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Opinion: Steering Clear of the 2 Percent Trap for Water Utilities

Apr 22, 2015

Property taxes may be capped, but water utilities must wrestle with far more complex variables day to day and year to year

In 2010, New Jersey adopted restrictions on local government budgets, limiting annual increases in overall property taxes to an average of two percent per year (with certain exceptions). Recent articles and press releases have pronounced this limitation a success, protecting taxpayers from continuing large increases in property taxes.

Now there are proposals to extend this two percent concept to other entities, specifically regional sewerage authorities.

Senate bill S-72 and the Assembly version, A-3782, are notable in their brevity, being less than two pages long. They would establish limitations on sewer charges and require approval by the state of each annual budget. The major issues lie with the cap. The legislation as written would set back efforts to restore and upgrade the integrity of our utilities.

Let’s look at the legislation, which is in two major parts.

First, the bill states: The percentage of growth in the fee-funded appropriations in the annual budget of a regional sewerage authority shall not exceed two percent per year… Assuming this concept is acceptable for local governments (which I won’t discuss here), why is it a problem for regional sewerage authorities?

Local governments have many functions.

Municipalities especially are multipurpose governments that provide public safety and health, public works, development review, solid-waste collection, libraries, senior citizen services, among others. A 2 percent cap forces decisions regarding the relative priorities among all the services. Making choices is a fundamental role of local governing bodies and forcing such decisions is appropriate.

Regional sewerage authorities only have one function.

They are required by law to operate sewerage facilities, which may include collection systems, pumping stations, treatment plants, and more. Critically, they have no choice but to accept the sewage from their customers, which varies from year to year, month to month, and hour to hour. The facilities must avoid discharges of untreated sewage into the waters of the state, and achieve all discharge-permit requirements for the treated effluent.

To accomplish this, the utilities must properly maintain and operate their systems, which periodically requires major capital expenditures. They usually bond for these large projects, which requires a guarantee to bondholders that the bonds will be repaid by revenues.

Regional sewerage utilities do not have the option of choosing between functions. Their total annual costs vary with sewage flows, energy costs, emergency repairs, materials costs, bond repayments, and other factors. While sewerage (and water supply) utilities certainly will try to avoid rapid changes in rates, up or down, they are often subject to outside forces on their budgets.

In addition, the legislation has no method for differentiating among types of sewerage authorities. Some regional sewerage authorities operate a sewage treatment plant to which a large pipeline delivers flows from their service areas. Others own local collection systems but not a treatment plant, while some own both. Each is subject to different budgeting pressures; collection systems have low energy costs while treatment plants are major energy users with many moving parts.

Utilities also may be in very different positions regarding the integrity of their physical assets. Some are relatively new systems with sound collection lines and treatment plants. Others have collection systems built over one hundred years ago. Some have engaged in extensive asset-management programs to keep their systems in good shape, while others have not. There is no provision in the bill for capital expenditure needs that will be required to keep systems from failing.

And yet, under the federal Water Resources Reform and Development Act of 2014, sewerage utilities receiving financial support through the NJ Environmental Infrastructure Financing Program must have financial sustainability plans that include asset-management components. The proposed state legislation and the new federal law appear to be in direct conflict.

Finally, the only exception allowed is for costs due to a declared emergency (such as Hurricanes Irene and Sandy). The cap for property taxes includes numerous exceptions such as health care, pensions, and debt service. As written, regional sewerage utilities would be treated far more harshly than local governments, despite having less operational flexibility.

There is a second major concern. The proposed legislation goes on to state: …and the amount billed to customers of the authority, or the amount billed to a local unit for its proportional share of the authority’s expenses, as the case may be, shall not exceed that amount billed in the previous budget year to each customer or local unit, as the case may be, by more than two percent.

This provision is simply unworkable regarding individual customers, and is problematic regarding municipal (local-unit) shares. Many sewer utilities charge large customers by flow, and some have flow-based charges for residential and commercial customers. What if a major customer increases their flows by 25 percent from one year to the next? It appears that its charge would be limited to a 2 percent increase. Even if the bill focused on the per-gallon rate, utility expenses can shift significantly from year to year, such as for energy costs or new bonding.

Municipalities do not control the flows from their customers to the regional sewerage authority, but are often billed based on the proportional municipal share of total authority costs based on flow. Again, the proposal legislation appears to restrict increases to two percent of the prior annual bill. Let’s play out a scenario. Year one is a drought year (but not a declared emergency), and flows to the regional sewerage authority drop significantly due to water conservation. Authority costs dropped five percent because treatment costs were reduced due to the low flows.

Year two has ample rainfall and sewage flows increase to normal levels, but customer and municipal charges are limited to a two percent increase, regardless of how much their flows had dropped the first year or increased in the second year.

In sum, the 2 percent cap is a trap that will drive utilities to reduce their expenditures even when costs really should rise to address critical needs for capital expenditures. Utilities could be forced to run to failure instead of operating for sustainable success. And yet, these utilities are subject to state and federal requirements that can result in large fines for such failures. The proposed bill does not address these concerns. Regional sewerage authorities will be fined if they do and slammed if they don’t. The same issues would apply to other water utilities if similar caps are proposed.

What, then, is the more responsible answer? It requires embracing reality and complexity -- each utility is different. Utilities should engage in strategic asset management that will provide direction on how to maintain the integrity of their systems. Their efforts should minimize lifecycle costs -- not just today’s rates but over the full life of the asset and utility. Capital, energy, maintenance, and operational costs can be right-sized through this process. As the New Jersey Clean Water Council recognized in its 2010 recommendations on this issue, there is no one size fits all metric, but it is possible for every utility -- wastewater and water supply -- to use the process of asset management to optimize system performance and costs. Utilities are different than governments. A blunt two percent cap will bring system failures, not success. Utilities serve us, but we should remember: If you kick the servant, you get bad service.

Daniel J. Van Abs is currently associate research professor for Water, Society and Environment at the Rutgers School of Environmental and Biological Sciences. He has spent more than 30 years as a professional, manager, and advocate in the fields of water resources, watershed and regional environmental management. The views expressed in this essay are solely those of the author.


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