Water Charges Reform Needed

carry on from: - **Definition**: Deals with who is liable to pay water charges.

rewrite me a skeleton argument based on thi text: Fair And Sustainable: Paying For Water WHAT THE GOVERNMENT COULD DO Bob Hills, Meg Huby and Peter Kenway Contents SECTION PAGE *. Executive Summary * *. Introduction * *. The Unique Nature Of Water * *. Some Strategic Problems With Water * *. The Criteria For Any New Charging System * *. The Anatomy Of Any Charging System * *. Assessment Of The Options * *. The Case For A Multiple Tariff With A Two-Tier Volumetric Rate * *. Key Points And Practical Actions * APPENDICES A. The Policy Options In Detail B. The Existing Legislative And Policy Framework C. Long-Run Marginal Cost Estimates in the Public Water Supply in England and Wales D. References PREFACE During this research study, the New Policy Institute organised two seminars to discuss the issues, involving the water companies, relevant government departments, academic, pressure groups and others. The first of these seminars discussed the problems and was a great success: everyone agreed on the nature of the problems, and there was a real sense of working together. The second discussed possible solutions and revealed fundamental, but long-standing, differences. Some people believe that the future lies with extending current metering arrangements to the whole population, while others view this prospect with horror but have no obvious longer term alternative. The lessons we draw are threefold. First, it is only by the government taking a clear lead that a way forward will be found. Second, the issue is not metering per se, but the tariff structure which accompanies the metering. Third, the problems require rational analysis without being wedded to either of the current arrangements (fixed charge only or volumetric charges proportional to water usage ) as the longer term solution. The other point that stands out is the importance of social justice in the argument. Simply put, the charges which * per cent of the population currently pay (fixed charges based on rateable values) vary according to a proxy for ability to pay, whereas the charges being introduced as part of metering (volumetric charges proportional to usage) do not. Without government action, the progressive move to the present metered-base tariff will have serious financial consequences, particularly (but not exclusively) for the poor and vulnerable in society. The extent to which the tariff structure should be influenced by ability to pay is a key decision for government to take before any sort of longer term plan can be formulated. The social implications of changes in the ways that service industries operate is a recurring theme of much of the New Policy Institute’s work. Our previous report on home ownership demonstrated how large such implications can be and our recent conference on financial exclusion illustrated how such problems are becoming worse over time. A government committed to the principles of inclusion and social justice must find ways of turning such principles into practical change. We suggest that the major service industries - from financial institutions and legal services to railways and postal services - represent a major opportunity for achieving this. We believe that this can often be achieved by changing the environment within which the relevant institutions make their decisions, while remaining in a market economy, such that their effects on the population are more in line with the values of a decent society. Guy Palmer October * ACKNOWLEDGEMENTS Particular thanks must go to Paul Herrington of Leicester University, who has been most generous with both his time and ideas. He contributed the whole of Appendix C, although responsibility for the conclusions of the rest of the paper remains the authors’ alone. Also thanks for their comments and other help to Doug Edmonds, David Kinnersley, John Thackray, Helen Jackson MP, Jerry Sherriff and David Howarth (Environment Agency), Scott Reid (OFWAT), Andrew Wells, Janet Wright and Julian Hale (Department of the Environment, Transport and the Regions), Robert Weeden and Jeanne Golay (Water Services Association), Valerie Homer (Water Companies Association), Chris Mellor (Anglian Water), Peter Willett (Northumbrian Water), Mark Wilson (Severn Trent Water), Barrie Delacour and Steve Morley (Southern Water), Bob Baty and Keith Richards (South West Water), Ruth Lister (Loughborough University), Bill Baker (NERA), Damian Dewhirst (GHK Economics and Management), Stuart Reid (IRRV), Robin Simpson (National Consumer Council), Howard Price (Chartered Institute of Environmental Health) and Jane Martinson (Financial Times). Responsibility for content and any errors, of course, remain with the authors alone. ABOUT THE AUTHORS Bob Hills is Research Officer at the New Policy Institute Meg Huby is Senior Lecturer in Social Policy at the University of York Peter Kenway is Director of the New Policy Institute and Lecturer in Economics at the University of Reading © New Policy Institute * First published October * New Policy Institute * Premier House * Greycoat Place London SW1P 1SB Tel: *-*-* ext * Fax: *-* * ISBN *-*-*-* *. EXECUTIVE SUMMARY Problems THE SHORT TERM PROBLEM * per cent of households in England and Wales are currently charged for water via a bill based on the rateable value of the dwelling they inhabit. Yet the Water Industry Act of * forbids the water companies from continuing to base their charges on a valuation list after March *. A new basis for the vast majority of dwellings is therefore needed. However: The natural successor to rateable values, namely the system of banding underlying the council tax, is also ruled out by legislation (the * Local Government Finance Act). Even if everyone wanted to replace charges based on rateable value by charges based on the volume of water used (volumetric charging), the installation of water meters on the scale that would be required to meet the deadline of the year * is impractical. At present, therefore, there is no satisfactory answer as to how to households should be charged for water after the year *. THE STRATEGIC PROBLEM Domestic consumption has been increasing since at least the 1960s and is projected to go on rising over the coming decades in response to both demographic and climate changes. Yet the present charging system contains no financial incentives for households to encourage water economy and to help keep future demand in line with supply. The scale of this strategic problem, though, is not clear cut. For example: Total abstraction of water from the environment for all purposes is actually lower than it was 25 years ago, since abstraction for non-household purposes has been falling. A reduction in the levels of leakage, allowing higher levels of consumption to be supported by the same level of abstraction, would provide some temporary relief to offset rising household demand. Difficulties are more acute in some regions and in some years than others. Overall, it appears that there is a significant strategic problem, but one that might not become pressing until, say, the year *. If radical options, such as the widespread metering of households, are needed, then it is in response to these timescales. The two problems above apply over very different time frames and cannot be solved simultaneously. We argue that the need to find solutions to the problem of charging for water in the short term presents an opportunity to facilitate the achievement of longer term objectives. The role of government 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. Finally, by proscribing both the continued use of rateable values and one obvious alternative (council tax bands), the last government was involved in charging methods. EXERCISING LEADERSHIP BY SETTING CRITERIA FOR A WATER CHARGING SYSTEM 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. These criteria reflect a range of factors, including standards and aspirations already announced by the government, existing EU and other international commitments (such as the * Rio declaration) as well as Labour’s core values. 