Water and
An Informational Overview

     U.S. Environmental Protection Agency
      Office of Wastewater Management
          EPA 832-F-03-027

                         Water and Wastewater Pricing
                                Holly Stallworth, Ph.D.
                    Economist, Office of Wastewater Management
                        U.S. Environmental Protection Agency
                                 EPA 832-F-03-027
            This document is provided for informational purposes only and does
                    not suggest any EPA regulatory authority or action.
I.   Introduction: The Role of Prices	1

II.  The Water Sector	2

  Public Ownership -Heavily Subsidized	2

  Laws, Regulations, and Local Politics	3

III.    Rate Structures and Practices in the Water Sector	4

  Current Pricing Practices in the Water Sector	4

  Conservation Rate Structures	5

IV.    Key Issues for Utilities, Communities, and Water Planners	5

  Affordability	6

  Revenue Stability	6

  Effectiveness	7

V.  Assessment Tools and Information Sources	7

  Show-Me Ratemaker	7

  IWR-MAIN Water Demand Analysis Software	7

  EPA Reports	7

  AWWA Manuals	8

VI.    References to Books, Reports, and Web Sites	9

I.    Introduction: The Role of Prices

This paper discusses the role of the price
mechanism in water and wastewater
conservation. It is designed to stimulate
conversation about water pricing strategies
among local water and wastewater utilities,
government planners, industry professionals,
and advocates of watershed protection.
Pricing strategies can also raise revenue to
meet clean water needs, but this purpose is
addressed in other EPA publications.

Most of us learned in elementary school that
water is indestructible and is recycled
through the hydrologic cycle. However,
recent experience has determined that water
cannot be treated as a perfectly renewable
resource. Withdrawals from our watersheds
for drinking, sanitation, agriculture, and
industrial use, and subsequent wastewater
treatment, are processes that, at today's
scale, have large "unpriced" external effects,
including land use consequences, biological
degradation, and water quantity depletion. In
view of these encroaching resource limits, it
is important to consider how to translate
these causal relationships through the price
mechanism to reflect the underlying costs to
society. As local utilities propose expansions
in water and wastewater capacity, significant
environmental issues are raised in most
major metropolitan areas. Clearly, the need
for conservation and planning is greater than
ever. Although there are many ways to
promote conservation, the focus of this
paper will be on pricing.

The most frequent response of economists to
the imperatives of environmental protection
and resource conservation is to use the price
mechanism more strategically. For
economists,  "full costs" refers to the
complete societal costs (environmental,
social, and actual) that stem from the
production and consumption of a good or
service. Economics shows us that social
welfare is maximized when all costs are
reflected in prices. This is sometimes
referred to as "full-cost pricing" or the
"polluter-pays principle." Only when
production and consumption decisions take
into account all costs to society can they
result in the most appropriate balance of
supply and demand. When prices are
artificially low, we tend to consume too
much. When prices are artificially high, we
consume too little.

From an environmental economics
perspective, pricing can be an extremely
valuable tool  for signaling the value of
water. Since water is basic to life,  and
certainly to the quality of life, the pricing of
water can be a powerful means of signaling
its scarcity to consumers, most of whom see
very little connection between their water
usage and their total bill. As water demands
are increasing and water supplies are
diminishing, economic tools are among the
most powerful ways to communicate the
true value of fresh water.

The polluter-pays principle is popular
among economists, but it is important to
emphasize that it usually suggests only a
theoretical optimum. It is rare to see an
"externality"  fully priced and charged. This
would mean identifying all the environ-
mental effects of the product at each stage in
the economic cycle from production to
waste, assigning  those effects a monetary
value, and using  the tax system or other
authorities to add this total monetized value
to the price.

American laws and social norms have not
yet embraced the approach of price
correction to achieve environmental goals.
European countries are farther along
inimplementing these kinds of price
changes, alternately called "ecological tax
reform" or "green fees." Approximately
one-third of U.S. electric utilities,  however,

practice a form of demand management via
peak-hour pricing of electricity. By pricing
electricity high enough to encourage
consumers to modify their electricity
consumption, these participating electric
utilities were able to take off 4 percent of the
total peak load in the United States (Energy
Information Administration, 1996).

