The California “Income-Graduated Fixed Charge”
Proposal Is Probably Impossible to Implement.
There are Better Options Available
Jim Lazar April, 2023
Most utilities across the United States have residential rate designs that consist of a Customer Charge, to recover billing and collection costs, and a per-kilowatt-hour rate or rates to recover generation, transmission, and distribution costs. The national average is about a $10/month customer charge, and an average per-kWh rate of about $.13. A little higher in New England, a little lower in the Pacific Northwest and some of the central plains states. Many have inclining block rates rates – the more you use, the more you pay. Some have time-varying rates – higher during peak load times.
California’s PUC does things a little differently. They currently have Customer Charges for the investor-owned utilities of less than $1/month. And they have moved from inclining block rates to time-varying rates. But what is most different is the level of California rates: the highest in the lower-48 states by a lot. The national average electricity rate (to all classes of customers) for 2021 was $.111/kWh; in California the average was $.196, just a hair below Alaska. Since then, California rates have continued to rise faster than most parts of the US, and typical customers of Pacific Gas and Electric now pay over $.30/kWh.
https://www.eia.gov/electricity/state/
The California rates are higher for a variety of reasons, including:
- Higher than average allowed return to shareholders;
- Higher than average allowed executive compensation levels;
- The cost of meeting California’s climate goals;
- Wildfire-related costs born by electric utilities in California;
- Much lower than average use per customer, a legacy of California’s long commitment to energy efficiency and the “million solar roofs” project championed by former Governor Schwarzenegger;
- A very generous low-income electricity bill discount, paid for by other electric consumers;
There are many problems created by very high electricity rates, and one of these is that it makes it unattractive to convert home heating and water heating from natural gas to electricity. With low-carbon resources providing most of California’s electricity, this electrification is one way to reduce California’s carbon emissions.
A leading academic has raised this issue in several forums, and proposed a specific solution which in my opinion is not practical. Severin Borenstein is a professor of economics at UC-Berkeley, and a member of the California Independent System Operator board of governors. He has a substantial following in California and elsewhere. It is with great trepidation that I challenge his proposal.
Dr. Borenstein’s proposal is to establish income-graduated fixed charges in electricity rates. The most extensive detail of this is in a publication available online, Designing Electricity Rates for an Equitable Transition, published in 2021. Many of us in the profession questioned whether he was serious in this proposal – it is a sharp departure from the principle that electricity rates should be based on the cost of providing electricity service.
This concept found its way to the California state legislature, and was enacted, replacing a previous limitation of $10/month for utility fixed charges, in Assembly Bill 205 in the 2022 session. The legislature directed the California Public Utilities Commission to implement this concept, with at least three income tiers. The state utilities submitted a joint proposal on April 7, with the following fixed charges shown in their filed testimony:
If approved, instead of paying for electricity service in proportion to the amount of service used, customers would pay up to $128/month before they use a single kilowatt-hour. In competitive industries, from supermarkets to hardware stores to clothing stores, the costs of the business, its buildings, distribution system, and profits are all built into the price of their products; this proposal would deviate from the principle that the role of the regulator is to enforce on monopolies the pricing discipline that markets impose under competition.
The utilities proposed that the state, not the utilities, would be the lead entity on determining which customers fall into which income category. That is pragmatic – the state has access to income data that the utilities do not. But I’m not sure that the CPUC has the authority to make this commitment.
Fewer than 10% of California income tax returns are for more than 650% of the federal poverty level, subject to the highest rate. But most middle-class and working families will fall into tier 3, with monthly fixed charges rising to $51/month for SCE and PG&E customers, and $73 for SDG&E. The price per kilowatt-hour will drop by about ten cents per kilowatt-hour. While the “average” rate will remain the same, most low-income consumers will pay less, and most middle and upper income consumers will pay more.
