MUNICIPAL CONNECTION CHARGE: FINANCING UTILITY EXPANSION by Bruce Thomas Bender A professional paper in partial fulfillment of the requirements for the degree of Master of Public Administration MONTANA STATE UNIVERSITY Bozeman, Montana December 1982 P373 Bll 31S Co p - ^ © COPYRIGHT by Bruce Thomas Bender 1982 All Rights Reserved 11 APPROVAL of a paper submitted by Bruce Thomas Bender This paper has been read by each member of the paper committee and has been found to be satisfactory regarding content, English usage, format, citations, bibliographic style, and consistency, and is ready for submission to the College of Graduate Studies. 2SL, L5.2L2, Date Chairperson, Graduate Committee Approved for the Major Department Date Head, Major Department Approved for the College of Graduate Studies Date Graduate Deal Ill STATEMENT OF PERMISSION TO USE In presenting this paper in partial fulfillment of the requirements for a master’s degree at Montana State University, I agree that the Library shall make it available to borrowers under rules of the Library. Brief quotations from this paper are allowable without special permission, provided that accurate acknowledgment of source is made. Permission for extensive quotation from or reproduction of this paper may be granted by my major professor, or in his/her absence, by the Director of Libraries when, in the opinion of either, the proposed use of the material is for scholarly purposes. Any copying or use of the material in this paper for financial gain shall not be allowed without my written permission. Signature Date IV TABLE OF CONTENTS Page APPROVAL ii STATEMENT OF PERMISSION TO USE in TABLE OF CONTENTS iv LIST OF TABLES vi ABSTRACT vii CHAPTER 1 MUNICIPAL FISCAL PROBLEMS. 1 Introduction 1 Fiscal Status of Local Government 2 Public Works 3 Growth 4 Alternatives 6 Connection Charge 7 2 RATIONALE AND THEORY OF CONNECTION CHARG E 10 Public Utility Financing 10 Public Pricing Theory 13 Connection Charge Theory 15 Benefit 16 Efficiency and Equity 17 Incidental Benefits 18 Conclusions 19 3 SURVEY OF MUNICIPAL USAGE 23 Survey 23 Survey Results 24 Other Usage Data 30 Summary 31 V TABLE OF CONTENTS-Continued Page 4 IMPACT ON MUNICIPAL GROWTH AND FINANCES 33 Survey Results 33 Oregon System Developmental Charge 34 General Studies 38 Other Considerations 40 Discussion of Impacts 41 5 MUNICIPAL LEGAL AUTHORITY TO ENACT CHARGE 46 General Law 46 Case Law 48 City of Rawlins 50 Montana 53 Summary and Discussion 54 6 IMPLEMENTATION PROCEDURES 59 Method of Calculation 60 Administration 65 Conclusions 68 7 A MODEL APPLIED TO THE CITY OF HELENA 70 General Description of Helena 70 Helena Connection Charges 71 Administrative Issues 75 Discussion 76 REFERENCES CITED 79 APPENDICES 85 APPENDIX A-SURVEY MATERIALS 86 Sample Letter to Surveyed Cities 87 Connection Fee Survey 88 List of Surveyed Cities 90 APPENDIX B-LEGAL OPINION 92 City of Helena City Attorney: Legal Opinion on Connection Charge 93 VI LIST OF TABLES Table Page 1. Connection Charge Survey—1982 25 2. City of Helena Water System Estimated Replacement Costs as of August, 1982 72 3. City of Helena Sewer System Estimated Replacement Cost as of August, 1982 72 4. City of Helena Existing Water Services by Size and Capacity Units (Fiscal Year 1982-1983) 73 5. City of Helena Water System Connection Charge (Fiscal Year 1982-1982) 74 6. City of Helena Sewer System Connection Charge (Fiscal Year 1982-1983) 74 7. Water and Sewer Connection Charge Fund Projections (Five Year Planning Period) 75 Vll ABSTRACT Municipalities in the nation are faced with a fiscal crisis due to rising costs and deplet¬ ing revenues. The municipal utility systems are affected especially because of inflated energy costs and federal mandates. This fiscal crisis has forced cities to analyze rather closely the impact of municipal growth. One result of this analysis is that some municipali¬ ties are requiring new utility customers to “buy into” the existing general utility systems. This payment is generally referred to as a “connection charge.” This paper evaluates the connection charge by analyzing: (1) the economic theory, (2) the impact of growth and finances, (3) the legal authority, (4) the present usage in cities, and (5) the implementation procedures. Case studies are summarized that pertain to the impact and legal authority of the connection charge. The survey results from twenty- nine cities exemplify the present use of this fee. A proposed connection charge is developed for the City of Helena, Montana. The connection charge is evaluated to be equitable, efficient, and nondiscriminating. The impact of this charge on municipal growth is negligible while the revenue has a positive effect on the municipal finances. The legal authority does exist for municipalities to enact the charge; and it is proposed that the connection charge is legal in Montana. 