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: Criterion Questions to ask to establish whether the criterion is met. Does the system: Economic Allow for water to be appropriately priced at the margin? efficiency Provide a balance of incentives for both households and water companies to use resources efficiently? Sustain Help protect the ecosystem, in terms of both the quantity and quality of water? environment 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 Protect households from pressure to economise on water where health and hygiene could suffer? justice 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. But, since it is unlikely that such a system could be in place by *, a system to deal with the short term problem should at least provide a foundation for the longer term, strategic solution. Possible charging systems 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(s). 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 blue line in the diagram below). The * per cent of households who are now metered pay according to the volume of water they use, plus a small fixed charge (see red line in the diagram below). INTERMEDIATE EXAMPLES Clearly, and as with most utilities, it is possible to ‘mix and match’ the charges with a combination of fixed charge and volumetric charge - indeed, the actual metering tariff at the moment is a hybrid of a sort. 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 (the red line below). A block tariff structure, where the amount paid still depends on the volume of water used but does not vary continuously with it (the blue line below). 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. An assessment of the current charging systems These comprise: Rateable values (the present English and Welsh system). Council Tax Bands (the present Scottish system). The present tariff for households opting for volumetric metering. 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 that no household is unable to afford the water for ordinary domestic usage that it needs for essential purposes. OUR ASSESSMENT 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 (see detailed discussion in the main text). 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. An alternative option that could meet all the criteria LONGER TERM 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. SHORT TERM No solution of the type advocated above, which includes widespread metering, could be fully implemented in time for the year * deadline. So, a short term solution is therefore required, and one which recognises that the vast majority of customers will inevitably still be on unmeasured tariffs, and thus fixed rate charges, at the time. A key principle is that any changes made for the year * should be consistent with the longer term direction. Since only very limited progress has been made since * towards replacing the old system based on rateable values, there is a strong case for arguing that at least some elements of the longer term solution should be introduced at the * ‘deadline’ in order to mark a real commitment to the new system. If, as in the option above, the longer term solution includes fixed charges related to council tax bands or liability, then one or both of the following would be possible in *: Move the basis of charging for unmetered households from rateable values to council tax bands (i.e. to the present Scottish system). Move metered households from the present to the new tariff, where the fixed charge elements are based on council tax bands or liability instead of being a uniform fee per household. The merits of these different short term moves will depend chiefly on the extent and nature of the incidence effects, as well as the practicalities of moving to a new system within three years. In practice, it is likely that some water companies will wish to retain rateable values as the basis of fixed charges in the short term, even if moving to council tax bands in the longer term. To accommodate this, the government would need to amend the * Water Industry Act to allow rateable values to continue beyond the present deadline. Potential criticisms of our argument OPPOSITION TO THE PRINCIPLE OF SOCIAL JUSTICE Consultations over an earlier version of this paper has revealed widespread agreement (including among water companies) that a substantial extension of the present metered-base tariff would have significant financial consequences, particularly for the poor and vulnerable in society. But consultation has also revealed widespread opposition within the water industry to the idea that the tariff structure itself should be influenced by social justice considerations. We believe that this is a matter of both values and practical politics. One issue is whether water should be simply regarded as a commodity to be bought and sold or whether some part of its usage (for essential purposes) should be considered a social good. Another is the observation that * per cent of current bills are already based on a proxy for the ability to pay (i.e. rateable values); advocating social justice as a criterion for future tariffs would help retain this feature of the way that we pay for water at the moment. Two other points are worth emphasising. First, it is clearly possible to reject some particular manifestations of the social justice criterion - for example, the idea that fixed charges should be based on council tax liability, including rebates - without rejecting the criterion as a whole. Second, social justice should be considered alongside other criteria, but should not take precedence over them. OPPOSITION TO METERING Consultation has also revealed 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 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 Consultation has also highlighted a number of problems which arise inevitably 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 (e.g. 