Pricing and Subsidies

Achieving financial sustainability depends both on containing costs and increasing revenues. This requires increasing billing and collection, reducing per unit costs, and adjusting tariffs. Definition of tariffs consists of the setting an average tariff, and the design of tariff structures, including which consumers pay more or less than the average tariff.

Average prices charged by utilities for water supply and sanitation (WSS) services across the world are often well below costs. Full cost recovery, including operation and maintenance as well as investment costs, is a worthy goal as financially autonomous service providers provide better services. However, it will be difficult to obtain in the near  future in many countries. Average tariffs would have to increase several times in many countries in Asia and Africa. Evidence suggests that the poor population of lower income countries may find it difficult to pay a bill for a basic level of service if services where charged at full cost.

Most WSS utilities have implemented some form of explicit consumer utility subsidy. Most of these are consumption subsidies based on the volume consumed.  The most common form is the increasing block tariff, a stepped tariff in which a different price per unit is charged for different blocks of consumption. Research shows that volume based subsidies are regressive: all or virtually all residential customers receive a subsidy and richer consumers receive more than poorer ones.

Administrative selection of subsidy beneficiaries can be an effective alternative to volume based subsidies. In this case, the government or the utility decide which consumers receive a subsidy. The targeting can be categorical (groups such as pensioners), geographical (all residential customers living in a certain neighborhood), or through means testing. Categorical targeting has often been generally regressive. Geographical and means testing selection in existing water subsidy programs lead to slightly more progressive distribution of benefits. Administrative selection can be costly and time intensive, and must be well-administered to be effective.

A third type of consumption subsidies are quality targeted subsidies in which only consumers using a certain level or type of utility service are subsidized. Public tap subsidies and condominial WSS can be highly effective at targeting benefits to the unconnected poor.

One problem with all consumption subsidies is that only households who are connected to the system receive a subsidy. This means that many poor households are excluded from the subsidy. Connection subsidies overcome this problem, as they are aimed at unconnected households that choose to connect to a WSS network.  Connection subsidies have a more direct impact on low coverage. However, connection subsidies should be seen as a potential part of a package of policy measures as the poor face other barriers besides the cost of connection (such as the cost of fixtures, restrictions on the provision of services in areas with insecure tenure, or limits to system capacity).

Because the majority of the existing WSS are captured by the non-poor, most households would see their bills rise if subsidies are eliminated or restructured. In fact, the bulk of any price increase would be paid by non-poor households. Resistance against price increase therefore often comes from middle income groups. It is not surprising that moving towards cost recovery has proven to be politically difficult. To gain support for restructuring subsidies, the utility has to convince the public that they will feel the benefit of improved service.

The characteristics of sanitation and hygiene provision often require financial approaches that differ from those of water supply.  Demand for sanitation lags behind demand for water supply, and willingness to pay is low. Benefits of improved sanitation and hygiene depend largely on investment decisions at the household level. In low income countries public funds must be allocated principally to the promotion and stimulation of demand for sanitation rather than to subsidizing hardware in order to not undermine the long-term sustainability of the sector. In middle income countries where sewage and wastewater treatment is required and affordable, public finances should cofinance these semi-public goods.

The World Bank supports countries to design and implement tariff levels and structures. This support to countries is supported by operational research to test existing and new approaches to pricing and subsidies.  The World Bank consider cost recovery for WSS services as a long term goal, but there is flexibility in determining the period of time to obtain this goal. Revenues recovered from users within the near term are to cover the utility’s operations and maintenance costs.