1 CHAPTER 1 MUNICIPAL FISCAL PROBLEMS Introduction Development of new residential, commercial and industrial properties obviously require extension of new streets, sewers, water lines, and other public facilities. It is per¬ haps less obvious that new development also creates additional demands upon existing urban facility systems. Added traffic is generated through the street system and new demands are placed upon water intake and transmission systems, sewage interceptor and treatment facilities, and other in-place urban systems. Much of the cost of service extensions to or in the immediate vicinity of newly developed properties are usually paid by the developers or purchasers of the property involved. Until recently, however, few cities have required new developments to “buy into” existing general service systems. Rather, upon completion of development, they have merely been added to the general pool of service charge payers without making any im¬ mediate investment for the use of the existing systems. Currently, cities are experiencing a revenue shortage caused by many problems includ¬ ing inflation and public resistance to tax and rate increases. Therefore city administrators and utility managers are closely evaluating the impact of municipal growth upon the exist¬ ing systems. They are searching for alternate sources of capital to expand their utility plant system, street arterial system, and park system to serve the new residents. Gradually, more and more cities are obtaining this alternate source of capital from development and the 2 new utility customer by requiring them to pay their share of the cost to provide the general urban facility systems. This paper focuses on one development fee called a “connection charge,” which may be imposed on new utility customers. The theory, legal concerns, and administrative pro¬ cedures associated with the connection charge are developed in the following chapters. This chapter reviews the municipal fiscal problems that have led to the introduction of the con¬ nection charge. Fiscal Status of Local Government Laments about the troubled fiscal status of local governments in the nation can be heard from any local government official, and detailed in the popular press. Business Week magazine did a fifty page special report entitled “State and Local Government in Trouble” to emphasize a growing national awareness that “the problems are so severe as to constitute a crisis for state and local government.”1 The early 1970s brought federal revenue sharing and surpluses in state budgets which enabled local governments to remain fiscally sound. But by 1978 an increasing proportion of the nation’s cities experienced operating deficits. This fiscal crisis is attributed to the fact that: 1. The tax base has been shrinking since late 70s 2. There have been massive cuts in intergovernmental assistance from federal and state governments 3. Inflation has eroded buying power 4. The ability of cities to borrow is withering amidst record breaking interest rates 5. Local bonds are less attractive because of new competition in tax exempt market 6. Federal and state mandates have proliferated 7. Voters disapprove of spending amidst a strong anti-tax sentiment2 3 The picture for local governments in Montana is no better. A recent report compiled by the State of Montana states that “real declines have occurred in total and non-tax revenues since 1979 for all Montana cities and towns.” The report continues that the property tax base has not kept pace with inflation. It continues that “despite cost saving efforts, all groups of local governments have had to substantially increase taxes to maintain services at or near 1979 levels.”3 In the 1983 budgets, cities in Montana had to increase their mill levy just to match the same revenue they obtained last year from the property tax. Public Works The local government revenue shortage is only increased by problems in the public works area. The decay of the nation’s infrastructure (bridges, roads, sewer and water systems, and mass transit) will push the maintenance investment to a level above what local government has been spending in new investment for the past years.4 The American Public Works Association summarizes it by: Since about 1970, public works at all governmental levels has experienced a pro¬ gressively more serious shortfall of revenues sufficient to both maintain services and facilities and also to invest in new or replacement capital stock.5 The public works area of local government has experienced accelerated rising costs above other public services due to these specific causes: energy pricing, costs of construction, and maintenance materials, deferred maintenance, and increased federal and state environmen¬ tal mandates. The most spectacular direct cost increases have been those that are energy related. Energy, construction and maintenance materials, and equipment have all increased in cost above the rate of inflation.6 Federal and state mandates on pollution control and safe drinking water have forced or are forcing municipalities to modernize and expand their sewer and water treatment systems. Korbitz states that “most existing water sources will require