Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households

Chun, Natalie Working Paper Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households ADB Economics Working Paper Series, No. 342 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Chun, Natalie (2013) : Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households, ADB Economics Working Paper Series, No. 342, Asian Development Bank (ADB), Manila, https://hdl.handle.net/11540/2325 This Version is available at: https://hdl.handle.net/10419/109470 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/3.0/igo Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households Natalie Chun No. 342 | March 2013 ADB Economics Working Paper Series Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households The design of alternative tariff structures can serve as a low-cost and effective tool in achieving higher take-up of basic services among poor households while allowing the provider to recover costs. A contingent valuation survey from SEUW’s Water Supply and Sanitation Project in Cebu, Philippines is used to show that tariff structures with a low one-time connection price and price differentiates based on wealth measures can result in a five-fold increase in the take up of water services by poor households over the base tariff structure. More moderate impacts, however, are found for the take-up of new sanitation and sewage services. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.7 billion people who live on less than $2 a day, with 828 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org/economics Printed on recycled paper Printed in the Philippines ADB Economics Working Paper Series Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households Natalie Chun No. 342 March 2013 Natalie Chun is an Economist at the Economics and Research Department, Asian Development Bank. Special thanks to Linda Adams and Paulus Van Klaveren for facilitating access to the data. Their discussions on the key issues that are faced by multilateral banks when evaluating the benefits and costs of water service investments were important in the development of this paper. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org © 2013 by Asian Development Bank March 2013 ISSN 1655-5252 Publication Stock No. WPS135533 The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. Note: In this publication, “$” refers to US dollars. The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly those facing the Asia and Pacific region; as well as conceptual, analytical, or methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness. The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The series is maintained by the Economics and Research Department. Printed on recycled paper CONTENTS ABSTRACT v I. INTRODUCTION 1 II. ESTIMATING DEMAND USING CONTINGENT VALUATION SURVEYS 2 III. PRICING STRATEGIES UNDER TWO-PART TARIFFS 4 A.Flat Tariff Structures 5 B.Price Differentiation Across Sub-Groups 6 IV. EXAMPLE: PRICE-DEMAND SIMULATIONS FOR WATER AND SANITATION SERVICES IN CEBU, PHILIPPINES 7 A.Demand for Improved Water Services per Cubic Meter of Water 10 B.Demand for New Septage Services 13 C.Demand for Sewage Services 15 V. DISCUSSION 16 A.Block Tariff Structures 16 B.Validity of Estimated Prices 17 VI. CONCLUSION 19 REFERENCES 21 ABSTRACT    The design of alternative tariff structures can serve as a low-cost and effective tool in achieving higher take-up of basic services among poor households while allowing the provider to recover costs. A contingent valuation survey from the Water Supply and Sanitation Project of the Asian Development Bank in Cebu, Philippines is used to show that tariff structures with a low one-time connection price and price differentiates based on wealth measures can result in a five-fold increase in the take-up of water services by poor households over the base tariff structure. More moderate impacts, however, are found for the take-up of new sanitation and sewage services. Highlights  Model developed takes into account that water provision is often a two-part tariff.  Paper simulates effects of different tariff structures on demand for water services.  Two-part tariffs that amortize connection fee into monthly fee increase takeup by poor.  Tariffs which differentiate on aspects correlated with income increase take-up by poor.  