Another example of price correction in the
United States is in the  area of municipal
solid waste. More than 4,000 communities
have established what  the U.S. Environ-
mental Protection Agency (EPA) terms
"pay-as-you-throw" programs (also known
as unit pricing or variable-rate pricing), in
which residents are charged for trash
collection based on the amount thrown
away. This creates a direct economic
incentive to recycle more and to generate
less waste. More information can be found
at the EPA Web  page  "Pay As You Throw "
at http://www.epa.gov/payt/.

As with many other resources, it is unlikely
that water and wastewater prices will ever
fully reflect the "full cost" approach favored
by environmental economics, but there are
some "directionally correct" pricing
structures designed to  encourage
conservation. Section III describes these rate
structures in more detail.

While beyond the scope of this paper, an
equally important reason to consider
conservation-based rate structures  is to raise
revenue for utilities faced with economic
and population growth, aging plants and
pipes, and tighter environmental regulations.
In a recent report issued by EPA's Office of
Water, the capital needs for water and
wastewater systems were estimated for the
next two decades. In present value terms,
funds needed for both  water and wastewater
systems over the next 20 years approach a
half trillion dollars (EPA, The Clean Water
and Drinking Water Gap Analysis, 2002).
To meet these needs, water and wastewater
providers will need to increase their
investments by at least 3 percent in real
terms over this time period.

Rising capital needs are attributed to:

•  Many sewage treatment plants and
   underground pipe systems needing
   replacement (with their useful lives
•  More stringent drinking water and
   wastewater standards; and
•  Increasing expense and controversy
   associated with developing new sources
   of water.

To summarize, strategic pricing of water and
wastewater can play a greater role in
meeting the investment needs of our nation's
water and wastewater utilities. Pricing
strategies can manage demand for water and
wastewater services (or slow the growth rate
of demand) and raise revenues to  support
critical capital investments. In the water
sector, these imperatives are greater than

II.  The Water Sector

Public Ownership - Heavily Subsidized
Over the past 200 years, water management
in the United States has been dominated by
government decisions concerning
agriculture, water rights, transportation,
hydroelectric power, manufacturing, and
drinking needs. The U.S. Bureau of
Reclamation and the U.S. Army Corps of
Engineers focused on large-scale
development of water resources during a
time in history when water was believed to
be abundant and easily renewed. Dams,
canals, aqueducts, and reservoirs were built
to move water from where it was abundant
to where it was needed, or to store it for use
during dry seasons. The federal government

financed much of that work, with the
Department of the Interior's Bureau of
Reclamation playing a key role. As its name
suggests, the goal of that agency was to
"reclaim" arid lands.

States generally govern water within their
boundaries. State laws and regulations
define the allocation of the rights of private
parties and government entities to use such
water. State water laws usually allocate
water according to a "grandfathered" system
of "first in time, first in right" (appropriative
rights)  or according to proximity of land
ownership (riparian rights). While water
uses must be beneficial, allowable
withdrawals are generally unpriced (free).

Today, the water allocation problem is more
difficult than ever due to a number offerees:
increased population, periodic drought,
depletion of groundwater, degradation of
water quality, land use concerns, and
competition among water users (agriculture,
recreation, urban drinking water, and
industrial use). In the arid West where
conflict over water rights has a long history,
some institutional reform of water policy is
under way to better manage the agricultural
use of water. Fueling the situation is the
historical underpricing of water. During the
1970s and 1980s, EPA's wastewater
treatment Construction Grants Program was
a major source of federal funds, providing
more than $60 billion for the construction of
public wastewater treatment projects.  In the
1987 amendments to the Clean Water Act,
Congress set 1990 as the last year that grants
would be appropriated. As the grants
program was phased out, it was replaced by
the  State Revolving Fund (SRF) program, in
which federal funds are used as seed money
to capitalize revolving loan funds that
provide low-interest loans for wastewater
SRF loans offer municipalities a substantial
discount compared to market rate financing;
however, this discount does not approach
the level of subsidy under the Construction
Grants Program. The 20-year era of the
Construction Grants Program (1972-1992)
produced a significant decline in the
pollutant loads discharged by sewage
treatment plants. These and other
government efforts to develop water
supplies and improve water treatment
produced many important environmental
benefits. However, an unintended and
unforeseen result was the weakening of a
price mechanism that might have guided the
supply and demand for water more

