Increasing Block Tariffs in the Water Sector: An Interpretation in Terms of Social Preferences

Meran, Georg and von Hirschhausen, Christian, Increasing Block Tariffs in the Water Sector: An Interpretation in Terms of Social Preferences (September 2014). DIW Berlin Discussion Paper No. 1434. Available at SSRN:http://ssrn.com/abstract=2553084 or http://dx.doi.org/10.2139/ssrn.2553084


Abstract

Many developing countries around the world apply progressive water tariffs, often structured in the form of discretely increasing block tariffs (IBTs). These tariffs have been criticized in the welfare economic literature due to their perceived inefficiency: many of the prices charged under IBTs do not correspond to marginal costs and thus violate the principle of allocative efficiency. In this paper we explore an alternative interpretation of the widespread use of IBTs, in terms of social preferences and fairness considerations. For this, we rely on an extension of the Fehr and Schmidt (1999) utility function, including inequality aversion, to which we add another parameter representing a preference for redistribution, which reflects a societal preference to correct for income difference perceived as unfair. In addition, the paper also includes household size in the analysis, finding that as poor households are on average larger (in per capita terms), a simple IBT tariff disregarding household size may not be "fair" at all. We conclude on a methodological note on the importance of addressing allocative and distributional issues simultaneously.