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HomeMy WebLinkAboutResponse by Water and Sewer Rate Study Committee 08-22-2005 Response by Water and Sewer Rate Study Committee 22 August 2005 to Comments on the Final Report of the Selectmen's Ad Hoc Water and Sewer Rate Study Committee Alan M.Levine August 3,2005 This memo contains our responses to Alan Levine's comments on our Final Report. We have followed Al's major section headings, and show the pages and section numbers of the Final Report that address Al's points. Impact on the General Fund The Committee is mindful that the recommendations that affect the General Fund have to be carefully managed. Our Final Report (page 6, Section 2) states, "The Committee understands that some recommendations will have to be phased-in to avoid General Fund disruptions." To make clear that"phasing-in"must not serve as an excuse for avoiding decisions and actions, the Report adds `phasing is acceptable provided there is a commitment and schedule for completing the changes" Comments on Recommendations re Changes to the Rates The lowest(FY04)rates were$2.20 per hundred cubic feet (hcf)for water and$4.89 for sewer. The highest rates were$4.99 and$13.13 respectively Since the lowest rates are less than the average costs per hcfi,then the highest rates must be greater than those costs. Our Interim Report notes that "40 gallons per day(gpd)per person" is sufficient for normal sanitary purposes 2 Thus, the amount of water a family uses is largely directly proportional to the number of persons in the family Regarding how many families are affected by the steepness of the current rates,Table 2.4.2-1 of the Final Report3 shows the spring 2004 period residential usage. Only 16.3% of the families lie within the 0-20 hcf block. Only 55.2%lie within the first two blocks (0-40 hcf). There are 38.8% (3.500)of the families in the third block, and 4.3% (382) are in the 81-110 ranee of the fourth block. We would like to clarify our intent regarding irrigation rates. Although ambiguously stated in the Final Report, our intent is that the irrigation rate continue to be set at the highest block rate, not for it to remain at$4.99. Determination of Rates We do not agree that the methodology for setting the rates is overly complicated. It is analogous to determining the residential and CIP tax rates4 Both computations need 8 arithmetic steps. 1 PILOTS and Indirect Costs The Committee recommends that PILOT payments be phased out. This recommendation considers Palmer&Dodge's (P&D)review of the legality of PILOTs, a review ordered by the BOS. In its conclusion,P&D states that"a Court could conclude"that the Town has"implicit authority"to charge PILOTs. But then P&D's opinion adds, "There are certain factors which could, however,lead a court to reach the opposite conclusion." Also there is P&D's judgment that changing the way the PILOTs are determined might"mitigate(but not eliminate) the risk that a court would not uphold the PILOTs" (bold fonts added)(See Final Report page 22, Section 2.6.) Since P&D was unable to assure that the water and sewer PILOTs are legally proper,the Committee concluded that the Town should begin phasing out these payments, and not risk a legal challenge sometime in the future. It should be noted that when proper Indirect allocations are determined,there may be Town services which have not been,but should be, included in the Enterprise's costs. If this proves to be the case, there would be an offset to the General Fund's costs as the PILOT is eliminated. Indirect Costs The Committee agrees that until there is a careful reassessment of all Indirect allocations (one of the projects for the Business Manager),it won't be known whether the present charges are accurate or not. (See Final Report page 22, Section 2.5.) Reserves The Committee believes that the Business Manager, by improving the Enterprise's financial planning, will be able to reduce reserves without jeopardizing the financial health of the Fund. However, the Committee recognizes that this will take better financial statements and overall management of the Enterprise. Since reducing reserves frees up cash,the Committee recommends that"operating reserves be kept to a minimum" As is the case with for-profit enterprises, well-developed forecasts (including weather effects) are essential to business plans. The Committee therefore believes that reserve amounts are an important measure of how well the Enterprise's finances are managed. Thus the report states that a reserve of 5% of revenue "should be the target" (See Final Report page 25, Section 2.9 ) Depredation Al suggested that a more substantial explanation of depreciation issues would be worthwhile. We have prepared a description of the two distinct aspects of financial reportings One aspect is the requirement to follow Generally Accepted Accounting Principles. The other is to have a tool for the management of the fund, including for rate setting. Billing Frequency Section 2.10 of the Final Report (page 26)identifies the reasons many residents want more frequent billing. At least as important are the benefits to the Enterprise (improvement in cash flow is one important advantage). The Committee does agree, however,that before a change can be made, all costs and benefits must be evaluated. 