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. Recommendations for government action PRACTICAL ACTIONS Our principal recommendation is that government’s role should be one of leadership, providing a framework within which water companies can developing new systems for charging their household customers. To overcome the year * problems, and as practical preparatory steps towards implementing a longer term strategy, we recommend that government: Amends the * Water Industry Act to allow rateable values to continue as the basis of charging after the year *. Amends the * Local Government Finance Act to allow council tax bands to be used as the basis of water charging. To lead directly to a longer term solution, we recommend that government: Publishes criteria for future water charging systems, including the detailed questions needed to allow the criteria to be applied. Sets a timetable within which water companies must publish proposals for a new system in accordance with these criteria, their introduction to be subject to the agreement of OFWAT. Asks OFWAT to publish an assessment of the proposals and the reasons for its approval, or otherwise, of the schemes. Instigates an independent review of future long term costs in the water and sewerage industry. *. INTRODUCTION The structure of this paper The purpose of this paper is to provide an answer to the question of what the government should do about the future problems of paying for water. To achieve this, it analyses the options for the future charging of water for households in both short and longer terms, with the material being organised as follows: Section * - The unique nature of water, discusses what water is used for and why it therefore has a unique status. Section * - Some strategic problems with water, discusses the factors likely to lead to continuing rising demand for household use of water and the problems this causes. Section * - The criteria for any new charging system, uses the strategic problems of water (from section *) to derive three broad criteria for future charging, and more detailed questions within each of these criteria. Section * - The anatomy of any charging system, uses the current two methods of water charging (by rateable value and by metered usage) to derive the key elements of any water charging system. Section * - Assessment of the options, analyses the key charging elements (from section *) against the criteria (from section *) and concludes the neither of the current methods adequately meets the criteria. Section * - The case for a multiple tariff with a two-tier volumetric rate, presents a alternative proposed water charging system which does meet all the criteria. Section * - Key points and practical actions, summarises the major points of the argument and lists our suggested actions for government to take. The rest of this introduction provides some context by briefly summarising the current situation, then drawing some broad conclusions about the nature of the opportunity for government. The current situation Historically, water has been charged to households on a fixed rate basis, independent of usage, and with these charges based on rateable values. However, the Water Industry Act of * forbade companies in England and Wales from charging on a rating valuation list from 31st March *. Council tax bands, the successor to rateable values, are currently ruled out by their own legislation, the Local Government Finance Act of *, which forbid their use for any other purpose. The situation in both Scotland and Northern Ireland is different. In Scotland, charges have already moved onto a council tax banding basis. In Northern Ireland, funding for water is completely tax based, with no direct billing. Although the original intention behind the legislation for England and Wales appears to have been to oblige the water companies to switch most households to a metered tariff by that time, progress in implementing the widespread metering required has relatively slow (still only * per cent of households) and it is now widely agreed to be out of the question in the timescale remaining. The reason for the slow progress has been that metering of households is both expensive and voluntary. It has therefore been largely restricted to new houses plus (in recent years) those households who specifically requested it. All the major privatised companies have followed this approach but “continue to oppose the principle of universal compulsory metering” (Water Services Association *: *). Throughout the period since *, OFWAT has been consistently in favour of metered tariffs: “metering is the fairest method of charging, as it relates to the amount of water used or sewage discharged and, hence, to costs” (OFWAT *: *). The new government has not yet made its position clear, on either metering or future tariffs, although it has stated that it will “review the system of charging for water, including future use of rateable values and metering policy”. In summary, therefore, the current situation is a mess: there is no practical solution currently on offer for the charging of water in England and Wales beyond the year *, charging methods are different in the different home countries, there is no clear route forward to universal metering, and there is no clear consensus between all the parties on the way forward. And, as described in detail in this report, this situation is in the context of major longer term problems concerning how to reconcile increasing household demand for water with limitations on its supply, and increasingly serious regional problems. The government’s opportunity Over the past few years, water has become something of a political hot potato. The water supply shortages of * not only followed a winter of unusually heavy rainfall, but were also caught up in the melee of public outrage over the salaries of ‘fat cat’ utility directors. Although these events were not necessarily connected, they focused media and public attention unfavourably on to the newly privatised water industry. In May *, the Deputy Prime Minister, Mr Prescott, addressed a high profile, specially convened water supply summit and set tough, mandatory leakage targets for the water companies. If, as seems the case, demand management proves essential to providing sustainable water supplies in the UK, our view is that the government take a stance on pricing as well as leakages if it is to have an integrated approach to conservation. In so doing, it will need to take account of: The division of responsibilities created by privatisation between the government, the regulator and the water companies. The unique status of water, as essential to both personal consumption and the natural environment. Considerations of both fairness and economic efficiency. The twin needs of conserving supplies and developing a new charging system provide an opportunity for the water companies, guided by the government, to make decisions which would command political and public support. One crucial element of this would be to ensure that the tariff structure is sufficiently flexible to cater for people in differing circumstances. It is also an opportunity for the new government to show that marketdriven outcomes can conform to a different set of standards and ends from those of the previous government. There is no reason to suppose that the government (and public) interest is necessarily and inevitably at odds with the water companies’ interest. Rather, there is a real possibility that the government can guide the companies in devising a system to solve the strategic problem of supply meeting demand that satisfies the needs of social equity, environmental sustainability and economic efficiency. *. THE UNIQUE NATURE OF WATER This section provides context for the rest of the paper by discussing the unique nature of water under the following headings: The different uses of water. The objectives of water service provision. Saving water. The