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Monday, September 22, 2014 |  Madison, WI: 69.0° F  A Few Clouds
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Customers shouldn't subsidize bad decisions by the Madison Water Utility
Stop the steep rate hikes
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Seven months ago, I wrote a piece for Isthmus that argued that Wisconsin water utilities are "shirking their responsibilities in order to become cash cows for fiscally strapped municipalities." In a nutshell, the problem is that some water utilities are transferring excessive revenue to the city governments that own them rather than using those funds to replace depreciated infrastructure.

This type of "asset harvesting" can't go on forever. At some point, utilities have to replace depreciated capital, and they will recover these costs through increases in customer rates. This is inefficient and unfair to customers, whose previous payments should have been used to replace infrastructure, not provide a back-door source of tax revenue to municipal governments.

Since I wrote that piece, there have been several developments that show these concerns are playing out here in Madison. For example, a May 16 Isthmus story on Madison's water supply said that, according to the city's water supply manager, "Madison Water Utility prided itself on having the cheapest water in Wisconsin, but that it was accomplished, in part, by not replacing mains when they should have been."

Three months later, the Madison Water Utility announced that it plans to raise its rates by 22%. If this rate hike is approved, MWU prices will have risen by 75% since 2006. The press has reported that much of the proposed rate increase is driven by the water utility's plans to replace water distribution mains, which -- if we believe city water specialists -- should have been replaced years ago.

Capital replacement is clearly putting pressure on the water utility's rates, but the media largely ignored another rapidly increasing MWU cost that is contributing to price increases. This expense is known as payments in lieu of taxes, or PILOT. These are essentially revenues that the water utility transfers to the city of Madison "in lieu of" the taxes it would have paid if it was a privately owned and taxed utility. MWU's proposed 2014 budget includes a PILOT transfer to the city of $5.92 million, all coming from payments for water services by MWU customers. This represents a 150% increase from the $2.36 million PILOT transfer the water utility made to the city in 2002, just over a decade ago.

This is extremely healthy growth in Madison's returns on its equity stake in the Madison Water Utility. If anyone reading this enjoyed similar returns on their mutual fund portfolio, please send me the name of your broker.

MWU's proposed rate increase still has to be approved by the Water Utility Board by the end of the year. The final proposal would then be submitted to the Public Service Commission, which has the final authority for determining whether, and how much, to increase MWU rates.

To its credit, the Water Utility Board is asking hard questions about MWU's proposal. At its September meeting, the board directed the Madison Water Utility to respond to a series of questions challenging the need and magnitude of the proposed rate increase. Those questions have not focused specifically on the "asset harvesting" concern, but this issue also deserves serious attention. Even if MWU's current management is playing catch-up because of bad decisions by MWU in the past, the Water Utility Board should not give its blessing to imprudent asset management practices. The board should acknowledge the errors of the past, not reward them in the present, and take steps to make sure that they don't happen again in the future.

One way to prevent the Madison Water Utility from being rewarded is to make an explicit, downward "penalty" adjustment in the return on equity proposed in MWU's upcoming rate application to the Public Service Commission. This would reduce the overall rate increase, as well as send the right signal to current and future managers that imprudent behavior will not be rewarded or subsidized by customers.

More broadly, the Public Service Commission needs to put tighter controls on allowed PILOT transfers by water utilities. The PSC has established rules for determining the "tax equivalent" rate for municipal utilities, but there is considerable discretion in how this rule is applied by municipalities. In February 2013, the PSC concluded an investigation into payments in lieu of taxes that found municipal water utilities are making PILOT transfers at rates far above the equivalent rates for private utilities. For example, if the Madison Water Utility was taxed in the same way as MGE or Alliant, it would pay 3.19% of its gross receipts as taxes, rather than the roughly 18% of its revenues that are transferred to the city of Madison as payments in lieu of taxes.

Changing the PILOT rules is a complex and politically sensitive subject that can affect nearly every municipality in the state. It is critical, though, for taxpayers to understand what they are actually paying in taxes, not to have part of their tax payments smeared into bills for municipal water services. The current PILOT system appears to be rife with abuse and needs to be reformed.

Larry Kaufmann is an economic consultant based in Madison.

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