2 Representation of the Ratepayers The Enterprise is the only source to provide essential water and sewer services to Town residents, businesses and institutions. These are the Town's stakeholders, and the Enterprise's "customers" We agree with Al that the formal supervisor(Town Manager or Finance Director) should instruct the Business Manager 1)to run the enterprise funds in a business-like manner as envisioned by the WSRSC, and 2)to report to the Town Manager/Selectmen(or the appropriate authority)any problems which could"unfairly"impact the water/sewer rates. Shifting Costs to the Tax Levy We disagree that "water consumption is bound to rise significantly if the rates decrease significantly" Water is generally considered to be price inelastic.° Most of the federal income tax savings derived by residents when indirect costs and debt costs are shifted to the property tax levy would be available to the residents for non-water spending. WSRSC's Summary In conclusion we believe that we have responded to Al's comments and concerns. We look forward to additional opportunities to put forward our recommendations and our reasoning behind them. Distribution Selectmen Town Manager Appropriation Committee WSRSC email list NOTES. Final report,page 14. "Dividing the revenues by the usage results in average water and sewer rates for block rate accounts of$3.27[water]and$7.39[sewer]respectively." 2 WSRSC Interim Report,27 September 2004,Section 2.5,page 16. Forty gpd per person is equivalent to about 10 hcf per semi-annual billing period. A family of 4 would use about 40 hcf per billing period. Note that the U.S.G.S. estimates average gpd per person use at a higher figure of 80 to 100(Water Science for Schools,U. S.Geological Survey, http://ga.water.usgs.gov/edu/gahome.html). 3 The table is reproduced below. Cum.Pct. Pct. Cum.Pct. From To #users Pct.users users HCF used Pct.hcf Revenue Revenue Revenue 1 5 123 I 1.4% 1.4% 297 0.1% $2,106 I 0.1% 0.1% 6 10 298 3.3% 4.7% 2189 0.5% $15,520 0.4% 0.5% 11 20 1048 11.6% 16.3% 16624 4.2% I $117,865 3.2% 3.7% 21 30 1 1603 I 17 7% 34.1% 43818 11.0% I $327,435 I 8.9% 12.5% 31 40 1 1905 I 21.0% 55.2% 68639 17.2% I $544,382 14.7% 27.3% 41 50 1 1528 16.9% 72.1% 77768 19.5% I $655,430 17 7% 45.0% 51 60 1 1050 11.6% 83.8% 56977 14.3% I $518,554 14.0% 59.1% 61 70 1 623 I 6.9% 90.7%1 41090 10.3% $392,004 I 10.6% 69.7% 71 801 299 3.3% 94.0%l 22758 5.7% $224,631 6.1% 75.8% 3 81 90 205 2.3% 96.3% 17179 4.3% $178,608 4.8% 80.6% 91 100 107 1.2% 974% 10114 2.5% $114,015 3.1% 83.7% 101 110 70 0.8% 98.2% 7264 1.8% $86,320 2.3% 86.0% 111 120 33 0.4% 98.6% 3784 0.9% $47,209 1.3% 87.3% 121 130 19 0.2% 98.8% 2363 0.6% $30,521 0.8% 88.1% 131 140 16 0.2% 99.0% 2152 0.5% $28,639 0.8% 88.9% 141 150 10 0.1% 99.1% 1437 0.4% $19,566 0.5% 89.4% 151 160 8 0.1% 99.2% 2349 0.6% $32,856 0.9% 90.3% 161 170 9 0.1% 99.3% 1486 0.4% $21,102 0.6% 90.9% 171 180 7 0.1% 99.4% 1217 0.3% $17,522 0.5% 91.4% 181 190 9 0.1% 99.5% 1647 0.4% $24,019 0.7% 92.0% 191 200 3 0.0% 99.5% 585 0.1% $8,659 0.2% 92.2% 200 100000 46 0.5% 100.0% 17458 4.4% $286,569 7.8% 100.0% 9019 100.0% 399195 0 $3,693,530 The determination of the water rates in 3 blocks(municipal pays at the middle block and irrigation pays at the high block)is compared to determining the residential and CIP property tax rates in the table below. Each requires 8 arithmetic steps. Step Computation of tax rates Computation of water rates number 1 Find assessments in 4 classes,and the Find usage in 3 blocks,irrigation,municipal, total assessment and the total usage 2 Find revenue requirement Find revenue requirement I 3 Find average tax rate(Step 2 divided by Find middle block&municipal water rate total in Step 1) (Step 2 divided by total in Step 1) 4 Find CIP rate(Step 3 times CIP factor) I 5 Find CIP revenue(Step 4 times CIP Find middle block&municipal revenue(Step assessments in Step 1) 3 times middle block&municipal usage in Step 1) 6 Find high block and irrigation revenue(Last year's high/irrigation block rate times high block and irrigation usage in Step 1) 7 Find revenue required from residential Find revenue required from low block(Step 2 (Step 2 minus Step 5) minus Step 5&Step 6) 8 Find residential rate(Step 7 divided by Find low block rate(Step 7 divided by low residential assessment in Step 1) block usage in Step 1) s There are two distinct financial functions for the accounting and reporting of the enterprise fund. The first is a comprehensive set of financial statements that must be presented in accordance with the rules laid out in the Generally Accepted Accounting Principles(GAAP). The Commonwealth requires that these statements be prepared. Adherence to GAAP puts such financial statements on a consistent basis which allows the statements to be compared with other like enterprises and within the same enterprise across time periods. GAAP requires that fixed assets be reported at book value (cost-accumulated depreciation). Assets are presented in this way in an effort to match revenue and expense for fixed assets that have a life of more than one year. It is not intended to provide a reserve for replacement but rather to charge a piece of historic cost in each period of use. In each period,the balance sheet records depreciation