dual role of metering. Fixed and varying charges. Social good or commodity? Conclusion: principles and politics. The different uses of water Water is used for a wide range of human purposes, with its social and environmental benefits going far beyond the fulfilment of its vital role in sustaining plant and animal life. Adequate supplies of clean water and sanitation are essential for the maintenance of living standards, health and well-being. Domestic water supply in England and Wales is used for drinking and for preparing and cooking food, but water is also used for bathing, for washing clothes, for general household cleaning and for disposing of sewage and other wastes. The private use of water for personal hygiene, and its controlled disposal in the sewerage system, lead to social benefits in terms of improved public health and a reduced incidence of communicable diseases. A healthy population also relies on access to nutritious and safe supplies of food as well as on avoiding disease. Direct irrigation of food crops, livestock watering and the hygienic preparation of foodstuffs all require the use of water, whether supplied by water companies or abstracted directly from lakes and rivers. Both individuals and society benefit from the use of water by the industrial sectors who manufacture and supply the plethora of goods and services which characterise present-day life styles. Particularly important in this respect is the electricity generating industry, where power stations use large volumes of water for cooling purposes. Water increases human well-being through its use for leisure activities and around *% of domestic water is used outside the home for gardens, washing cars and in swimming pools in England and Wales (Water Services Association, *). Perhaps the amenity value of water is most marked in the natural environment: most people like to live in pleasant surroundings or to visit and enjoy the countryside where water provides aesthetic and spiritual pleasures as well as opportunities for active sports and recreational activities. Water plays a crucial role in shaping the natural environment, with the levels and flows of surface and ground water in particular areas helping determine patterns of vegetation growth and diversity of wildlife habitats. When it is abstracted from the environment for public supply or other purposes, the quantity of remaining water resources is lowered. After use, most water is eventually returned to the environment but the time delay between abstraction and return, geographical differences between the point of abstraction and point of return and the condition of the water returned as effluent all alter the quality of water available for future use. The need to conserve wildlife and habitats provides a strong reason for protecting the aquatic environment. But arguments for environmental protection can be reinforced from a social perspective. Any decline in the quantity or quality of water in the environment has implications for its further use as a resource for human activity. The establishment of new reservoirs, the transportation of water in response to scarcity and the extension of the treatment of drinking water to deal with problems caused by deterioration in the quality of water sources all increase the costs of water services. As well as higher water bills, this also leads to rising costs for other goods and services. Rising food prices may result partly from increased costs of water used in agricultural production and partly because changes in patterns of natural water quantity and quality will affect the kinds of food which can be produced in particular areas. The objectives of water service provision The complex interactions between environmental and social well-being mean that, in the long term, water service providers must meet two related objectives: To ensure continuity of adequate supplies of clean water and safe disposal of sewage for everyone. To protect the natural environment, conserving the quantity and quality of water resources. These long-term goals are in keeping with the agreement reached at the Earth Summit in Rio de Janeiro in *: “Water resources have to be protected, taking into account the functioning of aquatic ecosystems and the perenniality of the resource, in order to satisfy and reconcile needs for water in human activities. In developing and using water resources, priority has to be given to the satisfaction of basic needs and the safeguarding of ecosystems.” (United Nations, *: *) In the short term, water companies in England and Wales are faced with the need to revise their systems of charging for water services pending changes in national legislation. Responding to this need involves decisions about how to charge for water, for example using a flat rate charge or by charging customers on the basis of volume used. This is a separate problem from the issue of how much to charge, although the two problems are invariably linked in the current debate. This paper argues that, the need to find solutions to the problem of charging for water in the short term presents an opportunity to facilitate the achievement of longer term objectives. The water companies currently have no legal responsibility to provide help for customers in difficulties but charging systems could operate to minimise the risk of any household facing hardship caused by inability to pay for adequate supplies for essential purposes. Methods of charging could also be devised to encourage consumers to view water as a scarce and valuable resource, increasing awareness of the need to conserve water and protect the environment. This in itself would act towards ensuring continuity of supply. Saving water Although water circulates continuously through the hydrological cycle of the earth and its atmosphere, the stock of fresh water available for use at any one time is extremely limited. Both the exploitation of new water sources and increasing rates of abstraction from existing sources can have significant detrimental effects on the environment. Dealing with the problem of leakage can do much to reduce the need to develop new sources: between a quarter and a third of all water taken from natural systems by water companies is estimated to leak from pipes before it reaches end users so that much more water than is actually needed is currently abstracted. “Over-abstraction, often for public supplies, has led to unacceptably low flows in some rivers in England and Wales, thereby damaging wildlife habitats and having an adverse effect on water quality and recreational and amenity value” (HMSO, *: *). Water saved by reducing leakage could substantially help to close the gap between supply and demand. Water can also be saved by action on the demand side by encouraging more efficient use. Incentives to conserve water and avoid waste take two related forms: Information and advice services can be used to raise public awareness about the value of water as a limited resource and to encourage people to avoid waste. However, since privatisation, public attitudes have undergone a transformation, such that these nonprice measures are unlikely on their own to provide sufficient reductions in demand. A charging system can be adopted which reflects the environmental costs associated with the abstraction and use of water, as well as the