The consequences of using increasing block tariffs to price urban water

Increasing block tariffs (IBTs) are currently used to price urban water in many Australian mainland capitals and a great many cities worldwide. This paper provides a systematic analysis of the impact of the adoption of IBTs to price urban water under the common constraints of scarce supply and cost recovery. The key tools available to policymakers using IBTs are the volumetric rate in the low tier and the threshold level of that tier. This paper shows how variations in these tools influence (i) the fixed charge set by the firm, (ii) the deadweight loss from the IBT and (iii) the bill paid by customers for particular levels of demand. Our analysis suggests that IBTs are neither fair nor efficient. We propose a modification to IBTs that, while retaining their perception of fairness, results in the efficient allocation of urban water.