Can we afford a NO vote on January 13?

So it looks like the new strategy for the "yes" side in the water rate election will be to argue that we have to adopt the policy now on the table, despite its flaws, because there is no time to come up with something better. The DEQ is losing patience and might start fining us $15,000 per day; delaying a capital project runs the risk of incurring higher costs when we get around to building (the City is tossing around a figure of $150,000 per month). The argument, then, is that it is better to have a flawed policy today than a better policy in a couple of months.

I think this argument is unpersuasive, for a couple of reasons: (1) the water rate election is the one place regular citizens have to break into the business-developer/City Staff/elected official echo-chamber that leads to ridiculous policies and accomplishing that would be well worth any of the short run costs being suggested; (2) the threatened costs of delay are being overstated. Before I lay out these arguments, however, let me make some observations about how we got into this predicament.

Things started to 'heat up' on water issues in early September 2014. The City Council Finance Committee had a meeting in the 11th and the minutes suggest that this is the first time the issue was seriously before City Council, at least.* Not long after that meeting - by end of September - people like myself were pointing out that the rate structure and connection fees treat current water customers and new development in an inconsistent way and that this inequity was a deal-breaker for many. The City offered, as a concession, a promise to review connection fees later. Without any commitment to the principle that the fee should cover costs, however, a mere review was inadequate. After that, the City tried to ignore the issue, insisting that new development would "pay its fair share" but not explaining what they mean by "fair share." This water policy proposal is in trouble because the City will not seriously address the serious issues of fairness and the bias toward new development in City planning.

Norman is one of very few cities in the country where citizens vote on their own water rates (it may be the only one). Bob Thompson, member of Norman's recent Charter Review Commission, addressed the issue rather clearly: “Member Thompson ... said there has always been a philosophical division between growth and no growth [sic] in Norman and there is always controversy about the strength of the pro-business, pro-development community and this is one of their issues. ... He said [the Charter provision] serves to limit the ambition of one side of the community versus the other” (Minutes 6/6/13 p. 4 of 5; p. 47 of The Charter review Commission Report).**

The value of the Charter provision is that it helps check ‘insider’ business/development community influence on both the City Council and City staff.  I admit that this Charter provision is an unwieldy tool for that purpose - in a perfect world, there would be a better way to achieve the relevant oversight. As anyone who has been to a City Council meeting knows, however, we do not live in a perfect world and so need to use the tools available. In particular, we should be glad we weren't induced to give away a powerful tool this summer and we should be willing to use it now that the time is ripe.

As I noted in my last blog post, the issue of new development paying its own way is coming to a head over the next year. Without some serious political noise, the path is clear: the City will 'study' both the water connection fee and the Wastewater Excise Tax; the 'study' will 'discover' that new development in Norman pays more than it does in other localities.*** Once City Council has these numbers in hand - from a 'neutral third party' no less! - it will forget about the idea of covering costs and the business community will make sure development fees and taxes never cover costs. If the principle that new development should cover its own costs has any constituency, this is the time for it to stand up for that principle by voting NO on new water rates until new development pays its fair share.

Can Norman afford a NO vote? Yes! Even if worst comes to worst and the DEQ fines us, that will just make the political impasse shorter: the development community could not stand the moritorium on new projects that would need to follow. There is reason to believe that the DEQ won't fine Norman right away, however, if it gets serious about adopting a water policy that passes muster with Norman's citizens. Something as simple as charging new development full price for water connections would probably suffice; more conservation - maybe make the summer surcharge part of the top-tier year round - would clinch it.

What about the threatened $150,000 per month 'cost of delay'? Well, that number is bogus. Its original source was Anthony Francisco at the the Finance Committee Meeting on Sept. 11, 2014: "I want to remind everyone of the time value of money. If you assume a conservative inflation rate of 4% per year for construction costs, the cost of delay is over $150,000 per month to build a $50 million project" (Finance Committee Minutes, September 11, 2014, p. 4)

This assertion doesn't really make sense. The bit about "the time value of money" involves *interest* rather than *inflation.* Interest rates are the cost of money. If you borrowed $50 million at 3.6% per annum and you had to delay payment a month, you would owe an extra $150,000. This however, isn't relevant to Norman's situation at all: we will borrow the money (sell the bonds) after a proposal passes, so there will be no delay in repayment however the January vote turns out. There will be nothing to repay until the money is borrowed.

Perhaps Francisco was really talking about inflation .... The assertion still doesn't make sense. First, while 4%, or even 3.6%, is a reasonable interest rate, it is way too large for an inflation rate. The current inflation rate (latest CPI data - 11/14) is 1.3%. The construction specific inflation indices I have seen have the current rates at or below twice the general CPI rate - the main cluster seems to be 2.1-2.3% (e.g., the construction components of the Producer Price Index). At 2.4% Construction Cost Inflation, a $50 million project would cost an extra $100,000 per month, on average.