All told, the institutional character of the
water sector and the influence of
governments has imbued the water  sector
with deep political roots and economic
norms—not unlike other parts of our public
infrastructure such as roads, airports, and

Laws, Regulations, and Local Politics
Rate setting can be constrained by the
varying legal and regulatory codes of states
and local jurisdictions. Most states have a
water code or law that outlines the rights of
public water and wastewater utilities as well
as the state's authority over investor-owned
utilities. Federal law, including the  Clean
Water Act and the Safe Drinking Water Act,
does not mandate water pricing policy.

Publicly owned systems are subject to the
oversight and competing interests of county,
city, or regional governing boards, water
authorities, or commissions. For publicly
owned utilities, elected officials are often
influenced by competing fiscal pressures.
And because long-term capital planning and
conservation measures are not required,
local decisions might not include the need to
create depreciation reserves or other

financial mechanisms to finance inevitable
system replacements. In addition, both
citizens and elected officials might wish to
keep water and wastewater prices low to
attract economic development.

In recognition of the competing interests that
affect rate structures, EPA's 1989
publication Building Support for Increased
User Fees (EPA 1989) was  introduced to
provide guidance on how to conduct an
effective public education program that
emphasizes the connection between higher
fees and the financial and operating integrity
of a water or wastewater utility. In public
education programs for new rate structures,
acceptance is improved when the public

• The need for capital improvement
  programs such as expansion and
• The benefits associated with water
  conservation:  pollution prevention
  through reduced water withdrawals and
  wastewater flows,  habitat protection, and
  energy conservation; and
• The increased revenues that allow a
  utility to pay for conservation measures
  such as metering, improved water
  accounting, leak detection, water-use
  audits, retrofits, reuse and recycling, and
  landscape improvements.

Clearly, information plays a role in how
water users respond to price. To the extent
that the public can be assured of the
appropriate use of revenues  derived from
higher prices, improved rate structures stand
a far better chance of succeeding.
III.  Rate Structures and Practices in
     the Water Sector

Current Pricing Practices in the Water
The importance of water to our survival
renders it, literally, priceless. But this
intrinsic value of water is frequently left out
of traditional pricing. Traditional pricing
quantifies the costs of capture, treatment,
and conveyance. Consequently, this method
often obscures the larger, but less
quantifiable, societal interests in preserving
our water resources.

Supplementing traditional pricing with
incentives for consumers to manage demand
is a combination that serves both financial
and environmental goals. This is also known
as demand management pricing.

Water and wastewater demand can be
manipulated by price to some degree. Water
for necessities (sanitation, cleaning, and
cooking) is far less responsive to price than
water for more discretionary uses (lawn
watering, car washing, and swimming
pools). Water policy analyst Janice Beecher
reviewed over 100 studies of the price
elasticity of demand with the following
conclusions (Beecher 1994):

• The most likely range for elasticity of
  residential water  demand is -0.20 to -
  0.40, meaning a 10 percent increase in
  price lowers demand by 2 to 4 percent;
• The most likely range for elasticity of
  industrial demand is -0.50 to -0.80,
  meaning a 10 percent increase in price
  lowers demand by 5 to 8 percent.

Clearly, water is "inelastic," meaning that
when the price increases, consumption
decreases but at a lower rate than the
increase in price. To foster conservation,

utility managers will need to consider how
consumers will react and may need to adopt
other conservation strategies as well.

Three rate surveys give us some insight into
existing industry practices regarding
conservation pricing. The Raftelis
Environmental Consulting Group's 2000
Water and Wastewater Rate Survey depicts
29 percent of surveyed communities using
increasing block rates (where cost per
thousand gallons increases at various
increments of usage). The American Water
Works Association's 1998 survey of the
residential rate structures of 827 utilities
shows approximately 22 percent employing
increasing block rates and 2 percent
employing seasonal rates. The largest
sample set (over 1,200 systems) comes from
EPA's Community Water System Survey
2000 found at
http ://www. epa. gov/safewater/cwssvr. html.
This survey shows only 9.2  percent of
systems employing increasing block rates.
To be precise, all these surveys pertain to
water rates and not wastewater rates.
However, most residential wastewater is not
metered but is instead billed in proportion to
water coming into  residences (drinking
water) or by some  other formula.

