Wednesday, 9 September 2009

Tax Commission report – water charges

This is the first of a couple of comments on the report by the Tax Commission, starting with the issue of water charges.

Some general points quickly to open. Why charge for water? Well, it is an efficiency thing. If you pay a fixed a price, or no price for a good or service, you will use an excessive amount. That is the efficiency argument. There is also an equity issue, in that heavy users might pay no more than light users.

Such is the basic premise behind the recommendation for the introduction of water charges in Ireland. But, as a grumpy old man, I find fault with most things and this is no exception. I have a short list of some of the difficulties I have with this proposal.

This is a charge that is going to be layered on top of charges (i.e. taxes) already levied to pay for water catchment, storage, treatment, distribution and maintenance. So in the guise of a more efficient and equitable approach to funding water supply we are actually facing a ramping up of cost. A ratchet affect.

Next is the efficiency point. And there are multiple problems here. Let’s start with the underlying commodity being delivered – water. As I mention above, the establishment of a marginal price for water use will lead people to use as much as the need/want and no more. Just like eating that extra Mars bar; the first one was worth the 80 cents you had to pay because you enjoyed it, the second one, not so much, the third one was worth a lot less than 80 cents so you stopped. In economics speak, they will align the marginal utility of water usage with the marginal price. The reason this is generally a good thing in economic is because it allows, in theory, for the most efficient allocation of a scarce resource. But water itself is not a scarce resource in Ireland. There have never been any water shortages in Ireland to my knowledge. It is for all intent and purpose unlimited in supply and hence should have zero marginal cost as a commodity. It requires no rationing by price or any other mechanism. To try and introduce a positive price would lead to an inefficient economic outcome by forcing people to under-use a resource that has no limit in supply. This case is certainly different in places where demographics, climate or geography do create a limit to supply (e.g. US, Australia, Africa etc.) but not in Ireland.

Next we turn to what is the more important point. It is not the water that needs to be allocated more efficiently (as I argue above it should have a zero marginal cost as an unlimited resource), but capital employed in its catchment, storage, treatment, distribution and maintenance. It is this inconvenient truth that creates a lot of the difficulties. I will suggest one here, but there are others. Consider that largely the capital required to collect, store, distribute water and maintain/repair the system is a large fixed cost for any population centre. Think of the water mains system. It doesn’t matter if you use 5,000 or 8,000 litres of water per day per household, you will still need the same pipes running the same mains pressure, with the same amount or maintenance. There is no efficiency to be derived from put a marginal price on water, making people use less in this instance. In fact, it could be detrimental, if you consider that it could lead to lower total revenues, which would impede the ability to meet the fixed cost of building and maintaining the distribution system.

Next, let’s consider the behaviour of the supplier. In normal circumstances the existence of a price allows for consumers not simply to choose the appropriate amount they want to consume (and not use wasteful amounts), but it also provides mechanism that allows for the more efficient use of capital. More efficient (hence lower cost) suppliers of a good can price at a lower point and entice consumers from competitors. Capital gets used and managed by the best companies. The desire to minimise costs and prices in order to attract customers is driven by a desire to maximise profits. But what are we considering here? The proposal is that a state owned monopoly will be setting charges for water usage. This can not be a sensible approach to achieving a more efficient allocation of capital when the two most essential ingredients are missing:

  • The existence of a profit motivation
  • The existence of competition.

For that reason this proposal will, if instituted, fail to produce more efficient outcomes. The state owned monopoly won’t be interested in maximising profits, so no need to work capital or labour more efficiently to minimise cost. With no competition it doesn’t matter how it prices (in fact it will need to be regulated), because it won’t lose any customers. Also consider that if the whole point of this exercise is to “save water” (use water more efficiently), this state owned monopoly will have no interest in reducing the greatest source of water loss – leakage during distribution. Why? Because the stuff isn’t scarce and so it doesn’t cost them if they lose a lot of it.
All in all this is a very lazy proposal. It will do nothing, where nothing is needed and simply ramp up household charges. And I am not stretching the truth to much to suggest that this format is simply a tax.

Finally, start totting up the extra costs that will necessarily be added to the provision of water in Ireland. Metering will be required for every household, which is a significant capital cost, billing and accounts sytems and employees will be needed as will yet another quango to regulate yet another state monopoly.

When the Irish economy is so broken, with poor policy and woeful insight from the supposed “professional economist” cabal, this is at best a distraction.

1 comment:

Fungus FitzJuggler III said...

Ahh, but like the elctoral machines that can give you the result you program them to, a lot of $ has to be spent and that means back handers.
Brown paper bags. Or did they just disappear?