additional expensive 4 treatment in order to achieve the new standards set by the federal Safe Drinking Water Act of 1974 (PL 93-523). ”7 Also, improved fire protection standards for insurance rating has placed a demand on the municipal water system for additional water storage, fire hydrants, and water flow. Federal and state revenue to meet these mandates is disappearing quickly. Whereas the City of Helena, Montana, had obtained federal aid for storage reservoirs, transmission mains, water pumping stations, and twice for a sewer treatment plant in past years, now this source no longer exists. To meet such water and sewer system needs, a large burden has been placed on utility rates. In the past, utility managers tried to establish rates that would cover several years revenue requirements. But as Banker points out: Recently, rapidly increasing costs have quickly wiped out adequate rate adjust¬ ments, and it is not uncommon for a water utility to require a 50 percent hike, or more, to meet immediate needs, and to anticipate further increases within two or three years. Some cities are resorting to annual adjustments.8 The City of Helena, Montana, has had to increase its rates, three times for water users and six times for the sewer system, in the past six years. Growth In these times of strain on both general and utility municipal budgets, elected officials and municipal department heads must be especially aware of the public costs associated with new development within municipalities. Growth means additional demands for water supply, sewage removal, solid waste removal, transportation facilities, recreational areas, and school classroom space.9 In light of the current municipal crisis innovations in planning and managing of municipal growth appear critical. In the late 1960s, Montana along with the nation entered into the age of planned growth. The Montana Subdivision and Planning Act instituted sophisticated planned land 5 development. Federal monies were made available to state and local governments to develop master plans in order to chart their growth in land development, sewer and water systems, park and bikeway systems, transportation, and storm drainage control. Concur¬ rently, a number of Montana cities and countries experienced significant growth during the 1960s and 1970s. (For example from 1950-1980, Helena increased 33 percent (%), whereas Lewis and Clark County increased 72% in population.)10 With this growth and new age of planning, Montana cities became more aware of the impact of growth. Previous to this planning era, communities traditionally provided all of the facilities for growth. But this new era for Montana and the nation has standardized certain con¬ ditions for private development. Typically, developers are required to pay money or con¬ tribute land to compensate for extra public facilities resulting from new construction. More established requirements include streets, curbs, gutters, sidewalks, sewer lines, water lines, and storm drainage within the development. It is increasingly common also to require land, or money in lieu of land, for parks and schools. In cases of large developments, cities may require contributions for off-site facilities; but the requirements as listed before are for facilities that are within the development or on-site. While new developments are presently paying for these facilities within their bounda¬ ries, the general public is typically still paying for expansion of the community general facilities (treatment plants, reservoirs, arterial streets, etc.) to serve this new growth. In the past these expansions were financed by general property taxes, but cities have shifted to paying for utility expansion through user rates. As mentioned previously, the sewer and water utility user is already burdened with high rates just to operate the present utility system. As a taxpayer, the same citizen is burdened with increasing taxes. This atmosphere has led city administrators to analyze the cost of adding a new customer to the utility system. 6 Alternatives The response to this overall fiscal crisis by most local governments in the nation is using one or more of these strategies: 1. Cut back in service 2. Increase productivity with fewer personnel 3. Shift service responsibilities to state or federal level 4. Expand or create new sources of revenue Number 4 strategy is receiving the most consideration. This expansion is shown by the fact that property taxes have declined in relative importance while other revenue sources have increased. The other revenue sources consist of nonproperty taxes, user charges, and inter¬ governmental revenue.11 In the United States, total service user charge revenues in the cities have increased 308% between 1957 and 1975. During this period, the average annual growth rate of revenue from total user charges was greater than the growth rate of revenue from taxes, 8.1% compared to 7.3%.12 With the current decrease in intergovernmental revenue, most interest is in nonproperty taxes and user