within the book values and the income statement shows current period depreciation expense. The second distinct function for the enterprise financial statements is to serve as an important tool for the management of the fund,including for rate setting. The rate setting is the process by which the enterprise fund recovers its cost of operations and provides for the cash and capital needs of the coming year. It is clear to the Committee that including both depreciation and dept service in the rate setting process represents a double counting. As stated above,depreciation is recovery of actual historic cost. That same cost is also recovered if actual debt payments(including principal and interest) 4 are included in rate setting. Further,there is no sound basis upon which to accumulate a reserve for replacement based on historic cost especially for 40 or more year assets. Further,the depreciation collected to date through rate setting has not been set aside in an actual reserve for replacement but has simply fallen to the bottom line in the form of reserves. It is the Committee's position that rate setting should include charges for the actual cost of the fixed assets to be recovered through debt service and that capital planning be a separate proactive exercise. 6 Interim report,page 17, "Studies of consumer behavior indicate that increasing average water prices by 10%would reduce usage by about 1.4%to 5.5%." See also"Impact on Residential Water Consumption of an Increasing Rate Structure",C.E.Young,K.R.Kingsley,and W E.Sharpe,Water resources Bulletin of AWRA,Vol 19,No. 1,February 1981. Se also"Real Water Rates",Public Utilities Fortnightly, 15 July, 1997 "In statistical studies,price does not appear as a major determinant of water usage." 5 Comments on the Final Report of the Selectmen's Ad Hoc Water and Sewer Rate Study Committee Alan M. Levine August 3, 2005 I provide these comments on the Water and Sewer Rate Study Committee (WSRSC) Final Report and on related discussions at a meeting of the Board of Selectmen held August 1, 2005, to stimulate discussion by the Appropriation Committee, the Board of Selectmen,the WSRSC, Town staff, Town Meeting members, and other interested persons, and I would like to give the WSRSC a chance to respond with clarifications, fuller explanations, etc. I would be happy to receive comments or the results of more extensive analyses. I must emphasize that the comments and analysis below represent my personal views. This document does not represent positions of the Appropriation Committee. Since my detailed comments below largely point out omissions or areas where I disagree with conclusions or methods, I would like to state first that I agree with many of the recommendations of the WSRSC, and I would like to compliment them for all the work that they did and the obvious high level of thought that went into the report. My detailed comments are listed below Impact on the General Fund If the recommendations of the report are followed, there will be impacts on the Town's General Fund. The specific recommendations in regard to the following items are relevant to this. a)Reduction of PILOTs b)Increase in water/sewer rates for municipal and school use c) Changes in amounts of transfers for indirect expenses. I recommend that changes of types a) and b) not be initiated until the responsible Town officials understand the full impacts of the changes and have had an adequate chance to formulate plans to mitigate any adverse effects. Comments on Recommendations re Changes to the Rates One of the major themes of the report is that the rate and block structure is "unfair", inequitable, or otherwise undesirable. The report states the belief that high volume users that pay higher per volume rates subsidize lower volume users that pay lower per volume rates. Rather than try to justify such a position,the report takes it as given. Here I discuss some of the issues that could have been investigated to understand the rationale for or against any particular rate structure. 1 The report does not shed any light on the costs of providing water and sewer services with respect to how those costs might change as, e.g.,the total volume of water supplied and sewage generated changes. Given that some costs are fixed, i.e., independent of volume,the cost per unit volume of providing service should decline as the total volume increases. On the other hand,the unit cost of delivering water(and treating sewage) can increase as the total volume increases if there is a limit to the availability of water at the supply(or to the capability of a body of water to receive treated sewage). Certainly this is the case at some level since we do not have access to an unlimited supply of fresh water The fact that the MWRA charges Lexington and other towns on a(non-inclined?) volume basis does not necessarily imply that the cost per unit volume charged by the MWRA is independent of how much water the MWRA supplies(or how much sewage it treats)overall for all its member cities and towns. The large size of the water and sewer volumes must affect the per volume costs. While it is obvious that there are fixed costs,I think it should be obvious as well that significant increases in demand at the MWRA level and possibly also at the