Increasing Block Tariffs in the Water Sector – An Interpretation in Terms of Social Preferences

Abstract

Abstract Many developing countries around the world apply progressive water tariffs, often structured in the form of discretely increasing block tariffs (IBTs). These tariffs have been criticized in the welfare economic literature due to their perceived inefficiency: many of the prices charged under IBTs do not correspond to marginal costs and thus violate the principle of allocative efficiency. In this paper we explore an alternative interpretation of the widespread use of IBTs, in terms of social preferences and fairness considerations. For this, we rely on an extension of the Fehr, E., and K. Schmidt (1999. “A Theory of Fairness, Competition, and Cooperation.” Quarterly Journal of Economics 114: 817–868.) utility function, including inequality aversion, to which we add another parameter representing a reference for redistribution which reflects a societal preference to correct for income difference perceived as unfair. Additionally, the model includes a variable on household size, finding that, as poor households are on average larger, a simple IBT tariff disregarding household size may not be “fair”.