What's a Fair Electricity Bill? – Energy Institute Blog - Energy Institute at Haas

What’s a Fair Electricity Bill? - Energy Institute Blog

What’s a Fair Electricity Bill?

Concerns about an income-graduated fixed charge, legislators’ and mine.

Your hot water heater is dying. Should you replace it with one that burns natural gas, or a heat pump that runs on electricity? To figure that out, you need to know the cost of each type of hot water heater, how quickly each could be installed, how well each will provide for your family’s hot water needs and – because you are on board with California’s climate goals – the GHG emissions from using each. But, since you aren’t a top 1%er, you also want to know how much each would cost to operate.

And well you should. For most California households, the price of the kilowatt-hours (kWhs) to run a heat pump hot water heater is so high that operating costs put electricity at a significant cost disadvantage, even though it is far more environmentally friendly. So, with a guilty conscience, you put in a gas unit, and save a boatload of money on your utility bills.

As other EI bloggers and I have discussed previously, the problem is that the electricity price you face – if you are a customer of one of California’s large investor-owned utilities – is many times higher than the actual cost of generating and delivering those kWhs. That’s because we are paying for gargantuan – and rising – fixed costs by increasing the volumetric (per kWh) price of electricity.

Many of these expenditures may be good social policy, but they have no direct link to a customer’s consumption volume: compensating victims of past wildfires, technologies and other investments to prevent future wildfires, incentivizing rooftop solar, providing reduced rates for low income customers, supporting R&D on new low carbon technologies, installing EV charging stations, subsidizing energy efficiency upgrades, and the list goes on. As a result, the price of electricity is now far above social marginal cost (SMC), which is the actual cost imposed on all of society from providing an extra kWh, including the costs from greenhouse gas emissions and other pollution. That induces people to choose natural gas hot water heaters, furnaces, and clothes dryers, as well as gasoline-powered cars, over electric alternatives that are actually less costly to society.

The legislature acts to lower the cost of choosing electric

Last year, the California legislature passed Assembly Bill 205, a sweeping budget bill that, among other things, requires the California Public Utilities Commission (CPUC) to create an income-graduated fixed charge (IGFC) for residential customers of regulated electricity utilities. The IGFC is to be offset by reductions in the volumetric price. The idea was that reducing the volumetric price would encourage electric over natural gas appliances, and EVs over gasoline vehicles. At the same time it would pay for some of those fixed costs through a fee that is larger for wealthier households, rather than the current approach that disproportionately hits low and middle income families.

The bill specified that the new rate structure shall be adopted by July 1, 2024, an incredibly short timeline by regulatory standards. In order to meet the deadline, the CPUC committed to address the mandate as part of an ongoing rulemaking, and since then has been doing studies and accepting comments from all comers (click here and search on Proceeding R2207005) in order to have the information they need to meet the legislature’s demand.

Second thoughts about the Income-graduated Fixed Charge

Then a few weeks ago, 22 members of the California Assembly, all of whom voted for AB 205, sent a letter to the CPUC saying, in effect, we’re not sure this IGFC is such a great idea and you need to slow down the process so that it can be thoroughly vetted. That was echoed soon after in an opinion piece from two state legislators on a Silicon Valley news site. Of course, there are many reasons legislators might vote for such an omnibus bill even if they disagreed with one particular piece of it, though it is less clear why they would wait more than a year to speak out against the IGFC if they found it so problematic.

My own view is that the IGFC is an imperfect approach to reforming California electricity rates. But it is a major improvement over the pure-volumetric approach we are using to collect those revenues today, the great majority of which pay for fixed costs. There is a better solution – which I’ll get back to, but the legislature seems unwilling to pursue.

First, I want to address some of the arguments made by the legislators. (I will paraphrase their arguments for brevity and clarity, but feel free to click through on the links above to read the originals.)

Lowering the price per kilowatt-hour will discourage conservation. Energy efficiency and conservation to reduce environmental damage can be very beneficial, but just like a powerful medicine, too much can be a problem. Our high prices of electricity undermine incentives to get off fossil fuels and reduce emissions by switching to electricity from natural gas and gasoline, such as by installing a heat pump or buying an electric vehicle. That is tying one arm behind the state’s back when it comes to decarbonization.