More importantly, construction cost inflation projections are not certainties; rather, they are expectations based on the outcomes af a wide variety of market transactions. Construction costs do not increase at a smooth, predictable rate; rather, different markets and different commodities change prices in fits and starts. Construction cost inflation estimates are really about the central tendency of price risks. Likewise, as the City has taken great pains to point out, the $50 million dollar budget for water projects is not a 'point estimate' either. The city has made it clear that the $50 million budget is safe and conservative - it contains enough of a 'safety margin' that the City doesn't have to go back to borrowers or citizens if costs come in a little high. (E.g., there is probably some money to cover construction delays due to weather built into the budget.) The combination of these two facts strongly implies that a few months of delay will not cause the City to increase the budget (and so not cause more bond sales or higher rates). At this size of a budget, a few hundred thousand dollars is (or at least should be) within the margin of budgeting error.

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* Interesting historical fact: the minutes from this meeting say that an extra 2 MGD in water capacity would cost $14 million. At this original City estimate of well costs, each new 3/4" connection would cost $1,785.

** The part of the Charter Commission Report that deals with citizen elections on utilities is a fascinating read because it exemplies the degree of business/new development bias the vote is supposed to ameliorate. For example, consider the following claim: “Member Dillingham ... said Norman cannot play in a regional economy unless we remove this Charter provision. Member Bates agreed and said part of that atmosphere is a result of politicizing basic services and basically holding a sword over the heads of government in their ability to do their job” (Minutes 5/2/13 pp. 4-5 of 5; pp. 42-3 of Charter Review Commission Report). This is as close as anyone besides Bob Thompson gets to the real issue at hand. What it misses, of course, is that basic services have already been politicized - utilities are hugely impacted by issues of sprawl and environmental impacts. Your view about what constitutes a healthy and vital community is largely driven by your views about local development; your views about development largely drive your views about whether to allow, and how to pay for, increased demands on City services. We know precisely what Member Bates thinks the “job” of government is - he made it very clear when he was the President of the Chamber of Commerce (e.g., http://www.normantranscript.com/headlines/x1916528321/Open-for-business).  “[H]olding a sword over the heads of government” with regard to the new-development/Chamber-of-Commerce agenda is precisely the value of this Charter provision. We should not want to “play in a regional economy” if the game is subsidizing business.

*** True enough, by the way - other cities in Oklahoma are worse about subsidizing new development than Norman.

The developer subsidy still matters ....

Basic economic theory shows how subsidies distort markets*: if someone else is paying for (part of) my purchases, I will buy more; if someone is paying for (part of) my purchases of some goods and not others, I will buy more of the former rather than the latter. Economists call these income and substitution effects, respectively. What do these economic insights tell us about the water capacity subsidy the City hopes to finish setting up in the water rate election?

I will start with the income effect. New housing (like almost every other economic good) isn’t the sort of thing we should try to maximize: the marginal benefits start to go down and the marginal costs start to go up at some point. If costs are reflected in prices, markets would lead people to economize on their consumption of new housing just when it starts to get costly. Subsidies will lead people to blow past the sensible limit on new housing. In practice, this means more new housing and more resource use - air, water, land - than is warranted by actual market demand. The fact that we are reaching the limits of our sewage, water, and stormwater systems suggests that we are actually at this point.

The substitution effect is equally important. Low water capacity prices for new development compared with everyone else creates a cost advantage for new housing (and commercial space) over old housing (and commercial space). Existing home and commercial-space owners are at a disadvantage when they have to pay (at least) full price for new water capacity and new development pays a cut rate. There is a fairness issue here, of course, but also a housing mix issue. As a matter of contingent fact, new development in Norman tends to be suburban, which tends to be the costliest development for the City in terms of resource use. Subsidizing new development, then, is a matter of encouraging them most resource intensive development, leading us to overconsume even more than the income effect might suggest.

One might think that the distortion created by a 40% discount on water capacity might not be so large as to have a big effect in the grand scheme of things. There is some truth to that - the total water capacity subsidy will be something like $1.2 million over the next two and a half years, roughly. That is real money, of course, but not a big percentage of the total costs and benefits we are talking about here. What matters here, however, is the principle.

Because of the threat of DEQ fines, etc., our water issues will get paid for, even if nothing else does. (The City can use general funds to prop up utilities if need be.) If the voters reject this rate increase on the grounds of fairness, we will get a more fair rate increase next time, albeit at a high price in terms of City government chaos. (Perhaps the City should be figuring out a contingency plan so we can make an informed decision here ....) What we won't have another crack at, however, is an opportunity to fix Norman's complicated sprawl/center-city/environment/development issues. The City has shown that it is incapable of keeping all of the relevant features of this planning problem on the table at one time (for each Center City Visioning process, we approve a Wal-Mart to undermine it). The only mechanism that citizens have to 'cry foul' with any real voice is a water rate election. In fact, the whole point of having citizens vote on water rates is to give them a lever to influence development policy - it isn't an elegant system, but we can make it effective.

