 8

Distributional impact of water pricing

Michael Seery
NSW Government Pricing Tribunal

I intend to try to cover in the half hour allotted to me basically three areas: firstly, what the NSW Government Pricing Tribunal is all about; a little about pricing but not in great detail; something about the Sydney Water Corporation's reforms. Most of my talk will be about what Sydney Water has done rather than about some of the other areas we have had control over. I will seek to discuss the impact analysis and round off with a summary.

I begin with an unsolicited advertisement on behalf of the tribunal. First, the tribunal regulates government monopoly services in New South Wales. It was established in 1992 by the then Greiner Government just before he left the scene and has been running for three years; our anniversary was only last week. We started on 1 July 1992.

We regulate the core functions of electricity, water and urban public passenger transport. The water services that we regulate are those for Sydney Water Corporation, Hunter Water Corporation, Gosford and Wyong Councils and some of the rural towns.

In 1992-93 the tribunal undertook its first major review of pricing policies of water and has issued its report. The work on the impact analysis that I will talk about this afternoon was developed as part of the work for that particular report. Since then the tribunal has done an interim report on electricity and we are at the moment in the throes of starting a review of urban public passenger transport services, of which hopefully the terms of reference will be published in the next couple of weeks.

When the new government came to power in March this year, they foreshadowed in their policies a few changes in our role. They suggested we pick up gas, forests, rural water and waste pricing. So at present we are running a review of pricing principles for rural water and of waste prices. In this sense rural water is irrigation water or bulk water. We are also undertaking a review of rural town water supplies. We are a fairly busy organisation considering we have only 15 people, a position that is about to change.

The government has also suggested that we might be involved in access regimes at the New South Wales level, and also we may have an IC style role for review of the public sector. So that's a fairly substantial organisation to be undertaken by 15 people.

Let me turn quickly to pricing. There are a number of objectives and this is probably where this talk fits in with today's topic of equity and the environment.

First, in setting prices one has the objective of efficiency - productive, allocative efficiency if you set the right price. Then there are the financial impacts of the organisation. Is it financially viable against the background of particular prices, or is it making too much money? For example, the Water Board in its previous life was paying substantial amounts of money to the government in the form of dividends. Should those dividends be paid to government or should they be returned to the customer?

Then there is the question of equity and the definition of equity. As Mick Common truly says in his background paper to this seminar, equity means different things to different people.

There are then the environmental objectives. There are the objectives of resource allocation, scarce resources, and environmental factors considered in pricing involve our looking at very large changes in our pricing for water services. These are all factors that have been done and considered by the tribunal in setting the prices for Sydney Water Corporation.

Unfortunately, there may be conflict between efficiency, equity and environment. If you increase the prices for efficiency or environmental reasons, you have to consider the issue of equity - the impacts of changes on people's lives. What it comes to at the end of the day is a balance between those items.

How do we measure equity? We have talked a lot this morning about intergenerational equity. To a rapid repayment of debt and undergearing are issues for intergenerational equity. The Tribunal also considers income equity, and access equity involving people's access to particular essential services.

From an efficiency viewpoint user pays is possibly the way to go. Using marginal costs you set up a system where people pay for the services that they use. It tends to have a more meaningful relationship, and I know that I do not need to explain the economics of user pays. To me, when paying for a service as you use it, you are more careful about the resource. I know in my own circumstances in our house that when we get large bills for a particular quarter, whether for water, telephone or electricity, the immediate reaction is to say: 'Well, listen, you people are using too much of that particular resource. You must make fewer phone calls, take shorter showers' because these things are essential to reduce the bill. We are not concerned about how many phone calls we make, but when you add up the phone calls each day over a period the money builds up. People do not realise that unless they are getting some signal. And that is what user pays and pricing is all about: signalling to people the right message to get the right balance.

In principle environmental externalities should be priced, but it is difficult to quantify what those externalities are, and also whose role it is to define them. There is a lot of discussion within New South Wales as to whether it is the tribunal's role, for example, to set environmental standards or whether another agency, such as the Environmental Protection Authority, sets the standard and then the tribunal just allows the costs of those increased standards to pass through. It is a concern, and was a consideration in the tribunal's report.

There is a bias against demand management. It is interesting to those of you who may be associated with New South Wales that the tribunal has recently established a demand management forum. It brings together a group of people, including environmentalists, agency and government departmental representatives, to look at demand management in the water industry and pricing.

A couple of years ago the tribunal conducted a survey in which we obtained community attitudes on pricing. The survey showed that 75 per cent of customers wanted 50 per cent or more of their bill to be usage charged rather than in the form of an access charge. The problem was that most people were sceptical about the total size of the bill, particularly at a time when large amounts of their bills were going to governments in the form of dividends.

As to priorities in pricing, there are some pure pricing theories but at the end of the day it is probably more of a balance and involves getting the pragmatism right. The transaction costs are very high in terms of metering and billing costs, and even development of new technologies. There are conflicting and multiple objectives in trying to achieve efficiency, financial, environmental and equity factors. At the end of the day it is a matter of balance, and if you introduce schemes you need to have some sort of transition path.