local level drive up per volume costs, since the water/sewer infrastructure needs to be designed or changed to accommodate the large demand. An illustration of the issue here was the discussion in the years around the time the MWRA was created about the likelihood that new water sources would need to be found since demand was increasing and it looked like the supply capacity of the Quabbin Reservoir would be inadequate. There was (controversial)talk of diverting water from the Connecticut River to Quabbin. New infrastructure would have been needed to accomplish this. The need for the extra capacity vanished when the demand for water later diminished,most likely because the MWRA raised water and sewer rates to pay for new sewage treatment and other facilities. The point is that the costs per unit volume of water and sewage are not fixed at predetermined levels but correspond to real capital and operating costs. The report puts forth the point of view that the inclining block structure is unfair to large families. There are no numbers given as to how family size may be expected to affect usage or how many such families are affected in Lexington. The report does acknowledge on p. 12 that" nearly 100%of households use no more than 100 hcf/half year " The report does not fully describe the degree to which the rates would be affected over a number of years if the recommended changes were to be fully adopted. The illustrations in the report, e.g., in Section 2.4.7,emphasize the changes that would occur in the first year of implementation,and thus fail to show the eventual full effect of the recommendations. I would guess that the recommended rates would decrease,relative to maintenance of a rate structure similar to that in present use,by as much as 30%for some of the high volume users (>120 hcf per billing cycle. Similarly, no number is given for the eventual increase in rates to be paid by the lowest volume users. The recommended rates would likely result in substantially lower water/sewer bills for exceptionally high volume residential users and commercial and institutional users. Furthermore,the report recommends that the rate for use of water for irrigation remain at 2 $4.99/hcf(see p. 14). This latter recommendation,taken literally, would represent a discount in the irrigation rate in future years relative to current rate setting policy, since it would otherwise increase. In accordance with the above comments, I find that I do not fully agree with the recommendations on the rates. However, I probably would not object to some reduction in the steepness of the inclined rate structure in the first three blocks nor would I object if the threshold for the highest block were to be increased to 100 hcf/billing cycle, as long as the rate in that highest block remained above the average rates by a factor similar to that of the highest block in the current rate structure. It is also possible that I just need to hear more before I am convinced of the wisdom of the WSRSC recommendations. I recommend that the flat irrigation rate be maintained above the average rate by a factor similar to that in the current rate structure. My understanding is that the same rate schedule applies to both residences and businesses. I am not anxious to see the rates lowered for the latter. I agree with the WSRSC that the block structure should be set according to the length of a billing interval. Determination of Rates The methodology for setting the rates described in the report is overly complicated. It would be much simpler to set the water rates, e.g.,by setting relative rates for each block for residential,commercial, and irrigation customers. Then one would multiply the relative rates by an easily computed factor that would generate the required revenue. PILOTs and Indirect Costs I agree that PILOTs should either be eliminated or put on a sound basis. I am willing to assume that both the direct and indirect expenses of running the enterprise funds will be estimated more satisfactorily In that case the critical issue that emerges re PILOTS is whether the Town is justified in charging the enterprise fund for services of a highly general nature, such as police and fire protection, use of roads and streets,use of Town land in rights of way, etc.,that are not covered under any transfer for indirect costs. Such costs are paid by every local non-tax-exempt business that owns property To not charge a business anything for these services is equivalent to giving a subsidy Once the direct and indirect expenses are accounted for with reasonable accuracy, I have no strong personal opinion about the PILOTs,but thought that they should not be dismissed without further consideration. The report describes the current assessment of indirect costs as"aggressive" While this is undoubtedly accurate in some of the categories of indirect costs,there are many indirect costs that are not included at all at present, and the net effect of a careful reassessment may be either positive or negative. 