Changing tariffs results in a 5-fold increase in access to water services by poor. Keywords: Asia, Philippines, water and sanitation services, tariffs; demand estimation, contingent valuation JEL Classifications: D12, D61, D63, O21 I. INTRODUCTION Increasing access to water, sanitation, and health services are seen as essential to human welfare with significant social benefits which are necessary for environmentally sustainable development. Expansion of water and sanitation services, in particular, can allow for greater monitoring and reductions in the contamination of scarce water resources. However, providing these services is expensive, requiring setting tariffs to cover costs of provision. In developing countries, this can result in significant exclusion of the poor as the tariffs required to recoup costs are often too high in relation to household income making it difficult for households to afford these services. Yet, while affordability analysis typically identifies a range of prices in which consumers are willing-to-pay for services, this analysis is rarely extended to provide specific guidance on the range and types of tariff structures that allows a service provider to achieve social or profit maximizing objectives while still recovering costs. This paper presents a methodological approach to identifying tariff structures that ensure cost recovery for the provider while increasing take-up of basic services among the poor. It entails modeling the demand function for the entire market of potential users of the service using survival curve estimation techniques and knowing the costs faced by the provider.1 This allows for the identification of differential pricing schemes where less disadvantaged groups are charged higher prices in order to effectively cross-subsidize the lower prices charged to the poor. The low additional cost to implementing tariff structures with differential pricing therefore makes it a potentially powerful tool for increasing take-up of important services among the poor enabling providers of basic services to aid in more sustainable development while still allowing the provision of the service to be viable over the long term. However, we show that altering tariff structures may not work for all types of services where the differences in willingness to pay (WTP) are less determined by level of income. To provide a concrete example, the approach is applied to a contingent valuation survey that captured household and businesses WTP for access to improved water and new sanitation services provided by the Metropolitan Cebu Water District (MCWD) in the Philippines. It is found that up-front connection charges are a major deterrent to more units opting to connect and access MCWD’s water services with only 4% of the non-connected units WTP the connection charges required for MCWD to break-even or 2% of all non-connected households WTP the current connection and average per cubic meter charge. However, by charging a much smaller up-front connection charge and amortizing the remaining costs of the connection charges into the monthly fee results in a substantial rise in demand from 30.9% of households to 49.9%. Moreover, this tariff structure results in 30.4% of non-connected households connecting to water services. Tariff structures that price differentiates to equalize demand across different subgroups increases take-up of water services by households to 56.8% based on household income sub-groups or 62.2% using geographic sub-groups. Moreover, it increases take-up of water services by poor households from 12.2% to 61.9% of the population. This is nearly a 500% increase over the current pricing scenario. Price differentiation, however, is found to be a less effective tool for increasing total household take-up of potential new septage and sewage services. It is shown to only increase overall household demand by 0.8% in the case of monthly septage service fees and 2.4 percentage points in the case of sewage services. However, it is effective in increasing take-up of services by 4.2 percentage points and 3.3 percentage points in the case of low income households. 1 Survival curve techniques are useful for models where the probability that an event has happened is increasing over a continuous variable. In the context of this paper it is the case where a respondent says “no” they will not pay for the service as the price increases. More typically, these models are used for events that are a function of time such as the probability of still being unemployed or remaining in school. 