I've given a fair amount of thought to the income-based fixed charge concept since Dr. Borenstein launched the concept in his Next10 paper. I think some of his analysis is flawed, but agree that California rates (but not those in most of the rest of the country) are above a proper measurement of even long-run marginal costs, a metric which I think is the correct standard for determining if rates are too high and will discourage economic usage. So, for California, there may be reason to pursue Dr. Borenstein’s concept – but not elsewhere in the U.S. where rates are more consistent with the cost of providing electricity service.
With the California legislature directing the PUC to develop such charges, we're about to find out if this concept is capable of implementation. Having a sound scientific framework is one thing. Having an achievable end product is quite another.
Bottom line: I don't think it is possible. Just a few of the reasons are below:
1) Nobody wants to give their tax return to the power company. Personally, I'd rather give them the video of my hemorrhoid surgery. And, if required, compliance will be low. Do you just charge all recalcitrant households the highest rate as a compliance tool, and give the low-income discount to those who are eligible based on examination of their income?
2) Not every residential account is associated with a "person" who has a discernible income. Many homes are owned by corporations, trusts, estates, and other non-individual entities.
3) Many residential electric accounts are associated with multiple people. Do you just sign up your nine-year-old as the "account holder" and evade the income test that way? Which "resident" or "residents" do you include. My own house has three voters registered here, and each of us file taxes separately. One of them lives in Brisbane, Australia (every American citizen is entitled to have one "voting" address in the U.S.) and contributes nothing to the household budget.
4) Income has no clear correlation to the electric utility cost of service. Poor people in rural areas are relatively expensive to serve; rich people in condos in urbanized areas are cheap to serve. Does the lack of correlation to the cost of utility service make it a "tax" under the laws of California? In California, most new "taxes" require a different process than the PUC runs, including a public vote.
5) How do you handle master-metered apartment buildings or mobile home parks and RV parks? California has many of them, with specific tariffs for some (but not for all). The electric utility does not even know who the “customers” are. What about "residential hotels" which do not even have submeters. Some very rich people live in very nice hotels full-time. And at the other end of the income spectrum, some poor people live in shelters, which are served at commercial rates. If you are a consultant who works from home: can you change your home electric service to a commercial rate and avoid the income-based fixed charge?
6) Many people have more than one residence. These range from a one-week timeshare to multiple mansions. Bill Gates has three homes in California, but his primary residence is near Seattle. I suspect he is NOT the customer-of-record in California (he would not want to be subject to California state income tax -- Washington has none), which is part of what keeps him and Jeff Bezos as Washington residents.
7) Are there other metrics that can be used, which are objectively measurable?
a) A Burbank or Hawaii-style Grid Access Charge (called a “service size charge” in Burbank) is higher for mansions than for apartments, and can be scaled to either the size of the connection (panel size) or measured demand (kVA) does this quite cleanly, but there is not a direct connection between income and panel size or maximum measured demand.
b) A front-footage charge, based on the property frontage on the road with electric service, is cost-based, because the cost of distribution systems is largely a function of distance between customers. Rural customers would pay more than urban, and single-family would pay more than multi-family. Mansions would pay more than rowhouses (or little boxes on the hillside). But the correlation to income may be quite weak...Nancy Pelosi's house has relatively little frontage, and plenty of low-income people live on rural acreage.
c) Annual kWh usage: usage is positively correlated with income. But that correlation is not very strong. The current rates in California recover substantially all distribution costs this way (because they do not even reflect billing and collection costs in Customer Charges, as is the norm for the industry).
8) Many residences in California are housing people who do not file tax returns. Some have too little income. Some have no Social Security account to file under (and mostly work in the cash economy). Some have electricity service billed to the landlord. These are not all poor people: some earn large amounts of money in shadowy ways.
9) How do you handle accessory dwelling units (ADUs) -- sometimes called mother-in-law apartments. These have often been separately metered, both because that puts the utility bill in the hands of the occupant, and because with California's inclining block rates, it was cheaper to have two or three accounts for the same building. But some of these are re-consolidating as the homes install solar, so that the load diversity at the property is available to service with on-site generation, and without inclining block rates, there's little incentive to split up the service. Why should these be treated differently if the power flows through a single-meter versus multiple meters.