financial costs of providing water services. Charging systems must, however, recognise that the non-substitutable nature of water makes it essential for human well-being and must be applied in such a way that no-one goes without the basic water they need because of inability to pay for it. The dual role of metering The metering of domestic water supplies has been receiving a great deal of attention ever since OFWAT published its first consultation document on new charging systems in * (OFWAT, *). Early consumer objections to metering stemmed from two related concerns. First, some customers in newly metered properties found their bills rising more sharply than those of neighbours, whose water use appeared similar but who were still charged according to rateable values. Such cases were given a high profile in the media which led to accusations of inequitable treatment of customers by water companies. The second cause for concern focused on perceptions that metering was in itself the cause of higher bills. Such perceptions, however, do not fully recognise the distinction between using meters to measure volumes of water consumed and using particular tariff structures to determine how much to charge for that volume. In principle, meters could be used purely for the purpose of measuring consumption and leakage with a totally different basis used for determining charges. The extra information which metering would provide to households and water companies would make some sources of leakage faster and easier to locate for repair. It would also facilitate more accurate measurement of water consumption, improving the estimates used for longer term planning to balance supply and demand. These two roles of metering, as a system for measuring flow and as a system on which to base charges, need not be automatically linked, and can be considered somewhat separately. Fixed and varying charges For more than 20 years now, most charges for water services have had two elements - a standing charge plus either an additional graduated element based on metering or a further fixed charge using rateable values as a proxy for usage. The setting of the first element has historically been considered relatively easy to deal with and recent debate has therefore focused on the second element. For many people, the use of a second fixed charge, based for example on the rateable value of the property, offers a degree of predictability in the size of water bills, allowing easier budgeting. Where total bills are based solely on fixed charges, however, households have no financial incentive to save water and may indeed be unaware of the nature of water as a vital environmental resource. The use of meters could help to remedy this situation since households would inevitably become more aware of the volumes they use. Many customers could reap financial benefits by cutting down on waste and by reducing their luxury or leisure uses of water. In addition, less tangible incentives for conservation would be likely to increase with changing ideas about the costs to the environment of over-abstraction. It is, of course, possible that some households may respond to financial incentives by reducing their water use to the detriment of hygiene and well-being. Families living on low incomes, or where someone has a health condition which requires an exceptionally high rate of water use for bathing or laundering, may find themselves faced with a choice between financial hardship caused by high bills or forms of hardship caused by cutting down on essential use. Tariff structures or rebate systems are needed which minimise the likelihood that any household would go without sufficient water to meet their essential needs. The difficulties of designing such a system reflect the unique character of water in society. Social good or commodity? In so far as water is vital to life and health it displays the characteristics of essentialness and non-substitutability. The provision of piped supplies of clean water, sewerage collection and treatment and environmental protection carry positive externalities in the form of benefits to public health and social well-being so that water constitutes a merit good. Merit goods are “goods that, on basically ethical grounds, society believes should be supplied to - and where appropriate actually consumed by - everybody, perhaps only to certain minimum levels, whether they like it or not and whether they can pay for it or not” (Beckerman, *: *). Taken together, these characteristics of water make it social good and place an implicit responsibility on government and water undertakers to ensure that it is available to all. On the other hand, water is also used for non-essential. Used in these ways, water can reasonably be regarded as a commodity to be bought and sold in the market at prices determined by production costs and by fluctuations in supply and demand. As a pure commodity, developing a charging system would pose few problems. Thus it is the dual nature of water as both social good and commodity which demands a more complex approach. It seems to point to the need for a tariff structure which recognises that an adequate supply must be provided regardless of individual ability to pay. At the same time, use over and above essential purposes can be priced to reflect the true economic and environmental costs of provision of water services. Conclusion: principles and politics The necessity to change the basis upon which water charges are calculated offers opportunities for re-considering not only how to charge, but also how much to charge. Restructuring the payment system has the potential to address problems of both social inequity and environmental deterioration. Nevertheless, even if we disregard the need for complex transitional arrangements, the difficulties of achieving radical change for sustainable development in the water industry are substantial. Because of the division of costs and responsibilities between a number of players, it requires examination of the relationships between the industry, its regulatory bodies (OFWAT, the Environment Agency and the Drinking Water Inspectorate), central government policy makers (the Departments of Environment and Social Security) and local authorities. The companies are clearly responsible for the continuing provision of water services and must also encourage their customers to conserve water. As commodity suppliers, they are well placed to deal with issues of water pricing. There is, however, no obligation on the companies to deal with the question of social equity or the affordability problems faced by low income customers, both currently seen as lying within the remit of the Department of Social Security. The nature of water as a social good highlights the inability of market mechanisms to take account of social and environmental externalities and underlines the need for close regulation of the industry. It has been argued that OFWAT should be given more powers to offer incentives to water companies to conserve water. The Deputy Prime Minister recently reinforced this message by announcing that water companies will be placed under a statutory duty to conserve water in carrying out their functions. This would indeed aid the regulatory task of the Environment Agency. But some important questions still remain about the dividing