Designing user fees to enhance local revenues and improve service delivery

Designing user fees to enhance local revenues and improve service delivery

Innovations in Local Revenue Mobilization SeminarJune 23-24, 2003

Sumila GulyaniAfrica Urban and Water 1, World Bank

Sumila Gulyani, June 2003

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Outline Significance of user fees in different paradigms Case: Tariff reform & demand in Armenia Supply-side issues in improving cost recovery

– Meter, bill, collect and enforce

– Reducing costs: technical losses and theft

LG capacity & incentives: The Ethiopia CBDSD pjt Conclusions Appendix


3

User fees or tariffs: A definition Prices charged for specific services to cover all or

part of the cost of provision. They include:

– Direct charges such as tolls, bills for water & electricity, bus tickets, school tuition fees

– License fee (eg. driver’s license & fishing fees)– Special assessments

- eg. surcharge on property tax to pay for paving

Issue: User contributions to projects & K costs?

Tariff reform is often central to structural adjustment, decentralization, & infrastr/social sector programs


4

Structural adjustment and restructuring: macro & local programs

Get prices “right” – And reduce subsidies and cross-subsidies

“Right” fees for services are crucial for:– allocative efficiency

– equity

– deficit reduction (very important goal)

With decentralization, service delivery and fee-setting are key issues in local govt restructuring


5

The demand-side approach:Important in infrastructure & social sectors

Provide services that people want and

are willing to pay for Determine demand or willingness-to-pay

– Contingent valuation surveys & revealed preferences

Charge fees & recover costs- composition, QD

Reduce/eliminate subsidizes- composition, QD With revenues, investment, supply, quality

Shift to high-price high-quality service


6

Fees are central to demand paradigm

Effect user behavior on the margin– cut wasteful or excess use; change composition

Provide demand information– helps improve service design & provision

Create revenues which in turn:– provide way out of low-level trap (utilities can invest in

maintenance, and in improving coverage & quality)

– increase options for private participation in sector– improve a utility’s potential for privatization

Notion: “Right” fees can transform service delivery(A magic bullet?)

II. Demand lessons from tariff reform in Armenia


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Economic crisis, reform & recovery

Series of shocks; at height of crisis (1993):– GDP down to half; inflation: 10000% p.a.; fiscal

deficit: 2/3rds of GDP

Turnaround: economy stabilizes– Late 1990s, GDP growing at 5% & inflation at 1-2%

– Achieved through strict monetary policy & deficit reduction

Utilities had collapsed during crisis; their reform was central to overall economic program


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Reforming the electricity sector

Reform Program– Targeted investments– Price increases & elimination of subsidies– New energy law & creation of regulatory agency

Results– From 4 hrs of service in 1994 to 24 hr supply– Bill collection rates (from low of 10% in 1994)– Improved cost recovery– But continued political resistance to tariff hikes

How are the households, especially the poor, faring? Dec. 1999 study: sample of 1500 households


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The 1999 price increase: Followed many of the design “principles”

Elimination of increasing block tariff – ADR 15, 20, 25 per kwh

Replaced with a uniform tariff of ADR 25/kwh Seen as price increase of 30%

– From average price of ADR 19.2 to 25/kwh Actual price increase is about 47%

– HHs were actually paying on avg. ADR 17/kwh 28% + 9% get ADR 1450 as cash compensation

– only 55% of the poor received it--targeting is hard– more analysis required to assess effectiveness


11

Household electricity consumption

1998 and 1999

100

125

150

175

200

Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Billing month

Mea

n h

ou

seh

old

co

nsu

mp

tio

n (

kW

h)

Non-poor 98 Poor 98Non-poor 99 Poor 99


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Average monthly bills and payments