Fixing the relationship between the development community and the citizenry is crucial NOW. As we saw at the City Council Meeting, some people are starting to question the basic principle that development should pay it's own way. It has even been suggested by some Councilmembers that we should be reconsidering our (currently inadequate) Wastewater Excise Tax (WWET). As underfunded as it is, the WWET is the 'crown jewel' of past policies to hold new development responsible for the costs it imposes on our community. There seems to be sentiment on Council to 'study it down', which would be going in the wrong direction. The water-connection fee is a small issue compared to that, but now is the time to take a stand, while we have some leverage.

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* Market distortions are not always bad. We might, for example, want to get people to switch from free-market levels of heroin consumption toward more methadone consumption.

The developer subsidy matters ....

It is clear that the City of Norman is, and hopes to continue, subsidizing water capacity for new development (12/12 post). This is a big deal for a pair of (interrelated) reasons: fairness and market distortion. I'll focus on the fairness issue here and handle the market distortion issue in a later post.

At its most basic, fairness requires that a government either treat citizens equally or explicitly justify any asymmetric treatment.* Norman's new water capacity policy fails this fundamental test: the City's water-capacity policy is to subsidize one part of the community; the City has consistently denied that it is doing so, much less provided a rationale.

Having made this initial point, I will not try to canvass all of the possible arguments someone might make to justify special treatment for new development. It is worth noting, however, a couple of points on why such arguments are difficult to make.

1) Plausible candidates for justifying differential treatment (e.g., providing aid to the needy) respect the basic idea of equal treatment because they try to support equal dignity and respect for all.** These sorts of justifications support the advantaged lifting up the downtrodden, however, not subsidies for the already well-to-do. Differential treatment can't be justified by aristocratic or (especially) plutocratic principles. "I deserve more because I am better" is directly opposed to the basic idea of equal treatment before the law (especially where better = richer).

2) The fact that developers do good for the community does not justify subsidies. Developers are in business and so work on an exchange basis: they do what they do - including providing community benefits - only so far as they see the money they are paid as sufficient. If a government wants more, of course, it can contract for more on a fee-for-service basis. Having different sets of rules for different groups is not necessary, then, to achieve the goods new development has to offer. In fact, subsidies and other special deals can distort the market, reducing or even eliminating any net benefit of development. More on this last point later.

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* Fairness is a contested notion, at least around the edges. It is also a notion that is likely to lead a philosopher astray into irrelevant details, so I will try to keep it simple. I am trying to work here from common ground rather than controversial assumptions.

** Mere consistent application of a set of rules may not respect equality in this way.  Consider the famous Anatole France quote: "In its majestic equality, the law forbids rich and poor alike to sleep under bridges, beg in the streets and steal loaves of bread."

Magic numbers from the City .... or not

I had planned to write a post dedicated to fairness next, but I just came across some new information that citizens need to know.

The City of Norman has evidently discovered a new super-well technology! In a flyer that is soon to appear on your doorstep, the City now claims that it can supply “up to 2 million gallons per day” of well capacity for $9 million dollars by drilling only “5 to 7 new wells”:

(Fig. 1: draft of the flyer the City plans to send out on the water rate increase)

These new super-wells would produce 1.5 to 2 times the average amount of water per day as Norman’s current wells.* (Weird that I couldn’t find anything about this breakthrough in water well technology when I searched the web. ….)

Of course, there is not actually a technological advancement here: the City is just trying to ‘muddy up’ the discussion of well costs. (“[U]p to 2 million gallons a day”? It would be equally accurate to say ‘up to 2 BILLION gallons per day’. A City official can dream, right?) To keep things clear, I will treat these numbers more seriously than they deserve below and show that even if they were true, there would still be a subsidy for new development - and an overcharge for current ratepayers.

Before I move to new numbers, however, a point about credibility. In fudging the budget numbers for well field expansion, the City of Norman has been caught trying to hide the subsidy it provides to new development. That is probably all you need to know about (1) the fairness of the subsidy and (2) the trust you should put in City pronouncements about the water rate election.

In order to assess the new super-well scenario, you need to remember that the rate increase proposal was calculated using non-super-well numbers. The rate increase proposal hasn’t changed; if water capacity were cheaper than the City originally thought, it rates should go down to reflect that fact. Current ratepayers, then, would be overcharged for the 1.5 MGD water capacity the City previously said they need.

Would super-wells make the connection fee subsidy go away? No. On the assumption that new development gets super-wells too, the cost per ¾” connection would fall to $1,148.** The subsidy for 2015, then, would be $348 per connection ($1,148 cost - $800 fee) and the 2016 and on subsidy would be $148 ($1,148 cost - $1000 fee).

