PRESCRIPTIVE PUBLIC CHOICE: APPLICATION TO RESIDENTIAL WATER RATE REFORM

I. INTRODUCTION This article defines the concept of political feasibility for appointed and elected rate approval officials. Applying the concept of political feasibility, this article prescribes necessary and sufficient conditions for rate reform such that a public choice model predicts that an efficient rate design will be selected over an inefficient one. The concept of embedded cost (EC) rate design sets fixed charges (such as a customer charge) to collect revenue sufficient to cover fixed costs and variable charges (a commodity charge) equal to average variable cost (a declining block (1) structure). Long-run marginal cost (LMC) is typically greater than the system average cost (2) (American Water Works Association [AWWA], 2000), so that a single-part tariff based on LMC rate design would collect revenue that exceeds cost. A two-part tariff can achieve economic efficiency while meeting the revenue constraint by setting the price equal to LMC and rebating excess revenue with a negative fixed charge unrelated to the amount consumed (Coase, 1946). Political feasibility depends on relative wealth effects among political support groups--water rate payers with divergent interests and preferences for one over another rate design. Customers with high demand ("large customers") prefer an EC rate design, with large fixed charges and small variable charges. Customers with smaller demand ("small customers") prefer an LMC rate design. Politically feasible rate reform balances the wealth effects among political support groups. In response to the 1976-1977 drought, Tucson, Arizona, implemented LMC rates. At the same time, a 1977 Blue Ribbon Committee on rate design in the City of Los Angeles, appointed by Mayor Tom Bradley, concluded that such a design would not be politically feasible and chose instead to switch from declining block rates to a flat rate structure (Mayor's Blue Ribbon Committee on DWP Rate Structure, 1977). One year later, the Tucson City Council was voted out en mass because of the water rate reform (Martin et al., 1984). At the end of a 6-yr drought from 1987 to 1992, (3) Los Angeles Mayor Tom Bradley appointed the 1991 1992 Mayor's Blue Ribbon Committee that recommended an LMC rate design (Mayor's Blue Ribbon Committee on Water Rates, 1992) to the Los Angeles Department of Water and Power (DWP) Board of Commissioners, which is appointed by the Mayor to oversee the DWP and normally oversees changes in the rate design. The Board approved and forwarded the rate design and it was subsequently adopted by the City Council as an ordinance in 1992, with support from only two of the five council members representing the hotter, interior San Fernando Valley, whose residents use more water on average than the rest of the city. Mayor Bradley retired, and after the drought, Mayor Richard Riordan was elected (4) with strong support from voters in the San Fernando Valley who voted out a long-standing city council member, one of the two San Fernando Valley council members who supported the 1992 rate design, (5) and elected an opponent (6) who campaigned against the rate design. The following summer when the higher summer second tier price went into effect, the Mayor received complaints from his constituents, and in response, Mayor Riordan reconstituted and appointed the 1993-1994 Mayor's Blue Ribbon Committee (7) and directed them to revisit the rate design (Mayor's Blue Ribbon Committee on Water Rates, 1994) and make any recommended changes to the Board of Utilities, all appointed by the new Mayor. Becker's (1983) public choice model predicts that during normal rainfall years, EC rate design will be chosen and that droughts open windows of opportunity to switch to LMC rates. This type of rate reform occurred in 1977 in Tucson (Martin et al., 1984) and in 1992 in Los Angeles (Hall and Hanemann, 1996). Becker's model explains why Tucson switched back to the old rate design after the drought but leaves unexplained why Los Angeles did not (Hall, 2000). …