The Theory of Water and Utility Pricing - Global Drinking Water Management and Conservation - page 86

municipalities on a cost-recovery basis. OCWA operates 450 facilities in the
province, making it one of the largest operators of water and wastewater facilities in
Canada (OCWA 2011 ).

5.5.3 Ramsey Pricing and Equity Issues

The theoretical discussion has been hitherto con ned to achieving productive

ef ciency. The theoretical foundation of the above discussion is based on Ramsey

pricing. Yet, the Ramsey model can incorporate not only ef ciency considerations

but also equity issues. In fact, Frank Ramsey presented his result as a theorem on
taxation rather than pricing. The Ramsey optimum tax rule, that is, the percentage
reduction in quantity demanded of each commodity be the same, was interpreted by
Kahn ( 1970 ) as the inverse elasticity rule. The inverse elasticity rule states that the
optimum tax rates and price elasticities of demand should be inversely related.
The Ramsey differential between price and marginal cost can be interpreted as an
Optimal Commodity Tax. While for ef

ciency the optimal tax is determined by the
inverse elasticity rule, there is no a priori reason why that tax should be the same
for all income classes. Indeed, distributional considerations can be introduced
depending on the “ inequality averseness ” of a particular country. The optimal tax
literature shows that differentiated commodity taxes can be used to supplement
income taxes as a redistributive tool (Atkinson and Stiglitz 1976 ). Wiegard ( 1980 )
shows that for an economy, uniform commodity taxes are optimal only if ef ciency

is the sole concern. On the other hand, once equity is introduced, the optimal taxes
change drastically. These economists also demonstrate that taxes on basic neces-
sities (such as food, electricity and housing) decrease and may even become neg-
ative. Of course water is a necessity and many nations have also accepted access to
water as a human right. 1 The optimal commodity tax would depend on inequality
averseness and so should not fall on necessities. In fact taxes on necessities could
even be negative, whereas taxes on luxury goods such as restaurant meals, gasoline,
communication goods, and personal equipment could rise.
Thus distributional considerations do not rule out a

flat rate charge for water up
to some threshold followed by a steeply rising price schedule. When taking dis-
tributional concerns into consideration, this could in fact override the inverse
elasticity rule, under which industrial users pay a lower Ramsey price for water than
residential users. But the actual post distributional taxes could introduce a much
differentiated price structure for water. For example, water prices for low-cost
housing units could be set below MC up to some threshold determined by health
considerations.

1 On 28 July 2010, through Resolution 64/292, the United Nations General Assembly explicitly
recognized the human right to water and sanitation and acknowledged that clean drinking water
and sanitation are essential to the realization of all human rights.