8 І ADB Economics Working Paper Series No. 342 Figure 1: Kernel Density WTP per cubic meter of Water Services WTP =- willingness to pay. Source: Author’s estimates. The data is used to separately estimate demand curves for businesses and households. All survival curve models include a standard set of variables of city fixed effects, indicators of building/household ownership, and connection to other private water providers. This captures that potential users of water services have different probabilities of investing in connection or service charges depending on ownership and prior investments in water connections. An indicator for ownership of deep water well was also included to capture that users of water in developing countries may utilize several sources of water depending on the purpose (Nauges and Whittington 2010). The household model also included variables that capture the characteristics of the household head such as education level and gender. In addition, total income, total income squared, and total income cubed, number of times a household had health illness attributed to water quality, and whether the respondent is married were also included. Business models additionally included indicators for the number of employees, broad industry indicators as well as interactions between indicators for own-building and own well ownership and number of employees.4 4 A variety of specifications were tested to examine robustness and significance of various coefficients. The final models contain variables that achieved higher r-squared values and where the majority of the variables were significant across models. Other models tested included squared terms for household size, years at present location, time spent collecting water per month, and utilized per capita income instead of total income. For businesses, firm size, building ownership, and firm size own well and firm size-own building interactions were included as additional controls. Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households І 9 Actual estimations set zero values to 0.001 to prevent STATA from dropping these in the estimation process. The rough approach to estimation was as follows: First, estimate weighted survival regressions for different businesses and households for surveyed price points. Second, use estimates to predict demand for every household or business for a large range of price points. Third, use demand estimates and supplier variables and fixed costs to identify estimated costs, revenue, and profits for each price point. Four, sum up different estimates to obtain aggregates. Five, solve for the optimal prices for the various tariff structures described in detail below using estimates of MCWD costs provided in Table 1. Table 1: MCWD Cost Assumptions (Philippine Pesos) Cost Water Connection Per Household/Business (Variable) 4,950 Water Service Maintenance/Other O&M/Depreciation (Fixed) 624,977,000 Debt Service (Fixed) 151,630,000 Per Cubic Meter Charge (Variable) 6.72 Septage Service Per Desludging (Variable) 1,000 Per Month (Variable) 25 Sewage Connection Per Household/Business (Variable) 2,000 Sewage Service Maintenance/Other O&M/Depreciation (Fixed) 10,000,000 Per Month (Variable) 25 Source: Author’s estimates. MCWD = Metro Cebu Water District, O&M = operation and maintenance. The computations for various scenarios of tariff structures were simplified by constraining businesses to price in discrete intervals. The result is that the prices identified are not precisely the profit maximizing or zero profit prices, but are the ones that come as close as possible given the discrete pricing restrictions. Results from the survival curve estimates for households show that education, household income, household size, and ownership of deep water well are generally significant positive predictors of greater WTP for water and sanitation services. Lack of household ownership and those with a connection through other private water providers are less willing to pay for connections, but are willing to pay more on average for actual monthly or variable services. Survival curve estimates for businesses show that those with a greater number of employees are generally willing to pay more for monthly variable charges given they are already connected to MCWD water sources, but this association is not apparent for non-connected businesses. Building ownership and mining and construction businesses are also characteristics of businesses that have a higher WTP for a variety of service charges.5 5 Estimates from the survival curves are available from the author upon request. 