3 Reserves In the last few years,I understand that annual revenues have fluctuated up and down by more than$1M. Some of this is due to billing problems in the Revenue Office. but according to the just released draft audit of the water/sewer financial operation,much of it is due to year-to-year changes in the weather At this time it is grossly premature to reduce the Water and Sewer Enterprise Fund reserves to anything close to 5% of the yearly budgets. Reserves of more than$2M should be maintained for at least the next few years to guard against weather related changes in revenue and the always possible problems with future billings. The level of reserves should also be tied to issues of water/sewer capital expenditures. A more careful study of the enterprise fund reserves will need to be done to comment with greater reliability on the reserve levels. Depreciation The report presents, without justification, a recommendation that depreciation be excluded from the rate calculations. 1 recognize that there should be a consistent treatment of depreciation and capital investment funding, and that such consistency may be lacking at present. A more substantial explanation of these issues would be worthwhile. Billing Frequency This topic is briefly discussed in the WSRSC Final Report and was also a subject discussed at the August l Board of Selectmen meeting. A number of rationales have been put forward by the WSRSC, members of the Board of Selectmen, and the Town's auditors(Melanson Heath& Co.)that suggest that more frequent billing, i.e., going from semiannual to quarterly billing, is desirable. The reasons include: 1) semiannual bills are so large that paying them causes hardship for many households; 2) more frequent bills would catch situations where water is leaking and it is not apparent to the user; and 3) that it will help reduce billing problems due to differences between actual and estimated meter readings, the times of meter readings, etc. (The auditor's report states "to obtain a higher percentage of actual readings, to monitor unusual usage patterns,to update meters, and to improve cash flow"). In regard to rationale 1), I am deeply skeptical that more frequent billing will alleviate hardships of paying large bills. When one realizes that a loaf of bread costs about$3 now, it must be admitted that water bills are just not that large. A semiannual water/sewer bill of$400 is a lot smaller than a typical real estate quarterly tax bill; going to quarterly water/sewer billing does not alleviate the purported hardship of needing to be ready to pay large bills. In regard to 2), I have not seen figures about how often leaks occur that result in an unexpectedly large bill, or how often an abatement or adjustment is granted for such a situation. I would hope that such statistics will be reviewed before using leaks as a 4 justification for increasing the billing frequency Furthermore, this rationale is really a reason for increasing the frequency of reading meters,not for increasing billing frequency—meters could be read, e.g., quarterly and any significant changes in usage flagged and relayed to the consumers. Actual bills are not necessary for catching leaks. In regard to 3), while I can understand that there appear to be reasons for increasing the sophistication of using meter readings, I fail to see that merely increasing the frequency of readings and billings will improve management of the bills. Rather,the extra workload for Town staff(more bills to process, more adjustments to make ) and the extra data are bound to create additional confusion that would only make the situation worse. Better procedures,better software, and better staff training seem to be the appropriate remedies, not more frequent billing. Furthermore, quarterly billing would materially increase the operating costs of checking meters, sending out bills, processing payments, making and approving adjustments,etc. The Water Dept. could and likely would need additional meter readers. The Revenue and Finance Depts. would also need additional staff. The contracts with the company that prints and sends out bills and the bank that processes payments would need to be revised. I would hope that the Board of Selectmen will get estimates of what is needed in terms of additional staff and other cost increases before they engage in further discussion of going to quarterly billing. For the above reasons, I strongly disagree with the recommendation to go to quarterly billing. However, if the Board of Selectmen still decides to do so, I hope that it would be deferred until the water/sewer financial issues have been straightened out and at least one year's experience demonstrates that the system can operate smoothly Representation of the Ratepayers In my opinion, the recommendation of the WSRSC that a business manager position be created is an excellent idea and perhaps the most important of all the recommendations in the report. The list of responsibilities for the manager is sensible; his/her duties should be as much managerial as financial. One should be careful not to underestimate the magnitude of the job. The report recommends that the to-be-hired business manager should represent the ratepayers. The business manager will be hired by the Town Manager and/or Finance Director,and will be a member of the professional staff like the heads of other departments. However, representation of the interests of the rate payers is fundamentally in the hands of the Water/Sewer Board, which is a responsibility of the Board