Designing user fees to enhance local revenues and improve service delivery

1. Designing user fees to enhance local revenues and improve service delivery Innovations in Local Revenue Mobilization Seminar June 23-24, 2003 Sumila Gulyani Africa Urban and Water 1, World Bank

2. 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?)

7. II. Demand lessons from tariff reform in Armenia

8. 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

9. 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

10. 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

12. Average monthly bills and payments

13. Total arrears or unpaid balances

14. Aggregate impact of change in electricity tariff* *For sample households only, **Percentage points

15. 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 >>>

16. III.Fixing supply-side issues to improve cost recovery(and enable the “demand” approach)

17. 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

18. Meter, Bill, Collect & Enforce • Ineffective metering & inaccurate billings • tampered/faulty meters; inaccurate reading by staff Bombay: 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 sector Egs. Indonesia property tax, UP power billings

19. Bill collection time in water utilities

20. 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; theftby meter tampering, illegal connections- 20% in Haryana, India

21. 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 

22. 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

23. IV. Changing incentives & building capacity of LGs: Example of the CBDSD project in Ethiopia

24. Ethiopia: CBDSD ProjectCapacity bldg for decentralized service delivery • 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 • LG (esp. municipal) restructuring component • Goal: To create entities that deliver services in a demand-responsive, financially-sustainable & accountable manner

25. 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

26. LG restructuring: 4 windowsCapacity bldg for decentralized service delivery • Policy & legislative reform • Federal level policies (e.g. housing, municipal finance regulations) • In emerging regions, TA to empower local governments • Deepening decentralization • In “advanced” regions, devp & implementation of detailed guidelines (regional wage policies for munis, sub-regional transfer formulae) • Restructuring of LGs (in “advanced” regions) • Infrastructure investments in restructured LGs

27. 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 support Will be scaled-up

28. V. Conclusions

29. 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

30. 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

31. 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

32. Appendix

33. 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

34. 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

35. 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

36. 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