10 І ADB Economics Working Paper Series No. 342 The analysis considers nine different pricing scenarios for MCWD water and sanitation services. These are: (1) Base price structure (where applicable), (2) Single price structure under profit maximization (equation 7), (3) Single price structure under zero-profit pricing (equation 8), (4) Price differentiation by household income and business under profit maximization (equation 9), (5) Equitable price differentiation where demand is equated across three groups of household per capita income and businesses (equations 10) Equitable price differentiation where demand is equated across three groups of household per capita income and profit maximization price is charged to businesses (equation 11). Price scenarios (7),( 8), and (9) correspond to price scenarios (4), (5), and (6) except price differentiation for households occurs instead by geographic categorizations according to percent of households in poverty in a barangay. Price differentiation by geographic area is considered in addition to price differentiation by household income because it may be more politically feasible and less costly to implement using geographic area categorizations if trying to identify household income levels are difficult. Moreover, it may better capture aspects of WTP that are not as precisely measured by household income alone. Income group divisions are poor, middle, and high where those considered poor are those whose monthly per capita income falls below the official 2009 per capita poverty line for Cebu of P1,556 ($37). Middle-income households are those whose monthly income is between the poverty line and 2.5 times the poverty line ($37–$92), while those with more than 2.5 times the poverty line are considered high income. Area group divisions are likewise divided into poor, middle, and high where poor areas are defined as those barangays having more than 33% of households below the poverty line, middle income areas those having between 10%–33% of households below the poverty line, while high income areas have less than 10% of households below the poverty line. A. Demand for Improved Water Services per Cubic Meter of Water Water services are currently provided by MCWD, but there is the intent to undertake investments which will improve the quality of water services. The improvement in service is expected to provide a constant supply of water 24 hours a day/7 days a week, prompt repair and customer service, decent water that is acceptable to drink from the tap, and meters that function properly. To access these water services it requires a one-time connection fee and monthly payments. Non-connected households and businesses were asked their WTP to connect to the improved water service and their WTP a monthly fee given they were willing to connect at some positive amount. Connected households and businesses were asked the amount they were willing to pay for the improved service over their currently monthly charges. Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households І 11 Charges are currently levied using a flat monthly fee for the first 10 cubic meters of water usage and rising per cubic meter charges thereafter. Almost all connected households consume greater than 10 cubic meters of water per month meaning that the majority of households face a per cubic meter charge. Thus, we make the simplification of considering the WTP for an average per cubic meter charge to levy on each household by dividing the WTP for monthly water service charges by the estimated monthly water usage that is expected to occur when having a private water connection. 6 Connection prices were constrained to occur in 500 Philippine pesos (P) intervals, with a minimum connection charge of P500 while per cubic meter charges occurred in intervals of P1. The current price structure sets connection charges at approximately P5,000 and the average per cubic meter charges paid by most households are approximately P15. Table 2 shows the price–demand values for the various pricing scenarios. Under the current base pricing structure only 30.9% of all households will be connected with only 2% of non-connected households choosing to take-up the service. These current prices reflect that the distribution of users is highly unequal with only 12.2% of poor households opting to connect compared to 28.3% of high income households. However, zero-profit pricing using a single price structure for all groups substantially improves upon the current price structure allowing demand to rise to 49.9% of all households. This is due to the lower