2,000

2,500

3,000

3,500

4,000

1998-poor 1999-poor 1998-non-poor 1999-non-poor

AR

D p

er h

ouse

hold

per

mon

th Avg. bill Avg. payment


13

Total arrears or unpaid balances

0

1

2

3

4

5

6

Mar-Nov 1998 Mar-Nov 1999

Mill

ion

AR

D

Non-poor Poor


14

Aggregate impact of

change in electricity tariff*

Household 1998 1999 Change between 1998 and 1999

Consumption—million

kWh (a) 2.22 1.83 -0.38 -17%

Billings—million ARD (b) 39.57 45.79 6.22 16%

Payments—million ARD (c) 38.22 40.33 2.11 6%

Collection rate—percent

(c/b) 97% 88% -9 pp.**

*For sample households only, **Percentage points


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Study impact and implications

Structural Adjustment Credit (SAC) IV– No new increase in electricity price

– Privatization conditionality kept; 2001 public protests

Implications: Prices are a powerful tool but results depend on

both demand- and supply-side variables– Demand elasticity & affordability effect quantity &

composition

– Supply-side issues >>>

III. Fixing supply-side issues to

improve cost recovery(and enable the “demand” approach)


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Improving cost recovery:Revenue - Costs

Enhance revenues:– (P*Q) Charge for service & set rates to recover cost

– Requires metering, billing, & enforcement

Cut costs:– reduce non-technical losses especially theft

– invest in maintenance

– improve operational efficiency & management

– improve staff productivity, shed excess staff

Ensure admin & collection cost < revenues


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Meter, Bill, Collect & Enforce

Ineffective metering & inaccurate billings– tampered/faulty meters; inaccurate reading by staffBombay: 75% metered but 20% work, so 15% effective metering

Low collection efficiency– collections are lower than total billing– collection time (months:1.2-Seoul, 3.3-Bogota, 7.6-Karachi)

Make it easier for users to pay Enforce full/timely payments (disconnection threat)

Option: Contracting-out to private sectorEgs. Indonesia property tax, UP power billings

Bill collection time in water utilities


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Costs: High technical & non-tech losses

Unaccounted for water (UfW)– 30-60% in developing countries (37% average while < 20%

in industrialized countries

Transmission & Distribution (T&D) losses – Higher than “normal” losses of 8-10%; In Colombia, rose

from 17% to 25% (1970-87); in Buenos Aires, fell from 30% to 10.6% (1992-98)

Reasons– distribution leaks, poor transmission infrastructure– partial metering; inaccurate meter reading/bills; theft by

meter tampering, illegal connections- 20% in Haryana, India


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Reducing theft in Brazil & Argentina

Utilities in Rio & Buenos Aires privatized– In Rio reduced losses from 15.7% to 14.6% (1% loss = US$ 20 million in revenue)

– In Buenos Aires, reduced from 30% to 10.6%(1% loss = US$ 9 million in revenue)

Steps taken to reduce losses– re-registration of all users (3 million in Rio)– random inspections (especially industrial users)– slum normalization program– tall poles (11-12m) & shields on distribution lines

Unintended effect of high fees: incentive for theft


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Cost recovery & service quality

Key assumptions in tariff & infra reform literature:– higher fee will raise revenues and cost recovery– higher revenues will facilitate quantity and quality

improvements by utility Evidence: It depends on demand, design & other

factors– Armenia: 47% higher fee raised revenues by 6%– Telekom, Indonesia, hi-profits but poor service– In Ghana, health centers did not spend revenues

Cannot ignore institutional capacity & incentives

IV. Changing incentives & building capacity of LGs:

Example of the CBDSD project in Ethiopia


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Ethiopia: CBDSD Project Capacity bldg for decentralized service delivery

1. Civil service reform component– Restructuring of selected ministries, agencies & bureaus (MABs)

– To: facilitate & support service delivery by local entities

– Includes: wage policy, budget reform, systems etc

2. LG (esp. municipal) restructuring component– Goal: To create entities that deliver services in a demand-

responsive, financially-sustainable & accountable manner


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Capacity Building as:

Organizational restructuring & empowerment of LGs

Institutional reforms– Improving incentives for performance (wages,

accountability, performance evaluation etc)