line between the companies’ responsibility for water conservation and that of the customers. Even more problematic is the issue of social responsibility. To some extent, the regulator plays a key role in setting limits to both fixed and varying water charges and in establishing the tariff systems to be used for charging. He can also issue guidelines for dealing with customers who have difficulty in paying their water bills. Nevertheless, he must also ensure that companies remain able to finance the proper carrying out of their functions. The objectives of customer and company protection do not always sit easily together. *. SOME STRATEGIC PROBLEMS WITH WATER The basic strategic issue discussed in this section is whether supply will continue to be able to meet demand. This breaks down into: Whether the environment can sustain predicted levels of abstraction. Whether there is the storage capacity to meet peak summer demand. Whether some regions face much more serious problems than others. The material below uses some recent forecasting work to analyse the nature and scale of the problems in each of these areas, thus informing the questions of whether, where and when demand restraint measures are necessary, and whether those measures should be built in to the charging system or implemented through non-price means. Environmental sustainability Sustainability depends on maintaining the balance between the input of water to the environment provided by rainfall and the rates of abstraction of water from the environment. CLIMATE CHANGE According to the Centre for Ecology and Hydrology, recent summers have proved appreciably dryer and warmer than the average of the past 150 years. Winters seem wetter and hotter (House of Commons *: *). UK temperatures are expected to rise at a generally similar rate as the global mean - around *.* per cent per decade. If so, by the 2050s, a hot summer such as * (currently a * in 90 year event) will become a * in 3 year event. Summer evaporation in southern UK in the 2050s will be * per cent higher than the *-* average (House of Commons *: xiii). Changing rainfall patterns and increased evaporation rates will have important effects on supplies to surface reservoirs and aquifers. TOTAL ABSTRACTIONS Although the figure for total abstractions has been falling gradually over the past 25 years, the reduction is due almost entirely to falls in abstractions for electricity generation. However, as the NRA puts it, “the large volumes of water required for through cooling, evaporative cooling and other purposes tend to be drawn from poor quality waters or waters which are tidal in nature. This water is usually returned to the river with little impact”(NRA, *: *). The one element of total water abstraction which has been rising steadily over the past 25 years is that for the public water supply., with increasing household demand the single most important element governing this rise. HOUSEHOLD DEMAND FOR WATER Between * and *, the total level of household consumption rose by * per cent (House of Commons *: *). Evidence suggests that this figure go on rising over the next 25 years. There appear to be four main factors that will increase total levels of household demand: The growth in population: the population is projected to rise by *.* per cent between * and * (Office for National Statistics, *), implying equivalent increases in the use of water for personal use. Changes in average household size: the average number of persons per household, which decreased from *.* in * to *.* in *, is predicted to fall further to *.* by * (Herrington 1996b: *). This decline in household size is likely to contribute to higher domestic consumption because per capita consumption is higher in smaller households. For example, Anglian Water’s SODCON survey found that the average unmeasured daily per capita consumption for a one-person household was almost twice as much as for a six-person household (House of Commons *: *). If we assume a linear relationship between household size and per capita consumption, these figures would suggest that the predicted change in household size is likely to lead to a * per cent increase in consumption. Increasing garden usage: it has been predicted that garden use of water will be two and a half times as large in * as it was in * - a result of demographic and lifestyle changes (Herrington, 1996b: *) - implying a rise of about *% in total domestic water usage. And, although sales of hose pipes and sprinklers almost doubled over the period *-*, the UK levels of ownership of such irrigation equipment still lag behind France and Germany (OFWAT *: *-*) Changing patterns of personal water use: it has been suggested that the amount of water used for personal washing will increase considerably over the period as a result of more bathing and showering. This is predicted to increase the personal use of water by around * per cent per head (Herrington 1996b: *). Collectively, these figures suggest that household demand could rise by around quarter over the next two decades or so. This is in line with the ‘high scenario’ forecast for the period * to * made by the NRA (NRA *: *). The companies themselves (in their strategic business plans to OFWAT) predicted a somewhat smaller increase in water delivered to households of *.* per cent over the period */* to */* but this figure included a number of assumptions about the positive effects of demand management programmes (OFWAT *: *). CHANGES IN LEVELS OF LEAKAGES Not all of the predicted increase in household demand need inevitably translate into increased abstractions. Improvement in leakage reduction programmes could potentially offset some of the increase in household demand. In */*, * per cent of the public water supply was estimated to have been lost through leakage. The industry estimates that * per cent of the total leakage was supply pipe leakage (in other words, strictly speaking, the customer’s responsibility), and * per cent was distribution losses (OFWAT 1996a: *) According to evidence presented at the Uff Enquiry into Water Supply in Yorkshire, “the age and nature of the distribution systems means that there will always be a background level of leakage, caused by seepage from millions of joints” (House of Commons *: *). Background leakage is estimated to be between * per cent and * per cent of water put into supply, depending on the condition of the system. This suggests that there is considerable scope for meeting increased household demand without further increasing abstractions. Although it is not possible to measure leakage precisely, the Director General of Water Services has set some fairly stringent targets for leakage reduction. Seasonal peaks in demand The general trends of increasing household demand and changing patterns of rainfall masks the mismatches which occur between patterns of demand and supply on a seasonal, geographical and sectoral basis. In some areas, the need to reach a balance between fluctuating peaks in demand and supply is becoming increasingly marked; indeed, meeting peak demand is already a serious problem in some places, as shown most dramatically in the case of Yorkshire Water in *. Long hot summers are characterised by increased use of water for irrigation and for garden hoses, sprinklers and swimming pools. Anglian Water, for example, shows that average usage per head over *-* was *-* per cent higher in July than in February or November (House of Commons *: *). Although studies of peak demand between * and * did not find increases relative to average demand, recent research for the DoE forecasts that, with increasing garden popularity and assuming a *.