Municipalities face a common dilemma when establishing fees for municipal owned and operated enterprise facilities (water, sewer, gas, electricity, etc.). Municipal officials, understandably, want to keep user rates low. However, experience shows that insufficient user rates, combined with a reluctance to adjust rates upward when necessary, contribute to a progressive operating deficit, ultimately requiring substantial rate increases.

This dilemma can be averted by taking a reasoned approach to setting user rates. In all cases, it is very important to deposit revenues from each enterprise facility in a separate fund for that particular operation. This allows the municipality to maintain close control on revenues and expenditures required for the operation, thereby alerting municipal officials when revenues are becoming inadequate and a rate adjustment is needed.

As the water distribution system is the most common municipally operated enterprise facility, this discussion will focus on water user rates.

There are many factors which should be weighed when considering water rates — factors such as operational costs, debt service, capital improvements and reserves to meet emergency needs. Payments in lieu of taxes (equivalent to levying a property tax upon a private business equal in assessed valuation to the public facility) and administrative expenses attributed to the enterprise (prorated portions of administrative salaries, legal expenses, insurance premiums, pension contributions, costs of audits, and other expenses partially attributed to the enterprise) may also be charged to an enterprise fund.

Rating structures generally fit into four basic categories: Flat Charge, Uniform Rate, Declining Block Rate or Ascending Block Rate. The Flat Charge Rate is used when the municipality has no metered customers. Each user is billed the same amount, regardless of usage. Administration of this rate is simple, since it does not consider usage volume in the billing process.

The Uniform Rate bills all water at the same unit rate, regardless of the amount used. This rate encourages water conservation, but can hamper industrial growth. This obstacle, however, may be overcome by establishing a separate uniform rate for industrial users, a logical step since it costs less to produce additional volumes of water once fixed costs are allocated.

The Declining Block Rate is preferred by large volume water users, since it provides for a progressive decrease in the unit cost of water as the aggregate volume used increases. Although widely used, this rate does not encourage water conservation.

In contrast, the Ascending Block Rate promotes water conservation by providing for a progressive increase in the unit cost of water as the aggregate volume used increases. However, the actual cost of production may not be reflected in the rates, making a separate industrial rate structure desirable.

Regardless of the rate structure chosen, a minimum rate can be established for all customers. This minimum rate should be based upon the fixed costs of the operation — expenses attributed to debt service, pensions, unemployment insurance, workers' compensation, audits, medicare contributions, liability insurance, utilities, chemicals, and some salaries. Municipalities may also want to consider charging higher rates to customers located outside the corporate limits.

August 1987 / Illinois Municipal Review / Page 23

There are several reasons for keeping user charges at adequate levels to meet expenses. Many revenue bond ordinances contain provisions to protect current bond holders by prohibiting the sale of additional bonds unless revenues exceed all expenses by a certain percentage — usually 130 percent. This prevents municipalities from using current revenue to extend water lines, when revenue may not be adequate to retire outstanding bonds.

Some municipalities choose to subsidize their water system with money from the General Fund. This practice is a luxury available to only a few Illinois municipalities. When a municipality has unusually high sales tax revenues generated from a regional shopping mall, for instance, subsidization may be considered to maintain lower user rates. However, this deviates from the practice of treating the water utility as a private business —able to support itself.

Municipalities should constantly monitor their water rate structure to ensure that water revenues are sufficient to meet costs. At the same time, enterprise facilities should be operated in a businesslike manner, cutting waste where possible, to be self-sufficient while providing the commodity to the consumer at the lowest possible cost.

A good practice is to evaluate rates annually and never less than once each two years. This practice will not only help a municipality avoid unpopular large rate increases, but will also provide for a more responsible operation by providing sufficient revenue to maintain and manage the facility.

DCCA's Office of Local Government Management Services can help municipalities evaluate their water rate structure, determine necessary rate adjustments, and make recommendations to municipal officials for consideration. For further information, call toll-free 1-800-562-4688 (LOC GOVT) or write:
  Department of Commerce and Community Affairs
  Office of Local Government Management Services
           620 E. Adams Street
           Springfield, IL 62701 •

Page 24 / Illinois Municipal Review / August 1987