Conservation Rate Structures
Prices can be used to help modify customer
behavior to use less water at the tap and to
prevent leakage and waste,  consequently
generating less wastewater for treatment. To
achieve significant conservation gains that
might enable water system managers to
postpone the need for new capital outlays,
utilities will need to expand their toolkit to
include the widest  array of conservation-
oriented initiatives, including measures  like
universal metering, water accounting and
use audits, retrofitting, and public education.
The Office of Water's Water Conservation
Plan Guidelines, issued in 1998, provides
guidelines for utilities on conservation
planning and the conservation measures
listed above, including conservation pricing.
See http://www.epa.gov/owm/water-
effici ency/web gui d. html.

The general types of conservation pricing
options are:

•  Repeal of volume discounts;
•  Increasing block rates; and
•  Seasonal rates.

Eliminating volume discounts removes any
existing disincentive for conservation.
Charging a higher unit price as consumption
rises is the most popular form of
conservation pricing. Seasonal rates, where
prices rise and fall according to water
supplies and weather conditions (with higher
prices usually occurring between April and
October), are used less often. With all these
options, consumers have an incentive to

IV.  Key Issues for Utilities,
     Communities, and Water

To effectively manage demand, a utility
must be able to  determine future water
needs. New water-demand forecasting
models take into account the socioeconomic
characteristics of a service area and project
water use patterns accordingly. Utilities can
see how seasonal changes, weather changes,
and socioeconomic changes will affect water
demand.  Most important, for the purposes of
conservation pricing, estimates of customer
response to changes in user charges can be

For effective pricing, utilities, communities,
and water planners will need to consider at
least three issues: the service population's
ability to afford higher rates, the effects of
conservation rates on a utility's revenues,

and their actual effectiveness in reducing
water demand. These are discussed below.

The Congressional Budget Office (CBO)
estimates that combined water and sewer
bills currently average one-half (0.5) of 1
percent of household income in this country
(Congressional Budget Office, Future
Investment in Drinking Water and
Wastewater Infrastructure, 2002). When
compared to other developed countries,
consumers  in the United States are paying
the lowest percentage of income for water
and wastewater services.

In this same report, CBO provided an
estimate of the percentage of household
income that would be needed in the year
2019 to pay for future infrastructure
investments. Under a low future costs
scenario, water and wastewater bills can be
expected to consume 0.6 percent  of
household income. Under a high future costs
scenario, CBO estimates that water and
wastewater bills will consume 0.9 percent of
household income. Under either scenario,
combined average water and wastewater
bills for Americans are expected to remain
under 1 percent of household income,
extremely low compared to other countries.

Because these statistics are national
averages and do not reflect regional
differences or effects on low-income groups,
the issue of affordability must be addressed.
The best rate design involves taking into
account the characteristics of particular
customer classes.  When considering
conservation pricing, a utility, water-
planning body, or local government might
consider the service area population's ability
to pay higher rates. Appropriately designed
programs can mitigate the hardship of rate
increases on low-income families. Not only
does this have humanitarian benefits, but
well-designed affordability programs can
also benefit the utilities by avoiding costs
associated with late payments, disconnection
notices, and service terminations.

The American Water Works Association
Research Foundation (AWWARF) issued
the most comprehensive report available on
rate structures designed to meet the needs of
low-income customers. (This Web site is
given in the references section; see
AWWARF 1998). Entitled Water
Affordability Programs, this report describes
five rate structures that can be considered as
model affordability programs. "Lifeline"
rate structures can mitigate undue hardships
for qualifying low-income customers by
charging a lower rate for the portion of their
monthly water supply that is considered
nondiscretionary (the basic amount needed
for sanitation, cooking, and cleaning).
Beyond this lifeline amount, higher rates are
charged. Alternatively, a discount can be
applied to the fixed portion of the bill,  (e.g.,
the meter charge,  service charge, or other
fixed amount). This method also maintains
incentives to conserve.

Utilities can also offer budget billing
programs, elderly discounts, and
conservation assistance to low-income
families. Section V covers a number of
assessment tools and information sources
that might be helpful in considering
conservation-oriented rate structures.

