Electricity rates in California are a roadblock to decarbonization, but reform can help.
As a passionate fan of the Chicago Cubs, I grew up expecting to lose. Rays of hope and promise always gave way to defeat and disappointment. I long thought that this aspect of my youth was great preparation for a career studying US climate policy, which seemed to be defined by a similar inevitability of defeat.
But, sometimes things change. The Cubs won the World Series in 2016 (after a brief 108-year drought), and now climate policy is suddenly on a winning streak. In the last several weeks, the Inflation Reduction Act unexpectedly rose from the dead, and California passed a suite of new, aggressive climate bills. This momentum is encouraging, but several factors could derail the ability of legislative gains to produce real carbon mitigation.
Here in California, one of these obstacles is the high price of electricity. In a report released last week, Severin, Meredith and I take a close look at how residential electricity pricing in California is acting as a barrier to a lower carbon economy by artificially raising the cost of electrifying homes and vehicles. (We’ll be hosting a webinar to discuss the report on October 4, 11 am – noon Pacific.)
If you live in California, most of your electricity bill is a regressive electricity “tax”
Our new report, which was supported by Next 10, shows that households served by California’s three large investor-owned utilities (IOUs) pay an average of nearly $700 per year in what we call an “electricity tax.” For customers of Pacific Gas & Electric and San Diego Gas & Electric, this “tax” is about two-thirds of customer bills on average, and it is around half for Southern California Edison customers.
This cost to customers is not literally a tax. It’s the gap between the price customers pay per kWh and the cost to the utility of providing that power. When I turn on my lights, I have to pay about 25 cents per kWh, but it only costs PG&E about 8 cents per KWh to deliver that additional power, including the cost of pollution. The huge gap between price and cost, which we quantified in a companion report last year, exists because California’s IOUs need the extra revenue to cover system costs, and other residual costs for grid hardening, energy efficiency programs, rooftop solar incentives, low-income subsidies and other programs, entirely by raising per kWh prices above cost.
In the report, we label the gap between price and social marginal cost a “tax” on electricity because it represents a fee above cost used to collect revenue to pay for some good or service (in this case the costs of the electricity infrastructure, as well as other state priorities). The problem with recovering needed revenue via this “tax” is that it makes electric vehicles, heat pumps and other climate-friendly technologies more expensive. Turns out it’s also regressive.
In the report, we use anonymized billing data on more than 11 million customers of these IOUs to estimate annual, household-specific electricity tax burdens. Given growing concerns about affordability, we are particularly interested in how this electricity tax varies with income. We use data on income from the US Census as well as survey data from California in order to get the best available estimate of income for each household in the billing data.
Our results show that lower-income households pay a much larger share of their income via the electricity tax than do wealthier households. We label the total paid via the tax the annual “residual cost burden.” As shown in the figure below, the lowest-income customers in both PG&E and SDG&E pay 3% of their income to the electricity tax, and remember that the tax is just the portion of their bill over and above the incremental cost of providing their power.
High prices slow progress on electrification
Does the electricity tax really make a difference for decarbonization? We find that it does.
To think this through, we used survey data on vehicle mileage from California drivers to ask how much extra these drivers would pay per year if they got an electric vehicle as a result of the electricity tax. We call this the “electrification cost premium,” as it shows how much more expensive it is to electrify as a result of having electricity prices above social marginal cost. We used survey data on home energy consumption in the state to do the same calculation for the adoption of a heat pump for space heating.
In both cases, the annual cost premium averages around $600 per year. As shown in the figure below, the amounts vary considerably across IOUs because of differences in the electricity tax across utilities and due to differences in miles driven or heating used.
This cost premium works directly against tax credits that are being proposed as a lynchpin for spurring electrification. A $600 tax, at a 5% discount rate over 15 years, nets out to a present value of $6,500, which means that the electricity cost premium in California effectively undoes the vaunted $7,500 federal tax credit for buying an EV.
Using recent estimates from our Energy Institute colleagues (see here and here), we estimate that lowering volumetric prices to social marginal cost would increase EV adoption by between 13 and 33 percent, and it would boost adoption of electric heating in new homes in the state by around one-third.