As I have already emphasised, the important thing is signalling and giving people the opportunity to make a choice based on those signals. How do you go about it? The options are: water usage prices and for some people, particularly for those in business, sewer usage prices; rate-based charges, which have been widely used in New South Wales in the past by virtue of property taxes paid by residential properties and also by business properties. There have also been developer charges which have been relatively small in the past and there is potential for them to increase in future. Also there are capacity-related access charges for the amount you pay each quarter up -front based on the amount of capacity.

What has been going on in terms of Sydney reforms? Usage charges are now 39 per cent of the revenue when the figure was only 21 per cent in 1992-93. That was the year before the tribunal increased usage charges. That is the total bill. For households that percentage is even higher. This has been as a result of higher usage charges, reduction in rates and removal of the environmental levy.

Back in the late 80s, in order to cover the costs of some of the extra work that was required to improve the standards of ocean outfalls and sewerage treatment, the government introduced a levy of $80 per year on all customers, which was paid regardless. That was due to be removed last year. In its submission to the tribunal in 1993, the Water Board suggested that they would remove the levy earlier but use that to offset any increases in usage charges. The tribunal, after considering the impact, decided to accept that offer.

Non-residential property rates have been cut from $360 million in 1992-93 to $141 million in 1995-96. So the tribunal has been removing the property based component for businesses, and from October this year the residential property rates will be removed. Not every property has been paying the residential rates. It has been based on unimproved capital value of the property, and only those properties with a value in excess of $30,000 have been paying it. However, they decided in about 1980 no longer to record the value of properties for all new properties. All the new properties that have been charged rates since 1983 have not been charged a property rate. So a very select part of Sydney has been paying the property rates, which is inequitable and the rate based component will be removed from October this year.

What has happened with the usage charge? In 1985-86 people had a free water allowance of about 300 kilolitres a year and on everything above that paid an excess water bill. In 1990-91, before the tribunal was established, that free water allowance was abolished and they introduced user pays on the first kilolitre of water used. It was very low. In 1992-93 the rates were charged at about 21c to 30c for most people. If you used an extraordinary amount of water you paid around 69c per kilolitre.

In January 1994 with the removal of the special environmental levy, a flat rate of 65c per kilolitre was introduced. This was increased from 1 July to 70c per kilolitre.

Those prices were based on some assessment of the marginal cost of water. The tribunal asked consultants to look at the water industry in Sydney and worked out what the marginal cost of water would be. Rather than being a pre-estimate, there was a range of estimates and the tribunal accepted the figure of 65c, which was in the range of estimates.

I mentioned the potential for developer charges to increase. Up until now difficulties have been experienced in seeking to calculate developer charges in Sydney. For those of you who are unaware, developer charges are charges made by the water authority on a developer of a particular development area for each lot of land to be developed in order to cover infrastructure costs.

The tribunal recently adopted a net present value approach and is about to implement it. The key issues in applying this once again lies in balancing signals and affordability. The tribunal wants to get the signals right for making locational choices from one area and another. However, it is concerned about affordability.

Many of the areas are on land for which infrastructure was provided a number of years ago. How is the question of treatment and valuation of existing assets handled? Are they included in the calculation?

As to discount rates and transparency, once again the tribunal has established a forum to advise on implementation of developer charges and the discount rate is a key issue.

Much work has been done by the tribunal in modelling prices, but I am more interested in impacts. To date, the analysis has been based on household impact modelling ie the impact on the household without consideration of income effects. The reason is basically the unavailability of data. Most of the useful data came from the household expenditure survey and from water authority records. In terms of households that was relatively easy to estimate the effects. These sources did not allow analysis of income and usage of water.

There have been five pieces of research carried out in this area. The first was by the Tasman Institute in 1992 which looked at Melbourne water; Hogbin Ercole and Associates used some household expenditure data and some building data from Sydney Water Board.

The tribunal engaged King & Bradbury to do an analysis, once again based on the household expenditure survey. In 1993 the tribunal undertook a survey of 2000 households in Sydney, Newcastle, Gosford and Wyong to collect socio -demographic data, appliance ownership data and also to obtain access to records from the water and electricity authorities. The tribunal used that data to develop a model which has been called 'Wetmod', a model for water, electricity and transport. It has enabled us to do some impact analysis.

The function of the model is to do the number crunching. It takes the 2000 records, applies the pricing formula for a particular agency in a year, compares it to a benchmark pricing formula and calculates the net impacts - the increases or decreases in costs. This can be done for water, electricity and transport at the one time or for each individual agency. That was reported in a conference paper I gave in 1993. Andrew Chisholm of the Tasman Institute has recently used that model to do some analysis for EPAC on an infrastructure project.