Revenue Stability
In the small body of literature on water
pricing, revenue instability is the most
frequently cited problem with various forms
of conservation rates (Beecher 1994). This  is
because conservation rates can shift cost
recovery from fixed charges to variable
charges (rates based on use). Utilities also
worry that price increases might reduce their
sales in an unpredictable manner, leading to
less certain revenue streams. If consumers
respond with a higher-than-expected

reduction in water use, conservation can
cause utilities to experience reduced
revenues and an unstable cash flow.

One way to mitigate this concern is to gather
reliable data on the local service area's
"elasticity of demand." Computer models
are available to estimate price elasticities for
different customer classes, and hence, the
revenue effects of conservation rate
structures. Forecasting demand will help
design rates that maintain financial stability
for the utility. Existing demand studies can
be used to approximate usage responses in a
general benchmarking approach, or
computer models can be used (in
conjunction with detailed customer records)
to specify  consumer responses to price with
greater accuracy. Section V describes some
of the tools available for making these

A second way to mitigate concern about
revenue instability is to create a revenue
stabilization fund that can be used to even
out the collection of revenue, particularly
during droughts. In this case, the utility must
be able to  collect revenues in excess of
annual expenditures in some years so that it
can draw on the fund during revenue
shortfalls that result from lower-than-
expected consumption. In addition, legal
safeguards are needed to protect these
reserves for their intended use. Surpluses
can be used to fund conservation programs
or build a reserve for future capacity
expansions or upgrades.

The literature on conservation pricing for
water is small but growing. University of
Georgia Professor Jeffrey L. Jordan provides
some insight in a 1994 article in the Water
Resources Bulletin. In 1991 Spalding
County, Georgia (part of the Atlanta metro
area), transitioned from a decreasing rate
structure to an increasing rate structure.
Without implementing any other
conservation measures, average yearly water
use per customer fell by 5 percent (Jordan
1994). More recently, Jordan has written in
the Journal of'the American Water Works
Association to report on results of a survey
sent to those utilities identified as using
some type of conservation rate structure
(Jordan and Albani, 1999). For those 12
systems where the authors had adequate
data, Jordan and Albani demonstrated that
yearly average consumption dipped 8
percent and peak-demand-month usage
declined 7 percent as a result of
conservation pricing.

V.   Assessment Tools and
     Information Sources

Show-Me Ratemaker
The state of Missouri's Department of
Natural Resources offers free software that
can be downloaded from its Web site at
ewer. Show-Me Ratemaker can be run on
Microsoft Excel, providing users with 5-year
financial projections and analyses of
different rates.

IWR-MAIN Water Demand Analysis
Developed under sponsorship of the U.S.
Army Corps of Engineers, the Institute for
Water Resources, Municipal and Industrial
Needs for Water Resources (IWR-MAIN)
software has been updated and continually
modified since its inception in 1982. The
most recent versions can be used on a
personal computer. More about this software
can be found at http://www.iwrmain.com/.

EPA Reports
EPA's Office of Water has issued two
reports aimed specifically at the water and
wastewater pricing issue. The first report,

Building Support for Increasing User Fees,
is a helpful guide on the public education
needed to price clean water at rates
commensurate with its value (EPA 1989).
This report stresses that rate adjustments are
most effective when used in conjunction
with a public education program. This report
can be viewed and downloaded
electronically from EPA's Web site at
http ://www. epa. gov/clariton/clhtml/pubtitle.

A follow-up to this report came in  1993 with
Evaluating Municipal Wastewater  User
Charge Systems, which provides the
information needed to comply with EPA's
construction grant user  charge system
regulations (EPA 1993). This report can be
ordered free of charge from the National
Service Center for Environmental
Publications at
http ://www. epa. gov/ncepihom/.
AWWA Manuals
The American Water Works Association
(AWWA) and the AWWA Research
Foundation have multiple publications of
interest. AWWA has periodically published
a definitive manual on pricing; the most
recent is Principles of Water Rates, Fees,
and Charges (AWWA 2000).  Additional
documents relevant to rate design can be
found at http://www.awwa.org/ and
http ://www. awwarf. com/.

