Income-based monthly fees could address affordability while reducing distorted electricity rates.
California leaders tout their pathbreaking initiatives to address both the climate crisis and economic inequality. But the way we charge for one of the most basic household needs – electricity – is undermining both of those efforts. The electricity rate structures of the state’s investor-owned utilities (IOUs) are discouraging building electrification and other important investments for reducing carbon emissions, while at the same time imposing a disproportionate burden on low-income customers.
Everyone knows that California IOUs, who serve over 70% of residential customers, have some of the highest electricity rates in the country. And they collect those revenues from households almost entirely through volumetric (i.e., priced per kilowatt-hour) charges. Those volumetric rates, however, cover much more than the cost of providing each additional kWh.
Why are California Electricity Rates So High?
State policymakers have poured the cost of myriad public policy goals into electricity rates – subsidies for rooftop solar and EV charging stations, support for nascent high-cost renewable energy technologies, reduced rates for low-income customers, energy efficiency programs, wildfire mitigation and compensation, and improving air and water purity in schools, among others. Plus, many electricity system fixed costs, including most of the cost of transmission and distribution, are also covered in those volumetric rates, but don’t really change with your electricity usage.
The result – as shown by research here and here – is that volumetric rates are two or more times higher than the actual incremental cost of providing electricity. This means households have too little incentive to switch to electricity from natural gas, gasoline, or other higher-carbon fuels for household and transportation services. They also have too much incentive to install rooftop solar and outfit their basements with big batteries, when the same carbon reductions could be achieved at lower cost with large-scale renewables and storage.
How to Cover the Revenue Gap
In ongoing research, Meredith Fowlie, Jim Sallee, and I (with the excellent assistance of our graduate student, Marshall Blundell) are examining what causes the gap between price and the incremental cost of providing a kWh, and looking closely at who ends up paying for the gap. In essence, the rate structure imposes a volumetric tax on electricity – a surcharge on each kWh – in order to cover state energy policies and other costs that don’t vary with the amount of electricity households use.
We wanted to compare the distributional implications of collecting revenue through this volumetric tax on electricity versus other sources of revenue, such as state income tax, sales tax or gasoline tax. Using government consumption data for households in California, we compared how much customers in the lowest income bracket spend on electricity and other goods compared to consumers in higher income brackets. The figure above suggests that the highest-income quintile of households only spend about twice as much on electricity as the poorest quintile. But they spend about three times as much on gasoline, about four times as much on all goods other than electricity, and over four times as much on goods covered by the state sales tax.
In other words, we are paying for these fixed costs through a tax that is substantially more regressive than a sales tax or a tax on gasoline, both of which are generally viewed as pretty regressive ways to raise revenues. The figure below shows just why those are viewed as regressive taxes. It’s the same as the figure above, but rescaled to fit in average income, which is 17 times higher for the highest quintile than for the lowest. Paying for these costs through even a flat tax on income would be far, far more progressive than through raising electricity prices.
Back at the beginning of 2020 (about a decade ago), when we were starting this project, I suspected that one implication might be that it would be a good idea to move many of the public policy programs off of electricity rates and on to the state budget, financed in the general fund, i.e., mostly through income taxes. Back then, California had a budget surplus. Raising that idea now just triggers laughter.
Reinventing Fixed Charges
When we have discussed this research with utility executives and with consumer advocates, there is remarkable agreement on the problem. But the agreement ends when the utilities propose their solution: monthly fixed charges. Utility managers get all gushy over fixed charges, which bring greater revenue certainty and lower volumetric prices that encourage more usage of their product. But consumer advocates start to turn a purplish-red color (or maybe that’s just Zoom) at the suggestion of increasing fixed charges, because that means charging every household the same amount (which would be a flat line at the bottom if it were on these graphs). Standard fixed charges are even more regressive than a volumetric tax on electricity.
Fixed charge advocates have countered that the charge could be reduced or waived for low-income households, such as the one-third of households on the CARE rate. But that still treats the other two-thirds of customers – from lower-middle income to extremely wealthy – the same. And, the CARE program is not exactly closely monitored. Income level is verified for only 1% of the households who sign up for the program, and there is little penalty for falsely claiming eligibility.
While brainstorming alternative funding sources, we realized that fixed charges could be efficient and equitable if they were truly income-based and income-verified. Who has the information to do that? The taxman.
Broadly, here’s how it would work: Households would pay a substantial monthly fixed charge, and then on their state tax return they would document the payments by submitting a utility ID that would be matched with billing information from their utility. That would automatically trigger a refund of all or part of their fixed charge payments depending on their income. The state would then collect the rebated revenue from the utility.
To implement this, some institutional barriers would need to be overcome: California’s Franchise Tax Board would need additional personnel to manage this process; utilities would have to be able to exchange information and money with the FTB; not all utility customers file state income taxes (though it would be worthwhile for a rebate of many hundreds of dollars); and some low-income customers would face cash flow issues. The cash flow problem could be addressed by allowing customers to stipulate their income in advance and pay the associated lower fixed charge, subject to verification when they file taxes.
Is this approach really feasible? Yes! The federal Earned Income Tax Credit has worked in a very similar way for decades, with households getting a refundable tax credit based on the income they demonstrate on their tax return. California introduced its own EITC in 2015, which operates the same way. And the Affordable Care Act’s subsidies for low-income households follow this approach, including allowing households to stipulate their income and qualify for the subsidy upfront, which is then verified and potentially adjusted when they file their tax return.
Electricity rate design in California today is seriously broken, both in the distorted incentives it creates and in the regressive impact. That will only worsen as more high-income households install solar and, now, batteries. At some point soon, we need to create a system that is not just environmentally sustainable, but also financially sustainable and equitable. Income-based fixed charges could help attain all three goals.
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Suggested citation: Borenstein, Severin. “Reinventing Fixed Charges” Energy Institute Blog, UC Berkeley, November 16, 2020, https://energyathaas.wordpress.com/2020/11/16/reinventing-fixed-charges/
Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.