of Selectmen. It does not make sense to me to try to change this arrangement in terms of formalities in the case of one member of the professional staff. Rather, I think that the sense of the recommendation could be followed by suggesting that the formal supervisor (Town Manager or Finance Director) instruct the business manager 1)to run the enterprise funds in a business-like manner as envisioned by the WSRSC, and 2) to report 5 to the Town Manager(or the appropriate authority)any problems which could"unfairly" impact the water/sewer rates. Shifting Costs to the Tax Levy In Appendix C there is discussion of shifting a major portion of the costs of running the water/sewer enterprise operation from the water/sewer rates to the tax levy, based on the rationale that citizens will save because of the deductibility of taxes for federal income tax purposes. The logic here is that everything else will remain constant. This is clearly a highly questionable assumption, since water consumption is bound to rise significantly if the rates decrease significantly Thus, it is highly likely that an increase in consumption and concomitant increase in MWRA obligations would more than cancel the savings from tax deductibility, and actually increase the costs to Lexington residents. 6 John Bartenstein, 01:50 PM 8/28/2004, Comments on Levine Analysis,Rate Structure Page 1 of 4 From: "John Bartenstein" <john.bartenstein@verizon.net> To: "Woodcock, Christopher" <woodcock@w-a.com>, "Bartenstein, John" <john.bartenstein@verizon.net>, "Belvin, Larry" <larry,belvin@comcast.net>, "Benjamin, Kathryn" <kathryn@jklmbenj.com>, "Chernick, Paul" <paul.chernick@verizon.net>, "Earsy, Bob" <bob@earsy.com>, "Eurich, Richard" <reurich@mail.mm-m.com>, "Fenn, Dan" <fenndh@aol.com>, "Hadley, Bill" <WHADLEY@ci.lexington.ma.us>, "Krieger, Jeanne \(home\)" <jkkrieger@rcn.com>, "Krieger, Jeanne\(work\)" <jeanne.krieger@bms.com>, "Laredo, David" <lindave2@aol.com>, "Lorraine Fournier" <Ifournier24@hotmail.com>, "Meehan, Dennis" <dmeehan@ci.lexington.ma.us>, "Osten, Jim" <jim.osten@globalinsight.com>, "Pagett, Richard" <jrpagett@rcn.com>, "Wood, Loren" <wood@ll.mit.edu> Cc: "Levine, Alan" <aml@space.mit.edu> Subject: Comments on Levine Analysis, Rate Structure Date: Sat, 28 Aug 2004 13:50:16 -0400 X-Mailer Microsoft Outlook, Build 10 0.2627 X-Authentication-lnfo: Submitted using SMTP AUTH at out011 verizon.net from [141 154 119.101] at Sat, 28 Aug 2004 12:46:55 -0500 Members of the WSRSC: I wanted to pass on some thoughts about the report that Alan Levine prepared for the 1999 Town Meeting on PILOTs and discussed with the committee at our meeting on July 20, 2004 That report is of interest not only for what it has to say about the consequences of moving PILOTs to the tax base, but also for what it has to say about the underlying water/sewer rate structure. Since the committee will be taking up the issue of the rate structure soon, this may be an appropriate time to consider these issues. As Al's report makes clear, one striking aspect of the existing inclining block rate structure is that it does not allocate the full costs of the town's water/sewer operations among all users. Certain residents of the town, those who are in the lowest rate bracket, do not pay the complete cost of the water they use, but only that portion -- about half-- attributable to MWRA charges. The components that make up the other half of the cost of operations -- including the direct costs of DPW's water and sewer employees; the indirect costs of other town departments that support water/sewer operations; capital costs; depreciation costs; principal and interest on water/sewer debt; deposits to build reserves; and PILOTs -- are simply not included in their bills. At the same time, those who are in higher rate brackets pay not only MWRA charges for the water they consume, but also virtually all of the additional town costs required to maintain the town's water/sewer infrastructure and to deliver water, not just to themselves but to all of the residents in town. This means that they are paying a significant premium above the actual, fully loaded cost of the water they consume, and that part of each water/sewer bill they pay is going to subsidize costs attributable to the smaller volume users. It also means that each time an additional increment of town costs is added to the water sewer rate structure -- such as increased indirect costs, capital charges for improvements to the infrastructure, Printed for"Jeanne K.Krieger" <jkkrieger(cr�,ren.com> 8/28/2005 John Bartenstein, 01:50 PM 8/28/2004, Comments on Levine Analysis,Rate Structure Page 2 of 4 deposits to build up reserves, and PILOTs -- the higher-volume water users bear these incremental costs almost exclusively As Al sums it up' "The bottom tiers of the water and sewer rates just cover the MWRA costs. The revenue from users in the higher tiers must fund both the MWRA and the non-MWRA water and sewer expenses." In analyzing the impact of moving PILOT charges from the water/sewer rates to the tax base, Al does not question the appropriateness of the existing water/sewer rate structure, but simply takes it as a given. (As he puts it, "[ajn infinite variety of changes in the rate structure are possible, but none of these other possibilities have been considered.") From this premise, he demonstrates that moving the PILOTs to the property tax base would not necessarily result in a net financial benefit to all citizens.