Those punishingly high prices also discourage valuable and appropriate use of electricity, such as when a low-income family wants to air condition their house to a healthy temperature. And, by the way, as we move to an incredibly clean California grid, what is the point of conserving electricity any more than conserving milk, shoes, medicines or any other valuable goods?

The price of electricity should reflect all the costs it imposes – including environmental damage – but California’s price has gone way beyond that. Our own study based on 2019 data found that residential consumers paid 2 to 3 times the cost of producing each kWh. With the skyrocketing rates since then – largely to pay for past wildfire damage and future grid hardening – the gap is now much greater.

This is a rate increase disguised as a rate redesign. Bills are going up, but not because of IGFCs. Rather, because we are choosing to pay for all sorts of climate costs by sticking them in electricity bills. That is a separate decision from whether those revenues are collected through fixed or volumetric charges. All of the proposals that the CPUC is considering are designed to collect the same amount of revenue as the all-volumetric approach, just getting some of it through a fixed charge. This is not a rate increase.

Nonetheless, some people (my constituents) are going to see higher bills. That’s correct. This redesign is aimed at collecting the same amount of revenue. If some people pay less, that means other people will pay more. Overall, this redesign will lower average bills of people who are low and middle income. On average, it will raise the bills of people who are wealthier. The argument that this is unfair is based on the presumption that the current system is fair, a system that has been shown to result in low-income households paying for a disproportionate share of those fixed costs and public policies. I would respectfully disagree.

This hurts more efficient households who have invested in reducing their electricity usage. True, to a small extent, but the research that I discussed a few months ago shows that about 3/4 or more of the difference between low and high consuming household is explained by three factors unrelated to how efficiently they use power: the number of people in the household, the climate in which it is located, and whether they have installed rooftop solar.

This is geographically inequitable, because the cost of living is much higher in some locations than others, so an income that is adequate in one area is a squeeze in another area. Perhaps, but our state income, sales, and gasoline taxes are the same in expensive Silicon Valley as in lower-cost Butte County. Differentiating this tax based on local cost-of-living would make it the outlier. If legislators really want to pursue that concept, there are a host of other taxes and fees to which they should apply it.

“Hold on. Did Severin just call the IGFC a tax?” Why yes I did. It is an income tax, albeit a fairly clumsy one.

Why do we need another income tax? We don’t.

We just need a way to pay for all of these climate expenses and other public policies so that they don’t fall crushingly on low and middle income families and so that it is affordable to run a heat pump or drive an EV. A much better solution – which would accomplish both of these goals while avoiding the administrative overhead of an IGFC – would be to move those climate and policy costs onto the state budget. That would address both the problem with residential prices and the same issue with commercial and industrial electricity prices, which discourage electrification in those sectors and undermine competitiveness.

State coffers pay for all sorts of climate change (and earthquake and other disaster) preparation and response. But when it gets to regulated utilities, legislators find it much easier to tell the utilities to “pay for it”, which really means to stick it in utility bills and have customers pay for it in a far more regressive manner. The state budget also funds other programs to help the needy with medical care, food security, and housing. But when it comes to energy bills, the legislature again tells utility customers to “pay for it”.

That’s why my first choice for improving California electricity rates is to stop using them to fund climate change mitigation and adaptation, and a host of other state public policies. Instead, cover those added costs through state revenue sources – mostly income taxes, which are far more progressive than utility bills, but partially sales taxes. Sales taxes are regressive, but not nearly as regressive as paying for policies through volumetric electricity prices.

That would be a significant call on the state budget, which some state politicians say is not feasible. It is disappointing that some think it is feasible to continue collecting that money through utility bills that are far more regressive and that undermine our fight against climate change. If legislators are now going to attack IGFCs, it’s time for them to stop shying away from a real solution: paying for climate and social policies through the budget they control.

Keep up with Energy Institute blogs, research, and events on X @energyathaas

Suggested citation: Borenstein, Severin. “What’s a Fair Electricity Bill?” Energy Institute Blog, UC Berkeley, November 13, 2023, https://energyathaas.wordpress.com/2023/11/13/whats-a-fair-electricity-…

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Severin Borenstein View All

Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.