As a result of the reforms in New South Wales, there has been a 40 per cent real reduction in the payments by business to the Sydney Water Board. Most of that reduction has occurred through the reduction in property rates. The usage charge doesn't make much difference to businesses because most were in the top bracket before anyway. Their net change has been very small in terms of the usage component, but they are saved through reduction in property rates.

It is often argued that the property rates in a number of ways are capitalised in the property. Property rates may reduce the net income to property owners and so reduce the value of buildings. Therefore when you remove the tax it gives a windfall gain to the property owner rather than a reduction in costs for the building occupants. The strength of this argument depends on the nature of the property rental market and how rents are determined across areas of different property rate bases.

People say: 'An old tax is a good tax - it is there, so why remove it?' For businesses removal of the property tax made the situation more equitable; it was one way of removing the cross-subsidy and there was a vast cross-subsidy from business to residential customers. The other question to be asked is: should government trading enterprises be tax collectors? It is an age-old story and it is a good question.

In terms of the impact of usage on households, we have found from the data that it is very difficult to see any relationship between usage and income. As you move through the income levels, there is very little difference between patterns of water usage. That is not a difficult point to understand.

Despite the restructuring of prices, the average direct effect has been modest. From our modelling we see that from 1992-93 to 1995-96 if people were paying property tax before, there has been between 10 and 15 per cent gain to the household.

If they weren't paying property tax, there has been between 4 and 11 per cent increase in charges. The important thing to be noted there is that the biggest increase is in the bottom group. The tribunal was concerned about that increase and suggested to Sydney Water that their proposal should include safety nets and special pensioner rebates for low income families.

If we look at household structure, we find that it is the larger families that are mostly impacted. The single couple households actually gain, even if they were not paying property tax before.

In terms of benefits, the model shows that if we want to introduce a policy, or even when analysing to a policy that is in place, the question is whether it is achieving the desired result. One of the arguments against changing things is that the change will cause a problem for a particular group. But people do not realise that the current policy may be causing a problem for a particular group and that those problems should be addressed. You have a choice: you either change to a new scheme and target where the problems are, or keep the current scheme but still target the problems. The Tribunal clearly supported the view that water pricing should not be driven in the long term by social objectives. Other approaches, whether through community service obligations, should be used to meet social objectives. That is an important consideration.

By their nature policy changes involve losses as well as gains. This should not be seen as an argument for inaction but for care in transition and policy design. Thus in introducing reforms to pricing mechanisms there is a need to manage the transitional paths and make large charges in one go.

The estimates of impacts are not point estimates. rather they form a range of effects based on the prices proposed, and enable choices within this range.

Both these factors suggest that social objectives won't have precedence but do have a role in the exercise of judgements.

The model shows flaws in any policy design and highlights where adjustments need to be made. This is what we did with our water pricing. It shows where we need to target particular customers, people who were not previously paying the environmental levy. When the environmental levy was introduced, pensioners did not pay it. As a result when the usage charge replaced it and there was a very small net effect if you were paying the environmental levy before, pensioners had a massive increase. So what was put in place was a rebate which was to be progressively reduced. It was a full rebate the first year, and was progressively reduced. Removing this rebate has now been slowed down than was previously the case, and it has been suggested as a community service obligation. It might not give you the exact answer but it shows you the magnitude of the problem. It allows for the design of the policy response.

As I said earlier, the Tasman Institute study was undertaken for EPAC. The Institute used our model, and there was an integrated assessment of the impacts. It looked at the direct effect on households from a move to user pays. It also looked at the indirect effects on households from changes in things such as dividend payments, and also from reductions in the cross-subsidies. The report suggests that there have been net gains from the reform process from 1985-86 to the present. The report suggest that 'most broad household types and income groups have benefited from the reforms'. In contrast our analysis was looking only at 1992-93 to the present.

To wrap up, Sydney Water as one of the agencies that we regulate has had a price reform agenda. That agenda existed before we came on to the scene. Perhaps one reason for the tribunal's modicum of success is that the agencies in general have been on our side. In the past they were not able to get their reform agenda through the political processes. Hunter Water Corporation introduced large usage pricing, including sewerage usage pricing, back in the early 1980s, but it wasn't until early 1993 that substantial usage pricing applied in Sydney Water Board.

The reason was that governments were not prepared to undertake or set the reform agenda; they could see the consequences. For the approach to be implemented and to be successful, it required an independent agency, such as the tribunal, to look at the effects and to consider methods of targeting problem areas.

The tribunal has been concerned about the impact of that reform agenda and has considered those impacts and sought the transition arrangements. The tribunal is not about telling the government what they should be doing for social policy. That's the government's job. The Tribunal's job is to identify where there may be a requirement for transitional arrangements or for longer term arrangements. And it is up to the government to decide whether it wants to introduce them.

In general, the cumulative impacts for most have been modest. There have been some extraneous results but in general they have been modest. What is important is that reforms are occurring. Reforms have achieved reforms in the water industry and are about to come about in the electricity and transport industries as well.

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