* degree Celsius rise in temperature, peak demand in south and east England in * will be * per cent higher than average demand, compared to * per cent in * (House of Commons *: *). It therefore seems that peak demand is likely to increase faster than average demand over the next 25 years. Problems with peak demand can arise from the insufficient capacity of local service reservoirs, even where there is no problem with average demand. As Herrington has emphasised, they are of crucial importance: “Peaks matter, and the extent to which they matter looks set to increase. They are important drivers of the amount of new and (occasionally replacement) capital expenditure on up to * per cent of an undertaking’s water supply assets; they are responsible for much of the forecast growth of public water supply use in England and Wales in the next 25 years; they were the major determinants of many water companies’ supply problems in * and in one company nearly provoked system failure” (Herrington 1996c: *). So although leakage reduction can solve some of the problem with average demand, there is certainly a problem when it comes to peak demand. The outlook becomes even more pessimistic when the situation is viewed region by region. Regional variations Although the proportions of rainfall experienced by each region has not altered dramatically in the period since * (Water Services Association *: *), rainfall does differ appreciably from area to area. Average annual rainfall in the former Anglian NRA region in * was * millimetres - only * per cent of the average for England and Wales. On the other hand, the highest, rainfall in the Welsh region was * per cent of the average, and *% of the average in the South West region. When combined with differing storage capacities in different regions, it is clear that the problem of supply meeting demand is far more acute in some areas than in others. Using a set of high, medium and low demand increase scenarios, the NRA predicted (NRA, *: *) the shortfall in average public water supply yields in * in every (then) NRA region, if only existing source yields were used. These ranged considerably, from no shortfall in North West and Northumbria under medium and low assumptions, to a shortfall of * Ml/d (million litres per day) in the Thames region under a high demand scenario. The NRA then applied those figures to a scenario in which all local resource options are developed (including some which may be ruled unacceptable on environmental grounds). In six areas (North West, Northumbria, Yorkshire, Wales, Southern and South West), there was no shortfall at all under high, medium or low demand scenario. Thames’s maximum shortfall was * millions of litres per day, compared to * in Severn Trent, * in Anglian and * in Wessex. This suggests that the areas facing a more imminent problem of meeting are in the South and East, in particular in the Thames, Severn Trent and South West areas. By contrast, in Northumbria, there is no forecast problem. Conclusions Household demand for water is currently increasing on average by * per cent a year. Leakage is currently around * per cent of supply, and it would be fair to expect it to reduce to, say, * per cent by *. This indicates that some of the projected demand growth over the next two decades could potentially be accommodated by progressive reductions in leakages. Since other elements of the public water supply are unlikely to rise significantly. But, in the longer term, the situation would seem to require either stabilisation of demand or (highly undesirable) increases in abstractions. The questions of how far and how soon abstraction rates will need to be increased depends partly on the success of proposed measures for leakage reduction and partly on the effectiveness of demand management. There is also considerable regional variation. NRA predictions show that, under a high demand scenario, the shortfall in average public water supply yield in * will be over * times as great in Thames as in Northumbria. Furthermore, peak demand (which is largely to do with infrastructure capacity) is already a problem in some areas. So, although there is no problem on average demand at the moment, such problems are likely to occur progressively over the next three decades, and peak and regional aspects mean that there is already a problem in some parts of the country in some years. *. THE CRITERIA FOR ANY NEW CHARGING SYSTEM The proper role of government The main question addressed in this section is what sorts of action would it be appropriate for the government to take to ensure that the future system for paying for water is the right one. We are not arguing that it is the government’s responsibility to provide a direct answer to the question of what the charging system should be for water, either in the year * or in the longer term. Decisions on charges are an operational matter which it is the responsibility of the companies themselves to decide. However, since the decision has considerable social, environmental and therefore political significance, the government has a very proper interest in the subject. Rather, our argument is that the government’s concerns should focus on the effects of any new system in a number of areas, including the economic, the environmental and the social. In order to express those concerns, and to ensure that its priorities are taken into account by the companies in reaching their decisions, the government should set out the criteria which it believes a charging system should satisfy. Although this does not exhaust its role, it is the setting of these criteria that is the first, and primary role of government in this matter, and they should be derived from the values that the new government espouses. The material below sets out what these criteria might be, while later analysis reviews the possible alternatives in the light of these criteria. Inevitably, this process leads to a ranking of the alternatives, with one or more them being designated as ‘preferred’. It is important, though, to emphasise that the aim of this exercise is not to come up with a recommended charging system but rather to demonstrate that the criteria can discriminate between different alternatives and to illustrate the sorts of system that these criteria apparently point towards. When the various possibilities are considered in detail by the companies, it may be that different conclusions will be reached from those indicated here. This does not matter, provided the conclusions can be shown to conform to the government’s criteria. Suggested criteria for any new charging system We suggest that there are three criteria for judging any new charging system: That it should be efficient in economic terms. That it should sustain the environment. That it should produce socially just outcomes. Note that these do not explicitly recognise the companies’ internal responsibilities towards their shareholders. In the present situation, the companies can be expected to develop solutions that