10) For rural service, there is often a "well house" which is separately metered. In California, with zero customer charges, that's a big cost savings for the customer, as the utility does the wiring for them. But these can be reconsolidated quite quickly, reducing the number of customers served. My very first exposure to electricity rates was in 1974, when I visited a friend who was living on her grandparent's ranch. Her grandpa put me to work digging a trench to connect the "shop" to the "house" because the local coop had instituted a $10/month "meter charge" and he saw no need to have three meters, so the well house and shop got connected into the house electrical panel. $200 worth of direct-burial cable, plus free labor from a kid who was hot for his granddaughter, provided a payback in a few months.
I could probably go on and on. The basic lesson is that people will find a way to jump under, over, around and through hoops that you put in their way. You need to think through the problem you are trying to solve before designing a solution. It seems to me that the California legislature adopted this (in a hurry) without thinking it through.
One of the Regulatory Assistance Project’s (RAP) mottos is: All regulation is incentive regulation. This concept creates incentives to have your electricity service in the name of someone who is impecuious -- your son, daughter, or perhaps your cat. Even if you have to put down a big security deposit. People will wriggle around it if it goes into effect.
I think this effort will fail. Most likely it will fail because it is ruled to be a tax. It should fail because it's a terrible idea to divorce utility rates from the cost of service to provide efficient and adequate utility service at fair, just, and reasonable rates.
What solutions to the California electricity pricing dilemma will work? There are several, including some identified by Dr. Borenstein in a recent radio program carried by public radio in California.
First, the CPUC needs to address the revenue requirement for the California utilities.
- Rate of Return: These utilities receive a higher allowed rate of profit, consisting of a higher allowed equity return and a higher equity capitalization ratio than most utilities in the US and Canada.
- Executive Compensation: Utility executives receive millions of dollars per year in compensation; in the case of the CEOs, it can go to tens of millions of dollars per year. Anything above the Governor’s salary should be the responsibility of shareholders, not ratepayers.
- Stranded Investments: Each company has funds invested in assets that no longer are economic. In many states, these are transferred to a status where the interest and principal payments are covered by ratepayers, but the shareholder profit ends. California can learn from other states.
Second, some of the high costs in California should probably be treated as state (or even national) taxpayer costs, not recovered exclusively from the ratepayers of these utilities.
- Wildfire mitigation costs: California utilities are paying costs for wildfire mitigation, while other utilities nationally do not bear these types of costs. These could be borne by the state out of taxes (rather than try to turn the electricity bill into a form of income tax).
- Low-income assistance: California has the most generous low-income electricity discount of any state. Nearly 30% of consumers receive a 35% discount. This is a welfare cost, not a utility cost of service, and should be paid by the state. And a uniform program should then be extended to customers of other utilities, such as the twenty municipal utilities that serve a quarter of the state.
- Excess costs of early solar and wind contracts: California utilities were among the first to contract for wind and solar resources, when these were very expensive. Some of those costs linger on. But the entire world has been the beneficiary of California’s early commitment: today new wind and solar enters service with total costs that are lower than the fuel costs alone for coal, oil, and natural gas powerplant. The entire world is benefiting – and perhaps should share in the pioneering costs that made this possible.
If these three cost items were removed from the electric utility revenue requirement, the price per kWh for customers could be reduced by about the same amount as if the income-graduated fixed charges were imposed. The same problem can be solved, in a much less intrusive manner.
And, unlike the income-graduated fixed charges, I think this alternative, of reducing the utility revenue requirement, and transferring social costs to general government, can actually work. That should be the goal. The CPUC is barking up the wrong tree.
Jim Lazar is an economist who worked a 44-year career in electric utility regulation and pricing, serving as an expert witness on electricity rate design in more than one hundred regulatory dockets. He is retired from the Regulatory Assistance Project, a global non-profit that assists electricity policy makers with the clean energy transition. He authored several books on the electricity industry, including Electricity Regulation in the US: A Guide, and Smart Rate Design for a Smart Future. Jim resides in Olympia, Washington.