This piece was first published in The Regulatory Review on November 23, 2021. It is reprinted with their permission.
Affordability has become a greater concern for regulators, utilities, and consumer groups, especially due to the COVID-19 pandemic and the expectation in some jurisdictions that electric rates will rise rapidly over the next several years. Household affordability of electricity and natural gas demands some form of special utility assistance or subsidy. State utility regulators must put forward smart initiatives to subsidize utilities for low-income houses.
Affordability by one definition entails households being able to pay for their utility services without jeopardizing their ability to purchase other essential goods and services, such as food, medicine, and housing. A commonly used “affordability” metric is the ratio of utility bills to income. The real culprit of unaffordable utility service is inadequate income.
The U.S. government operates special utility assistance initiatives—or SUAs. But whether regulated utilities should themselves assure the affordability of their service for low-income customers is a question that has occupied policymakers for several decades.
Political pressures and legislative mandates have ultimately compelled utilities, with approval by their regulators, to protect low-income households from unaffordable utility bills. Some observers view these actions as “taxation by regulation” that require slightly higher rates to the majority of customers to pay for an SUA benefitting a smaller, target group of customers. This “tariff effect,” which makes the majority minimally worse off to make a small minority materially better off, has definite political appeal in a wide range of government activities.
Public utility regulators are on the front lines in evaluating and approving these initiatives in the public interest, conditioned on legal, economic, and other constraints. Increased effectiveness of these programs means that more dollars are going to eligible low-income households—not wasted on excessive administrative costs or benefitting non-needy households.
Smart regulation requires that an SUA funded by utility ratepayers provide adequate benefits to the intended targets, namely, eligible low-income households. But because funding for an SUA typically falls short of meeting the needs of all low-income households, regulators should try to ensure that each dollar expended returns the highest possible dividend.
In dealing with an “affordability” problem, policymakers can apply one of three broad approaches: increasing the incomes of poor households; lowering the share of the utility bill for which the customer is responsible for paying; or reducing the customer’s utility usage.
SUA initiatives focus on the latter two approaches, while cash supplements fall under the first approach. With each approach, utility services become more affordable, either by increasing a household’s income or by reducing the amount a household must spend on utility services.
Various kinds of SUAs have differing effects on recipients, funding utility customers, and utility shareholders, as well as on society in general. Most SUA initiatives reduce energy bills for eligible households either by lowering the effective price of utility service or by reducing energy consumption through, for example, weatherization programs. These initiatives leave households with more discretionary money to purchase other goods and services, some of which are as essential as utility service.
Regulators and other policymakers should identify the criteria for socially desirable SUAs. No single initiative comes out favorably in meeting all criteria, but some of them satisfy certain criteria while satisfying others less well. Six primary criteria indicate socially desirable SUAs:
- the recipients of an SUA should receive maximum benefits relative to the dollars funded by utility customers;
- consumer education should make eligible households aware of available assistance and how to reduce their energy bills;
- an SUA should avoid large efficiency losses or cross-subsidization;
- an SUA should have reasonable administrative costs;
- funding should have a tolerable financial effect on individual subsidizing customers; and
- an SUA should lower collection costs, service disconnections, arrearages, and debt write-offs.
The principle of “spreading the burden” across many utility customers reduces the financial cost on individual utility customers. But questions arise as to which utility customers should fund the subsidies and at what point does the “subsidy” cost becomes excessive. A well-intentioned objective that attempts to reduce low-income households’ energy burden to the level of other households could lead to an excessive increase in general rates that violates equity and other regulatory goals.
Rate relief to low-income households could also benefit all customers if in its absence the utility would have disconnected low-income households, or those customers would have accumulated large debt or costs associated with service reconnection.
Some utilities consider an SUA a good business strategy when it increases their net revenues. Without subsidies, a utility is likely to receive only partial bill payments from some low-income households—and collecting unpaid amounts incur additional costs. If the unpaid amount becomes uncollectible, the utility would likely write off this amount as bad debt.
Alternatively, the utility might be able to avoid those costs by discounting customers’ bills. These cost reductions can more than offset the lost revenues from discounting and thereby increase the utility’s net revenues or reduce the burden on subsidizing customers.
Such outcomes probably explain why some utilities have initiated SUAs to help low-income households: Utilities might find it easier to garner regulatory favors, such as approval for recovery of revenue shortfalls, when they champion an SUA.
The most important message to take here is that an SUA should maximize the benefits to targeted households relative to the funding provided by other utility customers, and it should minimize adverse effects. In funding and executing an SUA, regulators should control for distortions in subsidy pricing and recipient behavior from moral hazard incentives that cause customers to not pay their utility bills on time or at all with little consequences.
Regulators should review current SUA initiatives to determine whether they operate most effectively and with minimal adverse effects on other regulatory goals. This balance is rarely achieved and prevents an SUA from being as effective as it can be. Regulators can do better.