VI.  References to Books, Reports, and Web Sites

American Water Works Association. 2000. Principles of Water Rates, Fees, and Charges, 5th ed.
http ://www. awwa. org/bookstore/product.cfm?id=3 OOP 1

American Water Works Association. 1999. Water Rate Structures and Pricing, 2nd ed. Denver,
CO. http://www.awwa.org/bookstore/product.cfm?id=3OOP 1

American Water Works Foundation. 1998. Water Affordability Programs. Denver, CO.

Beecher, J.A., et al. 1994. Revenue Effects of Water Conservation and Conservation Pricing:
Issues and Practices. National Regulatory Research Institute, Columbus, OH.

Chesnutt, T. W., and J. A Becher. 1998. Conservation rates in the real world. Journal AWWA,

Congressional Budget Office. 2002. Future Investment in Drinking Water and Wastewater
Infrastructure. Washington, DC.

Energy Information Administration. 1996. U.S. Electric Utility Demand-Side Management
1996. DOE/EIA-0589(96).  U.S. Department of Energy, Washington, DC.

U.S. Environmental Protection Agency, Office of Water. 2003. 2000 Clean Watersheds Needs
Survey Report to Congress. U.S. Environmental Protection Agency, Washington, DC.
http ://www. epa. gov/owm/mtb/cwns/2000rtc/toc.htm

U.S. Environmental Protection Agency, Office of Water. 2002. The Clean Water and Drinking
Water Gap Analysis. EPA-816-R-02-020. U.S. Environmental Protection Agency, Office of
Water, Washington, DC. http://www.epa.gov/owm/gapreport.pdf

U.S. Environmental Protection Agency, Office of Water. 2002. Community Water System Survey
2000. U.S. Environmental Protection Agency, Office of Water, Washington, DC.
http ://www. epa. gov/safewater/cwssvr. html

U.S. Environmental Protection Agency, Office of Water. 1998. Water Conservation Plan
Guidelines. EPA-832-D-98-001, 1998. U.S. Environmental Protection Agency, Office of Water,
Washington, DC. http://www.epa.gov/owm/water-efficiency/webguid.html

U.S. Environmental Protection Agency, Office of Water. 1993. Evaluating Municipal
Wastewater User Charge Systems: What You Need to Know. EPA-832-R-93-010. U.S.
Environmental Protection Agency, Office of Water, Washington DC. Ordering information is
given at http://www.epa.gov/ncepihom/

U.S. Environmental Protection Agency, Office of Water.  1990. National Wastewater User Fee
Study of the Construction Grants Program. EPA 430/09-90-011. U.S. Environmental Protection
Agency, Office of Water, Washington, DC.

U.S. Environmental Protection Agency, Office of Water.  1989. Building Support For Increasing
User Fees.  EPA 430/09-89-006. U.S. Environmental Protection Agency, Office of Water,
Washington DC. http://www.epa.gov/clariton/clhtml/pubtitle.html

Government Finance Research Center. 1987. Proceedings of Financing for the Next Generation:
A National Conference on Innovations in Financing Wastewater Treatment. Government
Finance Officers Association, Washington, DC.

Jordon, J. L. and R. Albani.  1999. Using Conservation Rate Structures. JournalAWWA, 91:8.

Jordan, J. L. 1995. Incorporating Externalities in Conservation Programs. Journal AWWA, 86:6.

Jordan, J. L. 1994. The Effectiveness of Pricing as a Stand-Alone Water Conservation Program.
Water Resources Bulletin, American Water Resources Association, 30:5.

Mitchell, D.M. and W.M. Hanemann. 1994. Setting Urban Water Rates for Efficiency and
Conservation. Report to California Urban Water Conservation Council, Sacramento, CA.

Raftelis Environmental Consulting Group, Inc. 2000. Raftelis Environmental Consulting Group
2000 Water and Wastewater Rate Survey. Raftelis Environmental Consulting Group, Inc.,
Charlotte, NC. http://www.raftelis.com/

Raftelis, G. A. 1989. Water and Wastewater Finance and Pricing, 2nd ed. Lewis Publishers,
Boca Raton, FL.
             This document is provided for informational purposes only and does
                     not suggest any EPA regulatory authority or action.