The super-well scenario wouldn’t be any more fair than reality: it merely turns part of the development subsidy into an excess charge to ratepayers. This should be no surprise. the problem with the way Norman is developing water capacity is that it uses different ways of calculating prices for utility customers and new development. As long as that asymmetry remains, the fairness issue will remain.

[UPDATE: The final draft of the flyer is out (see here: http://www.ci.norman.ok.us/sites/default/files/Features/City%20of%20Norman%20Water%20Rate%20Increase%20Special%20Election%20January%2013%2C%202015.pdf) . The City scaled back on the 'fudge' - the $9 million might bring in 1.75 MGD - but we're still talking super wells that produce from 1.8 to 1.3 times the average well. So much for "just the facts" ....]

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* 2 MGD over 5 wells is a well average of 400,000 GD; over 7 wells is a well average of 285,714. Given that our current well average now is a little below 193,000, that is pretty remarkable.

** Until we develop new super-customers, a ¾” water connection still requires 255 GD, so 2 MGD still supports 7843 connections. At a cost of $9 million for 2 MGD, the cost of a connection is $1,148 (= $9,000,000/7843 connections).

Proposed water rate increase: current customers pay greater rate for new capacity than new development

Norman needs new water sources. Recognizing this, the City is proposing to spend $12 million for Water Well Field Expansion.

(Fig. 1: Text File for R-1415-60, which was passed by City Council on Nov. 25, 2014)

The $12 million dollars in new wells is supposed to provide 2 MGD (million gallons per day) of water capacity.

(Fig. 2: City Staff presentation to City Council Study Session, Sept. 30, 2014)

The new water well capacity is supposed to serve both existing utility customers and the water needs of new development. The City staff has determined that current customers need 75% of the new capacity (1.5 MGD), leaving 25% of the capacity (0.5 MGD) for new development.* Based on that understanding, $9 million toward the Water Well Field Expansion is built into the rate increase proposal citizens will be voting on January 13, 2015 and the remaining $3 million is supposed to be taken care of by the increase in the connection fee City Council passed on November 25, 2014.

The rate increase proposal was carefully and conservatively designed to generate at least the $9 million dollars budgeted toward increased water capacity. As a City of Norman utility customer, then, you will pay at least the full budgeted price for your part of the new water capacity.

Things are a quite different when it comes to the connection fee that new development pays.

(Fig. 3: Staff attachment, Agenda for City Council Meeting, Nov. 25, 2014)

Figure 3 shows the new connection fees the City Council adopted on November 25, 2014.** The rates for a basic ¾” connection are highlighted. It is very easy to see that the connection fee is insufficient to cover the $3 million price-tag for the 0.5 MGD being reserved for new development. The City figures that a basic ¾” connection requires 255 GD (gallons per day) capacity (see Figure 2 above).*** 500,000 GD divided by 255 GD per connection leaves 1,961 basic connections for new development. At even $1000 per connection, 1,961 connections only raises $1.961 million dollars. Given that the connection fee will only be $800 for the first year, the amount raised will only be something like $1.795 million.**** New development will either be getting $3 million worth of water for less than $1.8 million or (more likely) pay $3 million in return for 3166 connections, which amounts to 25% of the cost for 40% of the capacity.

The upshot of these calculations is that the connection fee provides water capacity to new development at a 40% discount over what the rate increase would charge current utility customers. That is a prime subsidy for the exact same product.

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* I have not seen how the City Staff determined this split, although I would like to see it.
** Although there are different rates for different connection sizes, the basic connection is ¾”; larger sizes carry more water and so the rates are determined by multiples of the basic connection, where the multiplier is determined by increased flow capacity. E.g., a 1” connection carries 1.67 times the water a  ¾” connection carries, so the connection fee for a 1” meter is 1.67 times the connection fee for a ¾” meter.
*** The 255 GD capacity per connection is a constant in City calculations. The 2060 Strategic Water Supply Plan, for example, figures that each person will use 145 GD and that the utility customer ranks will grow 1500 new customers per year. New demand, then, works out to be 217,500 GD after a year. Given that the City supposes there will be 832 ¾”-equivalent connections per year (600 connections, 87% of which are ¾”, 5% of which are 1”, 3% of which are 1.5”, and 5% of which are 2”), that works out to be 261 GD per connection (within rounding adjustments). Also, the City figures that the average current well produces a little less than 193,000 GD and that the average well supports 754 connections (City Council Study Session, Sept. 30, 2014). Again, that works out to be 256 GD per connection.
**** In footnote 3, I showed that the City estimates 832 ¾”-equivalent connections per year. (832*$800)+((1961-832)*$1000) = $1,794,600. Note also that the amount of water used for new development should only last 2.36 years (=1961 connections/832 connections per year).