* But for this committee, the existing rate structure is not a given. It is part of the charge of the committee to take a hard look at whether the existing water/sewer rate structure is fundamentally fair, justified by valid policy considerations, and fulfills the legal requirement of being "just and equitable." See G.L. c. 41, sec. 69B. How that underlying question is resolved might, in turn, have an impact on the committee's evaluation of the conclusions in Al's report. Depending on how one views the appropriateness of the current allocation of the PILOTs when charged through water sewer rates, the burden shift that would result from reallocating them as a property tax (proportional to assessed home value) may or may not be desirable. We have discussed the concept that water/sewer rates should ordinarily be based, as closely as possible, on the cost of service unless there are good and sufficient policy reasons to deviate from that principle. There seem to be three potential justifications for the existing water/sewer rate structure's substantial departure from the "cost of service" principle: (1) that it promotes conservation of water; (2) that lower volume water users tend to be elderly and/or less affluent, and therefore should have their water/sewer costs subsidized; and (3) that true "high volume" users (which include larger commercial entitities and perhaps heavy users of irrigation water as well) impose disproportionate costs on the system which should be appropriately accounted for The Committee should scrutinize each one of these rationales. I will not dwell on the first rationale at this point, other than to note that, based on our meeting with MWRA officials, inducing member communities to promote water conservation through pricing does not appear to be a high priority of the MWRA at this point. Although MWRA certainly encourages conservation efforts, it neither utilizes inclining block pricing in its wholesale distribution of water nor requires its member communities to do so in their retail resales. Given the dramatic reduction in demand that has occurred in the last decade or two as a result of changes in the state plumbing code and higher prices in general, MWRA officials reported that the MWRA system is expected to be well within its capacity, even in periods of drought, for the foreseeable future. Under the circumstances, it is not clear that Lexington can have much of an impact on a regional conservation issue by buying water at uniform wholesale rates and then repricing it locally Even if water conservation were a high-priority goal, it is not entirely clear that"inclining block rates," as opposed to seasonal rates or other pricing schemes, are a particularly effective mechanism for promoting water conservation. This is so because, among other reasons, the demand for household water use (as opposed to outdoor use) does not appear to be particularly elastic; and for every dollar of premium that is charged one customer, there will necessarily be a dollar of discount provided another customer (unlike, say, the gas tax where a standard increment is added to every gallon purchased). Finally, ironically, discouraging water consumption town-wide is not financially beneficial to town residents generally (at least in the short run) because the less "billable" water that is consumed Printed for "Jeanne K. Krieger" <jkkrieger@arcn.com> 8/28/2005 John Bartenstein, 01:50 PM 8/28/2004, Comments on Levine Analysis,Rate Structure Page 3 of 4 over which fixed costs can be spread, the higher the water/sewer rates must be set per hcf to pay for those fixed costs. The second rationale, providing rate relief to the financially needy, seems somewhat speculative at this point in the absence of hard, empirical data to verify it. In particular, it is not intuitively obvious that charging discounted water rates to low-volume users, while simultaneously charging premiums to higher volume users, is the most effective way to target relief for the truly needy While one can certainly envision small households consisting of one or two senior citizens who use very little water and are financially needy, one can also envision many other households with relatively low water needs that are not financially needy -- for example, professional couples who have no children, or whose children have grown up and no longer live with them, or who spend weekends and summers at a vacation home. Conversely, one can certainly imagine larger households that have relatively high water needs but that are not affluent -- for example, families with a large number of children but a relatively low household income -- for whom the premium charged to high-volume users is a significant burden. It would be very helpful to see an empirical analysis that examines whether, and to what extent, there is in fact a correlation between water usage and financial need. It should also be kept in mind that there are other water/sewer rate relief programs that target the elderly and the needy more precisely, including the 20% discount available to low-income residents