monthly connection charges that are amortized over a 5-year period and results in a pricing structure that has a connection charge of P500 and a P14 per cubic meter charge. Equitable price differentiation by household groups achieves an even greater take-up of water services resulting in 56.8% when screening by household income and 62.2% when screening by household area. This results in a rise of nearly 27 percentage points in take-up under income screening or 31 percentage points among lowincome households over the zero-profit single price structure of 32.2%. The better outcomes for poor households when screening by area reflect unobservable differences in WTP that are better captured by area rather than income allowing the service provider to extract higher amounts from groups on the whole. It shows that price differentiation is able to substantially improve take-up among low income households not only over the baseline results, but also over the single price structure. 6 A limitation with the WTP question for water service is that it was asked in regards to a flat monthly fee that is independent of the amount of water consumption. In reality, households connected to MCWD are metered and therefore are charged by per cubic meter of water consumption. To deal with this, water consumption for nonconnected users is estimated using the predicted coefficients obtained from least squares regression models for connected users that utilize the same variables used in the survival curve models. Connected household’s WTP per cubic meter is identified from their monthly bill plus their stated WTP over their current monthly bill divided by estimated water consumption. 12 І ADB Economics Working Paper Series No. 342 Table 2: Price–Demand Simulations for Monthly per Cubic Meter of Water Fee Pricing Strategy (Profit) Est. Profit (‘000) Price Changed (Philippine Peso) Connection m 3 HH Group Biz All HH Group Biz All Poor Mid High Poor Mid High 5-year Amortization of Connection Cost Base –186 5,000 5,000 5,000 5,000 15 15 15 15 Single (Max) 3,035 1,500 1,500 1,500 1,500 32 32 32 32 Single (Zero) 21 500 500 500 500 14 14 14 14 Income All Income All HHInc & Biz (Max) 3,514 1,500 500 1,500 1,500 26 27 28 47 Eq HHInc & Biz (Zero) 76 500 500 500 500 8 10 18 21 Eq HHInc & Max Biz (Zero) 64 500 1,500 1,500 1,500 8 5 17 47 Income All Income All HHArea & Biz (Max) 3,536 1,500 500 500 1,500 29 27 26 47 Eq HHArea & Biz (Zero) 869 500 500 500 500 8 16 28 26 Eq HHArea & Max Biz (Zero) 244 500 500 500 1,500 6 12 23 47 Pricing Strategy (Profit) Est. Profit (‘000) Demand All Non-Connected All HH Income Biz All All HH Income Biz All Poor Mid High Poor Mid High 5-year Amortization of Connection Cost Base –186 0.309 0.122 0.222 0.483 0.418 0.020 0.012 0.011 0.044 0.032 Single (Max) 3,035 0.186 0.059 0.116 0.304 0.396 0.055 0.025 0.033 0.117 0.201 Single (Zero) 21 0.499 0.322 0.426 0.653 0.626 0.304 0.243 0.282 0.395 0.482 HHInc & Biz (Max) 3,514 0.235 0.100 0.168 0.368 0.325 0.081 0.046 0.058 0.148 0.177 Eq HHInc & Biz (Zero) 76 0.559 0.559 0.559 0.559 0.559 0.323 0.486 0.431 0.286 0.436 Eq HHInc & Max Biz (Zero) 64 0.568 0.568 0.568 0.568 0.325 0.366 0.486 0.408 0.278 0.177 HHArea & Biz (Max) 3536 0.237 0.089 0.164 0.379 0.325 0.073 0.039 0.052 0.137 0.177 Eq HHArea & Biz (Zero) 869 0.513 0.507 0.515 0.514 0.519 0.337 0.437 0.341 0.243 0.410 Eq HHArea & Max Biz (Zero) 244 0.622 0.619 0.619 0.626 0.325 0.452 0.555 0.493 0.296 0.177 Notes: Biz = business, Eq = equitable, HH = household, HHArea = household area, HHInc = household income, m3 = cubic meter. Source: Author’s estimates. Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households І 13 B. Demand for New Septage Services A new septage management program is being considered by MCWD which would desludge the septic tank, transport the septage to a septage treatment facility, treat the septage to kill harmful pathogens, and properly dispose of the septage. To access these services it is expected that either per-desludging fee or a monthly septage service fee will be levied with no connection charge. As a result, all households that had a septic tank were asked both their WTP per desludging or their WTP for septage services on a monthly basis. Survival curves were estimated conditional on households or businesses having a septic tank. 78% of households in the sample have a septic resulting in an effective market size of 531,415 households while 100% of businesses have septic tanks. The cost of septage services were assumed to have a variable cost of P1,800 per desludging while the monthly desludging had a cost of P150—equivalent to P1,800 per year with no fixed costs. 