Systems Development– E.g. financial & expenditure management systems,

budget monitoring Training

– On-the-job and short-term courses– Development & implementation of a strategic plan


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LG restructuring: 4 windows Capacity bldg for decentralized service delivery

1. Policy & legislative reform – Federal level policies (e.g. housing, municipal finance

regulations)

– In emerging regions, TA to empower local governments

2. Deepening decentralization– In “advanced” regions, devp & implementation of detailed

guidelines (regional wage policies for munis, sub-regional transfer formulae)

3. Restructuring of LGs (in “advanced” regions)

4. Infrastructure investments in restructured LGs


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Design Principles

Demand-driven & flexible– Not pre-determined (wrt content)

Based on rules of access (supply-side constraints)– Defined in Operational Manual

Open to all LGs that meet criteria Programmatic approach

CBDSD is first leg of long-term Bank supportWill be scaled-up

V. Conclusions


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Demand, Tariff Design & Goals Determine demand -- i.e. what people want

– people are willing-to-pay for a certain level of service

Fees can play a crucial role in:– breaking low-level infrastructure trap

– preparing sector for private participation

Introduce volumetric tariffs with fixed fee– but ensure that administrative costs < revenues

Fees may be regressive; options for targeting poor:– free or amortized connection charge; “negative”

charge; special approaches such as public standpipes


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Improving financial viability

Cost recovery can and should be :– high in electricity & water; medium in urban transport;

low in basic education and health

Financial viability depends not only on tariffs but also on:– billing, collection rate & time, enforcement

– reducing theft/non-technical losses

– reducing production costs, enhancing staff productivity


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Do fees improve service provision?

Fees, in themselves, do not ensure: – more services or coverage (quantity)

– better services (quality)

– financially viable utilities (cost recovery)

At times, quality may be a pre-requisite for increasing fee & improving collections

Institutional incentives & capacity are key to better quantity, quality, and financial viability

Focus on fees and institutional issues together

Appendix


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Public finance rationale for user fees

1) Allocative efficiency-Prices will signal correct quantity & quality of services

that citizens demand

2) Revenue generation-Becomes increasingly important as governments’

budgets are constrained and/or deficits are high

3) Equity and fairness-Users pay for benefits rather than all tax payers

-If designed progressively, poor pay proportionally less (vertical equity)

These Depend on Elasticity of Demand


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Recommended tariff designFor the idealistic practitioner : )

Connection fee (including metering cost) Bill = Fixed fee+volumetric charge (2-part tariff)

– Fixed fee designed to recover capital costs– Volumetric charge should be set at MC

Peak load pricing & seasonal surcharge Reduce cross-subsidies Increasing or decreasing blocks—mixed results

– Many recommend uniform rate– But if you use a block structure, keep it simple

Achieves 2 basic goals: Enables cost recovery & affects user behavior


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User fees: Experience from Africa User fees and market price of services are often high

and quantity used is low (e.g. water in Kenya)

Few users now expect service for free; are willing to pay User contributions to capital (K) costs & O&M

– Upfront contributions are increasingly required for pjt (e.g. CDD, social funds, water pjts)

– Upfront contributions have worked & are a good proxy for demand; but usually not sufficient to cover K costs

– Overall, contributions to & recovery levels in projects tend to be below target (e.g. 5-10% vs targets of 25-38% in upgrading)

– More reasonable to aim for recovery of O&M costs; grant financing of 80-90% of K costs is common


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User Fees & Slum Upgrading in Africa Mechanisms

– Up-front deposits, community bank accounts, monthly payments before service, scheduled payments before title

Track record mostly unsatisfactory– Overall cost recovery levels are low & below target

– e.g. 5-10% vs. targets of 25-38%

– Property tax revenues did not materialize

Upfront fees & contributions have worked better– e.g. GIE in Senegal; project oversubscribed in Mali

Don’t give up on user fees– But treat fees as indicator of “demand”

– Modest on recovery; upgrading requires Govt subsidy

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Designing user fees to enhance local revenues and improve service delivery

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