The High Cost of Cheap Water

If residential water prices rose by half a penny, consumption would drop by 41%

The heat wave in Stanford, California has focused my mind on the riddle of cheap water prices. After posting an essay in August about the bizarrely low price for local tap water of $0.007 per gallon, I learned that is actually far higher than what is being charged by other municipalities out West. The top residential price for a gallon of tap water in Las Vegas is half a penny. Bakersfield, CA, charges a top rate of one-third a penny. What gives?

Photo by MI PHAM on Unsplash

Yes, I know that residential consumption in many states like California is a tiny fraction (actually around 1/4) of agricultural consumption. But the same principle holds: artificially cheap water leads directly to excess consumption of a scarce resource. The farming industry would have to charge higher prices for its corn and soybeans, almonds and lettuce, berries and cattle, if it paid market prices for its water. So? America has to pay one way or the other, and there are much better and genuinely conservative ways to help the poor than wasting water.

It’s common for utilities to use pricing tiers for residential customers, as a way to make sure poorer families get the first block of 5000 gallons of H2O per month at the cheapest price. The Las Vegas Water district charges a fixed price of $12 per month plus 0.14 cents per gallon for the first 5000 gallons used by a single family residence. The next 5000 gallons are 0.25 cents per gallon (i.e., 1/4 of a penny). You might expect the top tier for water usage above 20,000 gallons per month would be high. Nope. It’s only 0.55 cents per gallon, or just over half a penny. The North Las Vegas utility also uses a four-tier approach, with its highest tier charging 0.48 cents for every gallon above 24,000 per month.

Elasticity is the Key

Critics will argue that water usage wouldn’t change if prices were higher. “Water is a human right, you monster, a basic human necessity. The city could charge a thousand dollars per gallon, and people would pay it because the alternative is death. You monster.” Back in the real world, that’s not how consumption works when we’re talking about a thousand gallons per day. But let’s set aside the monster talk, and think like economists. When somebody says demand is fixed, that translates into econ-speak as a question of elasticity. As the brilliant David Henderson explains:

The elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. The greater the absolute value of this ratio, the greater is the elasticity of demand.

So what is the elasticity of water?

We might think this is something the great policy wizards in our capitals know with certainty. We would be wrong. I’ve found more than a few academic papers saying that there’s just no certainty about water’s price elasticity because most utilities have been using semi-fixed prices for what was historically a semi-free natural supply. Plus, there’s the notion of water as a common good for all to share. And no, the powers in charge don’t want to hear about the Tragedy of the Commons. They plug their ears and say critics are monsters. Even those of us who want to save the planet. Turns out, there are some good estimates of H2O elasticity. Think of these as the lowest potential elasticity, given the constraints.

A meta-analysis of dozens of such studies was written by Jasper Dalhuisen and some colleagues in 2003, which found that residential water demand was sensitive to price. I copied their main figure below, which shows “The distribution of price elasticities has a sample mean of -.41 and a median of -.35.” In other words, if the price of residential water was raised by 100 percent (from a half penny to a full penny per gallon), then consumption would drop by somewhere around 41 to 35 percent.

I dug further, and found myself sympathetic for local pols trying to do right on this issue. The courts actually hobbled California’s effort to use higher and tiered pricing for its water back in 2015. It was illegal for local governments to charge more for any good or service than its cost, they ruled. Okay, that makes sense. But it begs the question: Why is the wholesale price of water so low in the first place?

The Federal government, of course, has been subsidizing water consumption at outrageous levels for just about ever. In fact, Chris Edwards at CATO published a great research report on exactly this problem:

The Bureau of Reclamation's original function of building major water infrastructure in the West has been largely completed. Today, its main function is being the largest wholesaler of water in the nation. It diverts a vast amount of water from rivers, and delivers it to farmers, industries, and cities. Interestingly, about one-quarter of the water it diverts from rivers is lost through spills and transportation even before it reaches any customers. … Governments have kept prices artificially low for so long that it has encouraged water waste and water usage in low-value activities. The Bureau of Reclamation charges users only a fraction of the full costs of water …

When will this madness end? The federal government is killing the Colorado River, in a relentless tenth-of-a-penny-per-gallon flood that nobody can stop.