satisfy their shareholders’ interest without any external stimulus from government. The choice of criteria themselves is influenced by a range of factors. These include standards and aspirations the government has already announced, both in its ‘Water Manifesto’ and in the speech given by Mr Prescott in May *. They also reflect existing commitments (for example, to the * Rio declaration) and external conditions (as set by the European Union). Last but not least, they reflect the Labour Party’s traditional objectives: increasing social welfare of those in need and ensuring that free market capitalism does not merely benefit the few. There are other important criteria - such as consumer understandability and administrative simplicity - but the three we have chosen are likely to be the fundamental determinants of whether or not any system is acceptable. We now look at our suggested criteria in turn, both to expand on what each entails and to identify a series of specific questions to be used in assessing whether each criterion is met by particular proposals for new charging systems. Note that it is obviously essential that any new system for charging should be both acceptable to the public in general and also understandable, and whatever the option chosen it will need to be implemented such that it also supports this objective. ECONOMIC EFFICIENCY Broadly speaking, economic efficiency simply means that the structure of prices should reflect the structure of costs (including any costs of installation and maintenance). The fact that water companies, like other household services providers such as power and telecommunication companies, present their customers with a regular bill is a great advantage in this respect since it allows them to distinguish between the different elements of total costs according to the reasons why they arise. In particular, it means that they can distinguish between those costs which are related to the volume of water used and those which are independent of it. One implication of this is that a high marginal price for marginal water consumption does not require that overall bills be high: they can be high or low depending on whether earlier usage is priced high or low. A second implication is that paying according to the volume of usage (as measured by meter) and, for example, the use of council tax bands need not be mutually exclusive, since the latter (or something similar) may still be desirable as the basis for the fixed charge. The specific questions that we are suggesting in order to establish whether the proposed charging system is economically efficient are therefore: *. Does the system allow for water to be appropriately priced at the margin? *. Does the tariff structure provide a balance of incentives for both households and water companies to use resources efficiently? ENVIRONMENTAL SUSTAINABILITY The importance of water within the environment is probably the most immediately pressing of all the external pressures on the water industry. The recent prolonged period of below average rainfall has served to raise the public awareness of the issue and has made the issue of leakage a matter of political attention and action. The specific questions we are suggesting regarding economic sustainability are: *. Does the system help protect the ecosystem in terms of both the quantity and quality of water? *. Does the system address the strategic water problems foreseen by the water company in its region? *. Does the system stimulate water companies to promote non-financial measures for the saving of water? In section *, we look at some various possible charging systems and assess them in the light of these criteria. Before, doing so, we need to look in more detail at the anatomy of any charging system to help inform this assessment. PROMOTION OF SOCIAL JUSTICE The dual nature of water means that the social implications of any new charging system must be given a high priority. There are two aspects to this: The first is the notion that as something essential for life and health, the ‘basic’ needs for water must be met, irrespective of the ability to pay. The second is the fact that any change in the charging system involves gainers and losers. Promoting social fairness means that any new system should produce a pattern of costs to households which, to some extent at least, is related to the ability to pay. This can be achieved either by proxy or by systems of exemptions and rebates. In this context, we are suggesting that an assessment of any charging system against

carry on: - **Evidence**: Council

* per cent of households in England and Wales are currently charged for water via a bill based on the rateable value of the dwelling they inhabit. Yet the Water Industry Act of * forbids the water companies from continuing to base their charges on a valuation list after March *. A new basis for the vast majority of dwellings is therefore needed. However: The natural successor to rateable values, namely the system of banding underlying the council tax, is also ruled out by legislation (the * Local Government Finance Act). Even if everyone wanted to replace charges based on rateable value by charges based on the volume of water used (volumetric charging), the installation of water meters on the scale that would be required to meet the deadline of the year * is impractical. At present, therefore, there is no satisfactory answer as to how to households should be charged for water after the year *. THE STRATEGIC PROBLEM Domestic consumption has been increasing since at least the 1960s and is projected to go on rising over the coming decades in response to both demographic and climate changes. Yet the present charging system contains no financial incentives for households to encourage water economy and to help keep future demand in line with supply. The scale of this strategic problem, though, is not clear cut. For example: Total abstraction of water from the environment for all purposes is actually lower than it was 25 years ago, since abstraction for non-household purposes has been falling. A reduction in the levels of leakage, allowing higher levels of consumption to be supported by the same level of abstraction, would provide some temporary relief to offset rising household demand. Difficulties are more acute in some regions and in some years than others. Overall, it appears that there is a significant strategic problem, but one that might not become pressing until, say, the year *. If radical options, such as the widespread metering of households, are needed, then it is in response to these timescales. The two problems above apply over very different time frames and cannot be solved simultaneously. We argue that the need to find solutions to the problem of charging for water in the short term presents an opportunity to facilitate the achievement of longer term objectives. The role of government 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. Finally, by proscribing both the continued use of rateable values and one obvious alternative (council tax bands), the last government was involved in charging methods. EXERCISING LEADERSHIP BY SETTING CRITERIA FOR A WATER CHARGING SYSTEM 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.

carry on from: - **Argument**: Property is a private dwelling, not subject to business rates.