Put another way, pushing electrification in California with our current rate structure is like trying to zoom down the highway with your parking break on. If you find yourself in this situation, you should release the brake. Similarly, policymakers can reform rates so that they don’t stall progress on electrification.
What can be done?
The good news about California’s electricity pricing conundrum is that there are ways to foster decarbonization by lowering prices while at the same time making the system more equitable. In this case, equity and efficiency can go together.
There are two key paths to reform.
The first is to lower electricity prices by moving suitable costs onto the state budget that are currently funded through utility bills. This won’t reduce costs, but it allows the state to raise revenue through the state sales tax (which is more progressive than the electricity tax) or income tax (which is dramatically more progressive than the electricity tax). In the report, we discuss which line items might be “suitable” for a transfer, highlighting wildfire mitigation costs and public purpose programs as the most obvious.
The second is to introduce fixed charges that vary by income on electricity bills, an “income-based fixed charge” (IBFC). Earlier this year, the state legislature passed, and the governor signed, a bill requiring the California Public Utility Commission to introduce such a charge by 2024.
In our latest report, we present an example of an IBFC, one designed to be as progressive as the state sales tax. The figure below shows one possible schedule of fixed charges for PG&E, where monthly charges would range from 0 for the lowest income households to $141 for households making more than $200,000 per year (roughly the top one-sixth of households in PG&E territory).
In exchange for adding these fixed charges, the volumetric price would drop dramatically, so the fixed charge is not simply a bill increase. PG&E households making more than $200,000 would, for example, see their monthly bills rise by only $35 per month on average, despite having a $141 monthly fixed charge. Conversely, lower-income households would see savings on average. A household, at any income level, that starts driving an electric vehicle or electrifies their home will see a much smaller bill increase than under the current system.
Bill impacts will vary across households depending upon factors such as their current consumption patterns, CARE participation, and service territory, as shown in the lower part of the figure.
This is but one example plan. Regulators seeking to implement an IBFC will need to consider how many tiers to create, how progressive to make the system, and whether or not to put measures in place to manage the big changes in bills that some might face, such as phasing an IBFC in over time. We hope that our calculations can help kickstart that conversation.
Minimum bills have minimal merit
Minimum bills, which increase bill amounts for households with sufficiently low consumption, are sometimes suggested as an alternative way to raise revenue without raising prices further or adding fixed charges.
We used the billing data to take a look at minimum bills and concluded that they are simultaneously ineffective and highly inequitable. Minimum bills of $30 per month (a dollar a day) raise a trivial amount of additional revenue. At $60 per month, minimum bills can increase revenue by modest amounts, but the burdens are quite regressive. About 40 cents of every dollar raised by minimum bills of $60 per month would come from households making less than $50,000 per year. This is even more regressive than the status quo.
Severin had previously demonstrated that minimum bills were inefficient because they create a zero price for consumption at quantities below the minimum. Now we know they complete the trifecta: they are inefficient, ineffective and inequitable. Minimum bills should be a non-starter.
Having been forged in fires of futility as a kid, I can rest content if the Cubs are lovable losers who resurface to win a title every 50 years or so.
Not so the climate. We need to be greedy about winning. We need to win so much that we get sick and tired of it.
So it is imperative that we remove obvious obstacles that threaten our pursuit of an equitable low-carbon future. The current electricity pricing system in California is one such hazard. We can see it clearly. We know it is unhelpful. We know how to change it. So let’s get to it.
For more information:
- Webinar on second report: October 4, 11 am – noon Pacific
- New report: Paying for Electricity in California: How Residential Rate Design Impacts Equity and Electrification
- First report: Designing Electricity Rates for An Equitable Energy Transition
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Sallee, James, “Equitable Decarbonization Requires Rate Reform,” Energy Institute Blog, UC Berkeley, September 26, 2022, https://energyathaas.wordpress.com/2022/09/26/equitable-decarbonization-requires-rate-reform/
James M. Sallee is an Associate Professor in the Department of Agricultural and Resource Economics at UC Berkeley, a Research Associate of the Energy Institute at Haas, and a Faculty Research Fellow of the National Bureau of Economic Research. He is a public economist who studies topics related to energy, the environment and taxation. Much of his work evaluates policies aimed at mitigating greenhouse gas emissions related to the use of automobiles.