1. Per Desludging Per desludging prices were constrained to occur in P500 intervals with a maximum charge of P30,000. As the questionnaire only contained a maximum bid price of P4,000 which still resulted in a high degree of positive responses (–2% of the sample) at this price point this introduced substantial error into the calculation of the profit maximizing prices. Table 3 shows the estimated demand at the zero profit price of P1,800. At this price, only 14% of households are willing to take-up the service and only 6.5% of businesses are interested in using the service. The low WTP of businesses is indicative that it is difficult to use businesses as a way to cross-subsidize desludging service usage of households. Using an equitable pricing scheme to equalize demand across groups therefore is only able to raise household demand to 15.9% using household income as the screening variable and 16.4% of households using area as the screening variable. Area screening is less effective in this case in raising demand among income poor households. Rising from 8.2% under a single price structure to 11.8% under area screening compared to 15.9% under income screening. Table 3: Price–Demand Simulations for Per Septic Desludging Service Fee Pricing Strategy [Profit] Est. Profit (‘000) Price Charged (Philippine Pesos) Demand HH Group Biz HH Income Biz Poo r Mid High A ll A ll Poo r Mid High A ll Single [Max] 228 25,000 25,000 25,000 25,000 0.018 0.007 0.013 0.027 0.003 Single [Zero] 0 1,800 1,800 1,800 1,800 0.140 0.082 0.116 0.185 0.065 Income HHInc & Biz [Max] 231 15,500 22,500 29,000 9000 0.018 0.012 0.015 0.023 0.013 Eq HHInc & Biz [Zero] 12 1,000 2,000 2,500 1,000 0.159 0.159 0.159 0.159 0.159 Eq HHInc & Max Biz [Zero] 20 1,000 2,000 2,500 9,000 0.159 0.159 0.159 0.159 0.013 Location A ll HHArea & Biz [Max] 231 16,500 24,000 30,000 9,000 0.019 0.008 0.014 0.028 0.013 Eq HHArea & Biz [Zero] 1 1,000 2,000 3,500 1,000 0.151 0.118 0.160 0.156 0.163 Eq HHArea & Max Biz [Zero] 3 1,000 2,000 3,000 9,000 0.164 0.118 0.160 0.187 0.013 Biz = Business, Eq = equitable, HH = household, HHArea = Household area, HHInc = Household income. Source: Author’s estimates. 14 І ADB Economics Working Paper Series No. 342 2. Per Flat Monthly Fee Pricing for monthly septage services were constrained to occur in P5 intervals. Table 4 shows the estimated price-demand simulations based on the price restrictions and cost assumptions. The WTP for monthly septage services is low with only 8.9% of households and 15.7% of businesses WTP for the service at the P150 break-even point. Prices which equalize demand across household groups results only in a rise in take-up of services to 9.3% under income and 9.7% under area screening. Take up among income poor household rises from 5.8% to a maximum of 9.7% under area screening. As in the case of water services, area screening performs better in increasing take-up among the poor. Compared to per desludging services these results indicate that businesses have a higher preference for paying on a monthly basis while households appear to prefer to pay on a usage basis. Table 4: Price–Demand Simulations for Septage Service Monthly Fee Pricing Strategy [Profit] Est. Profit (‘000) Price Charged (Philippine Pesos) HH Group Biz All Poo r Mid High Single [Max] 23 260 260 260 260 Single [Zero] 0 150 150 150 150 Income All HHInc & Biz [Max] 23 245 255 260 280 Eq HHInc & Biz [Zero] 0 115 135 170 195 Eq HHInc & Max Biz [Zero] 0 115 135 170 280 A rea All HHArea & Biz [Max] 23 235 255 275 280 Eq HHArea & Biz [Zero] 0 100 160 200 190 Eq HHArea & Max Biz [Zero] 0 100 155 195 280 Pricing Strategy [Profit] Est. Profit (‘000) Demand HH Income Biz A ll Poo r Mid High A ll Single [Max] 23 0.029 0.016 0.025 0.038 0.049 Single [Zero] 0 0.089 0.058 0.077 0.113 0.157 HHInc & Biz [Max] 23 0.030 0.019 0.026 0.038 0.042 Eq HHInc & Biz [Zero] 0 0.092 0.092 0.092 0.092 0.092 Eq HHInc & Max Biz [Zero] 0 0.093 0.093 0.093 0.093 0.042 HHArea & Biz [Max] 23 0.03 0.018 0.026 0.039 0.042 Eq HHArea & Biz [Zero] 0 0.095 0.095 0.095 0.095 0.095 Eq HHArea & Max Biz [Zero] 0 0.097 0.097 0.096 0.097 0.042 Biz = Business, Eq = equitable, HH = household, HHArea = household area, HHInc = household income, m3 = cubic meter. Source: Author’s estimates. Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households І 15 C. Demand for Sewage Services A new sewage management service is being considered by MCWD which would install a combined sewer-drainage system to collect and transport sewage from houses and businesses to a separate sewage treatment facility. Provision of sewage services therefore entails an initial capital investment cost to connect households to the main sewage line and monthly fees to maintain and provide this service. Assumed costs for sewage services entailed variable connections costs of P2,000, monthly variable costs of P25, and fixed costs of P10 million. Households and businesses were asked their WTP for a one-time capital cost of installation and a monthly fee to operate and maintain the system. The model for the two-part tariff structure was used to evaluate pricing for this service based on the connection fee and monthly fee with prices constrained to be P500 for connection fees and P5 for monthly sewage service fees. Table 5 shows estimated demand for sewage services at optimal and zero profit pricing strategies. By charging a lower connection charge of P1,000 and amortizing the rest over 5 years of monthly fees at P55 per month, compared to the connection charge required to cover costs immediately, demand by households rises to 14.2%. Price differentiation again does little to increase demand resulting in a rise of overall household demand to 15.6% under income screening and 14.1% under area screening. However, it works to substantially increase demand among poor households when screening by income leading to a take-up rate of the service of 15.6% compared to only 8.2% under a single price structure. The gains are much more marginal in the case of area screening where only 9.1% of poor households choose to take-up the service. Table 5: Price–Demand Simulations for Monthly Per Cubic Meter of Water Fee Pricing Strategy [Profit] Est. Profit ('000) Price Charged (Philippine Pesos) Connection Monthly HH Group Biz All HH Group Biz All Poo r Mid High Poo r Mid High 5-year A mortization of Connection Cost Base –45 2,000 2,000 2,000 2,000 25 25 25 25 Single [Max] 402 2,000 2,000 2,000 2,000 191 191 191 191 Single [Zero] 19 1,000 1,000 1,000 1,000 55 55 55 55 Income A ll Income A ll HHInc & Biz [Max] 425 2,500 2,500 2,000 1,000 300 300 185 131 Eq HHInc & Biz [Zero] 51 1,000 1,000 2,000 1,000 20 15 105 15 Eq HHInc & Max Biz [Zero] 4 1,000 1,000 2,000 1,000 20 15 70 131 A rea A ll Area A ll HHArea & Biz [Max] 447 2,500 2,000 2,000 1,000 300 190 175 131 Eq HHArea & Biz [Zero] 2 1,000 1,000 2,000 1,000 25 45 115 15 Eq HHArea & Max Biz [Zero] 17 1,000 1,000 2,000 1,000 25 45 115 131 2-year Amortization of Connection Cost Single [Zero] 5 1,000 1,000 1,000 1,000 80 80 80 80 Income A ll Income A ll Eq HHInc & Biz [Zero] 1 1,000 1,000 2,000 1,000 20 15 120 15 Eq HHInc & Max Biz [Zero] 3 1,000 1,000 2,000 1,000 20 15 105 146 A rea A ll Area A ll Eq HHArea & Biz [Zero] 4 1,000 1,000 2,000 1,000 25 80 160 15 Eq HHArea & Max Biz [Zero] 3 1,000 1,000 2,000 1,000 25 70 145 146 16 І ADB Economics Working Paper Series No. 342 Table 5 continued. Pricing Strategy [Profit] Est. Profit ('000) Demand Biz All All HH Income A ll Poo r Mid High 5-year Amortization of Connection Cost Base –45 0.111 0.058 0.088 0.160 0.000 Single [Max] 402 0.073 0.044 0.061 0.097 0.000 Single [Zero] 19 0.142 0.082 0.116 0.196 0.121 HHInc & Biz [Max] 425 0.061 0.029 0.037 0.101 0.068 Eq HHInc & Biz [Zero] 51 0.146 0.146 0.146 0.146 0.146 Eq HHInc & Max Biz [Zero] 4 0.156 0.156 0.156 0.156 0.068 HHArea & Biz [Max] 447 0.073 0.043 0.061 0.098 0.068 Eq HHArea & Biz [Zero] 2 0.141 0.091 0.130 0.177 0.179 Eq HHArea & Max Biz [Zero] 17 0.141 0.091 0.130 0.177 0.068 2-year Amortization of Connection Cost Single [Zero] 5 0.119 0.071 0.099 0.163 0.106 Eq HHInc & Biz [Zero] 1 0.140 0.140 0.140 0.140 0.140 Eq HHInc & Max Biz [Zero] 3 0.146 0.146 0.146 0.146 0.057 Eq HHArea & Biz [Zero] 4 0.128 0.091 0.130 0.144 0.145 Eq HHArea & Max Biz [Zero] 3 0.134 0.091 0.130 0.158 0.057 Biz = Business, Eq = equitable, HH = household, HHArea = Household area, HHInc = Household income. Source: Author’s estimates. The bottom panel of the table examines amortization over a 2-year period as opposed to a 5-year period. As this is a new service, one-time connection costs account for a greater percentage of overall costs compared to water services. Therefore, amortization over a 2-year period leads to a substantial rise in prices that need to be charged on a monthly basis. A comparison of the flat price structure shows the impact this has on demand decreasing from 14.2% to 11.9% of households