Mythbusters: full cost recovery through tariffs

Published on: 15/10/2016

The problem with the concept of 'full cost recovery' is not so much with the idea that all the costs of a service need to be paid for. In fact, all costs need to be covered, for a service to be sustainable. The problem lies in the fact that the concept generally is understood to mean that all the costs need to be covered through tariffs. And it is myth that this is possible, or feasible. And through the data that becomes available through the new monitoring systems that myth gets busted.

Tariffs

I dived into one of those monitoring systems: SIASAR (the rural water and sanitation information system, that is now being applied in several Latin American countries), and specifically into its database for the country that I know best, Honduras. That database now contains data of some 3200 water committees (which is estimated to be about half of all water committees in the country). Amongst the wealth of data from these water committees, is data on the average tariff that are being levied. I made a table of the spread of these tariffs, and converted these to US$ at current exchange rates.

Table 1: Tariff levels of water committees in Honduras (Source: SIASAR database)

Operation and minor maintenance costs

These data show that although most water committees do levy a tariff, almost half of them have a very low tariff of less than 1 US$/family/month. Very few water committees have tariffs of more than 2 US$/family/month. But the key question is whether these tariffs are enough for 'full cost recovery'. Answering that question fully would require an analysis of the expenditure of every single water committee, as operation and maintenance costs differ from one system to another, and depend on factors such as the number of water users, the type of system (pump-based or gravity-fed), etc. But studies have indicated that for operation and minor maintenance (so paying a scheme attendant, chlorination, repairing leakages, etc) a tariff of about 2,5 US$/family/month would be adequate in most cases. This means that the vast majority of water committees have too low tariffs to even cover the basic operation and maintenance. And as result, committees simply don't spend enough on that, so they are not purchasing chlorine, or not paying a remuneration to a scheme attendant.

It is also important to look at the differences between water committees. When digging deeper into the SIASAR database it becomes clear that the more formalised committees (e.g. the ones that are legally established) have higher tariffs than those that are not. Also, the tariffs are generally higher in the bigger communities – maybe because community members in smaller systems tend to do more unpaid labour work on their water systems, rather than paying an operator for it? So the bigger and more established water committees can definitely have tariffs that cover all of their operation and maintenance costs.

Savings for replacement costs

Analysing the extent to which the tariffs are adequate to cover future replacement costs is a bit more tricky. Ideally one would need to do a multi-annual assessment of savings and expected major maintenance and replacement works. Such multi-annual financial data is unfortunately not available in SIASAR. So, I took another more approximate indicator from SIASAR, i.e. the amount of savings of the water committee, divided by the number of users. The resulting amount represents an equivalent of savings per family, which the committee could use for replacement works. The results are below:

Table 2: Savings of water committees in Honduras, expressed as the saving per water using family (Source: SIASAR database)

As can be seen, 22% of the water committees don't have any savings at all, either because they don't have a bank account, or the account is empty. And another 26% of water committees have negligible savings of less than 5 US$/family. But, we need to know whether these savings are enough to cover the full costs of future replacements. From earlier studies we know that major replacements on the gravity-fed piped schemes in Honduras are around 100 US$/person (or 500 US$/family). The data in the table above imply that only about a quarter of the water committees currently have more than 5% of the average replacement costs of a water system in savings. Of course, not all these water systems have to do replacements now - some may still have a few years of savings to go before being faced with such costs. Moreover, replacement works do not always come in such bulky amounts. But even when that is taken into account, still the vast majority of water committees would never get to savings of 500 US$/family that in theory would be required for the full replacement of the infrastructure assets. Myth busted.

The data thus show that current tariffs and savings of water committees are in most communities below what is needed for full cost recovery. But could these be raised towards full cost recovery levels? Can communities climb the tariff ladder? If we look at operation and minor maintenance, it seems that the gap between what is currently paid and what is needed for a minimal level of operation and maintenance is not too big, really a matter of increasing current tariffs by 1-2 US$/family/month. That should be feasible and affordable to users. However, bringing tariffs up to a level where significant savings can be done for future replacement costs will be a huge step. Further work would be needed into the affordability of such steps. But one could even question the feasibility of a water committee having savings that are equivalent to 500 US$ per user, sitting in a bank account for periods of up to twenty years (the average life-span of gravity-fed piped systems). 

These data show that reaching full cost recovery through tariffs is a myth. Operation and minor maintenance could and should be covered through tariffs. But current tariff and saving levels are miles away from being sufficient for full replacement costs. This doesn't mean that costs should simply not be covered; rather it means the shortfall between tariffs and the full costs need to be paid for from somewhere else: the public sector. We need to move therefore from the myth of 'full cost recovery through tariffs' to the necessity of 'full cost recovery through tariffs and taxes'.