charges. But, since the State of Montana prohibits all local governments from instituting any new tax on goods and services, Montana local governments are mostly interested in possible user fees. The focus of this paper is a new user fee that finances sewer and water general facili¬ ties expansion. Ferry summarizes the problem “Utility managers, faced with extreme pub¬ lic resistance to rate increases on one hand and inflation on the other, are searching for alternate sources of capital”13 to handle growth. The International City Management Association reports: Some local governments are finding methods of making new development pay their own way. The use of impact fees and development charges to pay for new public services is gaining in popularity in communities experiencing rapid growth and in states where local property tax revenues have been significantly reduced.14 7 These development charges are also known as system development charges, and when deal¬ ing with connection to the municipal utilities, are known as connection charges, availabil¬ ity charges, capacity charges, plant investment fees, or entrance fees. For the purposes of this paper, this type of municipal fee will be called connection charge. Connection Charge The extensive use of the connection charge by municipalities across the nation has occurred only in the last ten years. It has not yet been introduced into Montana. It has evolved from the movements toward placing a price on all public services, and in public utilities, to have unique customer classes pay their particular share of the costs. The connection charge is levied on a separate utility customer class consisting of new customers for these reasons: (1) the new customer adds a capacity demand to the munici¬ pal utility; (2) he benefits from his connection to the utility; and (3) he has not contributed his apportioned share of the costs of capital improvements. The characteristics of the con¬ nection charge are: (1) it is a one-time initial fee charged to any new development or new customer upon connection to the city utility system; (2) it is an equitable, efficient, and non-discriminating means to obtain revenue; (3) its purpose is to recover costs equal to the new customer’s share of the capital investment in the utility treatment plant and transmis¬ sion systems that are required to provide service; and (4) this fee would aid in relieving the financial burden upon the existing utility user and provide the necessary finances for plant expansion. As the connection charge is a new utility user charge, and has not yet been intro¬ duced into Montana, the purpose and scope of this paper is to answer the following questions: 1. What is the economical and financial theory that supports the connection charge 2. To what extent is the connection charge being used in Western United States 8 3. What impact does this new fee have on new development and municipal finances 4. How is the connection charge calculated and administered 5. What is the legal authority to enact this charge On the basis of this analysis the paper will conclude with an illustrative discussion of how the connection charge might be implemented for the City of Helena, Montana. 9 Footnotes 1 “State and Local Governments in Trouble,” Business Week, 26 October 1981, p. 135. 2 Ibid.; Catherine L. Spain and Blue Wooldridge, “Local Property Tax Alternatives: The Role of Non Property Taxes and Charges,” Public Management, May 1981, p. 6. 3 Montana, Consulting Services Bureau, Local Government Financial Conditions, February 1982, p. 5. 4 “State and Local Governments in Trouble,” p. 137. 5 American Public Works Association, Revenue Shortfall: The Public Works Challenge of the 1980’s (Chicago: American Public Works Association, 1981), p. III. 6 Ibid., p. 6. 7 William E. Korbitz, ed., Urban Public Works Administration, Municipal Management Series (Washington, D.C.: International City Management Association, 1976), p. 366. 8 R. F. Banker, “Should Water Rates Be Raised?”, The American City and County, May 1979, p. 63. 9 Steve Carter et al., “Local Government Techniques for Managing Growth,” Manage¬ ment Information Service 6 (May 1974): 1. 10 Helena, Mt., Areawide Planning Organization, Helena Comprehensive Plan, 1981, p. 18. 11 Spain, p. 6. 12 Selma J. Mushkin and Charles L. Vehorn, “User Fees and Charges,” Governmental Finance, November 1977, p. 42. 13 William K. Ferry, “Connection Charges: One Way to Finance System Expansion,” Journal of American Water Works Association 71 (January 1979): 2. 14 Thomas P. Smith, “Recent Developments in Planning,” The Municipal Yearbook in 1982, pp. 197-199 (Washington, D.C.: International City Management Association, 1982), p. 199. 