taking up the service. The percentage point decrease is larger for more wealthy households leading to a decrease in inequality of take-up of services under this pricing strategy. V. DISCUSSION A. Block Tariff Structures Block tariffs are common in many developing countries and has often been perceived as an effective tool for decreasing the burden of payments incurred by poorer households. This is based on the assumption that poorer households are more sensitive to the price and therefore would alter their consumption pattern to consume less water. This type of pricing scenario was not investigated within the context of our example as the questionnaire design made it impossible to extract direct information about WTP per cubic meter and household consumption responses to rising per cubic meter fees. Block tariffs are a component of MCWD’s current pricing structure. This structure has a flat monthly fee for the first 10 cubic meters and then levies per cubic meter fees which rise for each 10 cubic meters thereafter up to 40 cubic meters of consumption. Thus, the current Cost Recoverable Tariffs to Increase Access to Basic Services among Poor Households І 17 structure provides some revealing evidence on the effectiveness of rising block tariffs in achieving a more fair distribution of payments among different household income groups. Table 6 shows the water consumptions and the estimated amount connected households pay and are WTP as proportion of their total income. Under the current tariff structure with rising cubic meter charges, but no price differentiation among household groups, poor households that are already connected to MCWD pay far more for monthly water services alone than high income households. In particular, the average connected household pays monthly bills of 4% of their total income. However, the tariff structure is not equitable with low-income households paying 7.4% of their total income to water services compared to only 1.9% for high income households. This indicates that those households below poverty and which are already connected to MCWD are disproportionately burdened by payments for water and sanitation services. While poorer households do consume substantially less water per household member than richer households, total household consumption is roughly the same due to the larger number of household members within poorer households. The trouble with block tariffs in trying to obtain more distributionally fair outcomes was raised by Whittington (1992). This indicates that using price differentiation is still an important pricing strategy in trying to achieve greater take-up among the poor and a more even distribution of payments as proportion of total household income. However, on the whole, the average WTP for water services is about 2.2% of income. The data for Metro Cebu reveals that mean WTP for water services ranges from 1.7% of monthly income for those that are considered high class to 2.8% of monthly income in the case of those in the lowest class. This amount is significantly less than the typical 3%–5% of expenditures rule of thumb that is typically used to assess whether a water service is affordable (Gunatilake and Tachiiri 2012; Wang, Xie, and Li 2010). Table 6: Water Service Consumption and Affordability of Monthly Fees by HH Per Capita Income Group Per Capita Income Group Water Service (Connected HH) Water Service (All HH) Mt. Water Consump. (m3) Mt. Fee (Philippine Pesos) % Fee of Income Est. Mt. Water Consump. (m3) Mean WTP Mt. Fee (Philippine Pesos) % WTP Fee of Income All 23 452.3 4.0 23.43 364.7 2.2 Poor 23 449.2 7.4 22.38 184.7 2.8 Mid 23 439.6 5.4 23.11 286.1 2.5 High 23 462.4 1.9 24.11 502.8 1.7 Consump. = consumption, HH = household, m3 = cubic meter, Mt. = monthly, WTP = willingness to pay. Source: Author’s estimates. B. Validity of Estimated Prices The more common modeling approach using contingent valuation survey data are those that use bivariate or probit models. The ideal model is one that fits the data as closely as possible while eliminating potential noise in responses that can be attributed to other things outside of the behavioral responses that would occur in actual situations. Deviations from the actual data may inevitably underestimate or overestimate demand resulting in inaccuracies in the estimated prices that are required for a service provider to break even and the prices that should be charged to the consumer base. It would also alter the expected outcomes of percent of users taking up a service.