Income-based pricing is a bad idea

I learned, via GS, that some Berkeley researchers have proposed [pdf] that  customers should pay for electricity based on their income.

Thus, I would pay half of what you would pay if I made half the income you did.

This is a terrible idea, IMO, but I can see how we got here, which I explain in two phases: charges related to costs (points 1-3) and charging rich people more (points 4-7):

  1. Utilities have fixed and variable costs and they recover those costs by charging customers fixed and variable prices.
  2. Utilities that are trying to green themselves and/or accomplish social goals need to make additional capital investments (transitional costs) that need to be financed by today’s customers on behalf of tomorrow’s citizens — some of which are customers but most of whom are stakeholders.
  3. In a “neutral” scenario, costs and prices are matched, i.e., fixed charges (via prices to customers) cover fixed costs. In a “conservation” scenario, variable charges are raised above variable costs and fixed charges lowered below fixed costs, to encourage people to use less electricity or water or whatever. One side effect of this scenario is that those who use more pay more. Another is financial instability (a change in use results in different changes in costs and revenues). I discuss these issues in my paper on pricing water.
  4. Payment for utility services, like payment for ice cream or gasoline or a mobile phone, are meant to reflect the seller’s costs and the buyer’s willingness to pay (demand for that good) — not their ability to pay (income available for all goods).
  5. But lots of utilities are regulated to achieve social goals that have nothing to do with normal pricing. That’s why there are sometimes “social tariffs” (=cheaper prices) for poorer people, which requires subsidies of some sort.
  6. Social tariffs doesn’t work very well in practice (see pp 131-133 of my paper), since it requires a lot of extra information, doesn’t match reality (people lie; bureaucrats mess up), and distorts behavior and choices. It’s better to help poor people by giving them money and leave prices alone. If there’s a need to bring more money into the system, then change the mix of tariffs, taxes and transfers that pay for costs, i.e., “neutral prices” to cover operating utility costs (tariffs) and transfers from the state government to cover transitional costs. Those transfers can come out of state income tax revenues that already exist, are easier to change, put the burden on people with more income, and do not distort prices/decisions.
  7. Utilities should not charge income taxes, and neither should any business or branch of government providing goods and services. Keep willingness to pay separate from ability to pay. (There’s a legitimate problem risk of a slippery slope here, i.e., setting prices for goods and services based on income, which is a total information nightmare even before considering that richer people will leave to a place with “fair” pricing.)

My one-handed conclusion is that the Berkeley researchers are excluding state income taxes because they need a local solution, but this one (a) has terrible optics, (b) won’t work very well, and (c) dodges the big question of how much extra the rich will need to pay to subsidize the poor in a sustainability transition.

NB: Criterion (c) also applies to the global fossil fuel transition, which is not going well. Only a fraction of the $trillions per year that are needed is getting paid.

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Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

4 thoughts on “Income-based pricing is a bad idea”

  1. Tinbergen pointed out that you need a tool for each objective. Trying to fix income inequality and incentivise energy efficiency with one tool is stupid.

  2. Dave Barnes writes:

    Well, more than one European country bases traffic tickets’ costs on the scofflaw’s income.

    1. Yes, I’ve heard, but fines (=a way to encourage obeying the law) are not the same as the price of water… or potatoes 🙂

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