who qualify for utility discounts, the Circuit Breaker tax credit program which allows a credit on the state income tax for qualifying seniors for up to half the household's water/sewer bills, and the program that permits qualifying seniors to defer payment of their water/sewer bills until the disposition of their property by inheritance or sale. The fnal rationale, requiring extraordinarily high volume, largely commercial, users to compensate the community appropriately for unique burdens that they impose on the system may well have merit. It is not clear, however, that this goal is captured effectively by the current graduated rate structure, which seems to sweep a fairly large number of residential households that do not have extraordinary water demands into the higher rate brackets. The volume thresholds for the rate brackets may not originally have been intended to be as low as they are now, and it would be worthwhile to give those thresholds a fresh look. Given these considerations, the committee might wish to examine whether the current rate structure can or should be adjusted, even if modestly, to: (a) require that the lowest volume users pay something closer to the actual cost of the water and sewer services they consume; (b) reduce somewhat the subsidy provided by higher volume residential water users to lower volume residential water users; and yet (c) continue to recognize the extraordinary costs to the system imposed by very high-volume, commercial users, or seasonal high-volume users of outdoor water, so as not to alter the current division of the burden of providing water and sewer service between the residential and commercial sectors. Should the committee conclude that the current inclining block structure ought to be maintained in some form that continues to impose a disproportionate share of town costs on higher volume residential users, then I think heightened attention must be given to the practical impact, fairness and legitimacy of including in those water/sewer rates certain town costs, payable disproportionately or even exclusively by high-volume water users, that do not provide a particularized benefit to those higher volume users but instead are of general benefit to the town. Under the principle of the Emerson College, such costs should be treated as a tax and recovered in the tax base. Among such costs, I would include any indirect costs charged to the water/sewer funds that are not justified by appropriate internal cost accounting principles, the costs of equipment or services paid for by the enterprise funds but used for Printed for"Jeanne K. Krieger" <jkkrieger@rcn.com> 8/28/2005 John Bartenstein, 01:50 PM 8/28/2004, Comments on Levine Analysis, Rate Structure Page 4 of 4 general municipal purposes such as snow removal; the cost of providing discounted water to municipal buildings, schools, playing fields or other facilities that are for the benefit of the population at large and not just high-volume water users; and, finally, the cost of PILOTs which, by definition, are earmarked for generalized municipal purposes. Like it or not, our existing municipal taxation system operates on the principle that town residents pay for generalized municipal services and costs (as opposed to particularized services) through a property tax that is levied in proportion to property value. Reallocating a portion of those generalized municipal costs based on water and sewer usage, particularly where responsibility for the bulk of those costs is skewed to a subset of higher-volume users, strikes me as neither rational nor appropriate. I hope these comments will be useful in thinking about rate structure issues and welcome feedback. John Bartenstein * From the premise that the costs added to the water/sewer rates by PILOTs are disproportionately levied on higher-volume water users, Al concludes that simply moving the PILOTs from the water/sewer rates to the tax base probably would not result, for any given user, in a dollar-for-dollar trade of a non-tax deductible dollar for a tax-deductible dollar He further points out that moving the PILOTs from the water/sewer rates to the tax base would allocate the economic burden of the PILOTs among town residents somewhat differently from the way it is allocated now Lower volume water users (particularly those in higher value houses), who are not currently bearing much if any of the burden of the PILOTs, would receive an increased share of the burden. Conversely, higher volume water users who are currently paying the brunt of the PILOTs, particularly those in lower value houses, would likely bear a smaller share of the burden -- and with the tail wind of a federal tax deduction would resumably come out a little farther ahead collectively than the lower volume users come out behind. Al makes the additional point, which we should not lose track of, that many (although not all) of the higher volume users that fall into the highest rate brackets are commercial users; that (as of 1999) commercial users paid approximately 28% of the town's water/sewer costs but only 22% of the property tax; and that commercial users (unlike residential users) can already deduct their water sewer costs for tax purposes and hence would not receive a tax benefit from the change.