10 CHAPTER 2 RATIONALE AND THEORY OF CONNECTION CHARGE Since a new utility customer adds to the capacity demand or usage of the utility system, municipalities are responding to this additional demand by requiring a payment or buy-in charge from a new customer. This one-time payment is the new customer’s pro¬ portionate share of the cost to construct the general capital facilities that serve him. The usage of this type of charge has expanded rapidly in the United States and has been labeled by many names, such as, connection charge, plant investment fee, and system development charge, to name a few. For matters of consistency, this paper will refer to this payment as the “connection charge.” This chapter will explain the rationale or theory of the connec¬ tion charge as found in the fields of utility economics and public finance theory. Although this fee could be used by private utilities and also the rationale could be applied to other types of public service, such as, oversizing streets, storm drainage, cultural centers and park systems, this paper deals primarily with municipal sewer and water utilities. Public Utility Financing To understand the connection charge theory, First it is necessary to have a knowledge of typical sewer and water utility financing in order to see how the connection charge revenue fits in the total picture. Utility expenses are typically divided into two areas or accounts: (1) maintenance and operation, and (2) capital improvements. Maintenance and operation expenses deal with recurring costs such as personnel, materials, maintenance of equipment and structures, equipment and plant operation, and other general operating costs. Capital improvement expenses are typically major costs for new or expanded facili- 11 ties or equipment that are relatively large size and expensive. Since the connection charge is a means of financing the major capital improvements such as treatment plants, pumping stations, and large pipelines, it is necessary to understand utility capital improvements financing. Annual revenue from utility user rates pays for the maintenance and operation expenses, but a utility can seldom pay the full costs of large capital investments in one fis¬ cal year. Therefore, numerous techniques have evolved to enable local governments to finance major capital improvements. Some of the techniques include pay-as-you-go finan¬ cing, general obligation bonds, revenue bonds, special assessment districts, federal and state grant funding, and contributions or exactions from developers.1 Pay-as-you-go is the financing of improvements by the accumulation of current revenues as current user rates, fees, sale of capital assets, or surplus operational revenues. Also this can be called a reserve fund and involves an accumulation of funds in advance of the start of construction. General obligation and revenue bonds are a means for municipalities to borrow money from investors and pay the principal and interest over a number of years. Through the general obligation bond method, the taxing power of the municipality is pledged to pay interest and principal to retire the debt. Revenue bonds are secured exclusively by the revenue from sewer or water service charge and payments are made by the same means. Special assessments districts borrow money for installing a public improvement, such as water and sewer lines, or streets, that directly benefits and is built within the district. Liens are placed upon the property within the district and payments are spread over ten to fifteen years. Federal and state grant funding is dependent on the utility qualifying for a grant based upon some special need specified by the grantor. 12 The last technique is contributions or exactions from developers. It is common prac¬ tice to require developers to install water and sewer mains and appurtenances through or along the developed tract and deed these facilities to the city. Though there are a number of possibilities, municipal utilities generally have to bor¬ row money by selling bonds in order to construct the major enlargements or modifications. The other financing methods provide revenue for smaller or more limited projects. When selling bonds, general obligation bonds are usually not the best choice since they usurp a portion of the bonding capacity of the city, depend on property taxes for redemption, and generally require a majority vote of the people. Therefore, municipal utilities tend to use revenue bonds.2 The connection charge revenue would assist in financing the major capital improve¬ ments by either accumulating in a reserve fund (pay-as-you-go) or by making annual pay¬ ments on the revenue bond. It is important to note the difference between the developers contribution or exac¬ tion and the connection charge. The developers contribution or exaction is a requirement made by the local government in the subdivision review process. This requirement is typi¬ cally negotiated and the contribution is dependent on meeting the needs generated by the new development. Typically these needs are sewer and water system, streets, storm drain¬ age, and park land. It can be expanded to school and recreational facilities. Again the con¬ tributions directly benefit the development. Whereas, the connection charge revenue is to be used for the city-wide aspects of the sewer and water system and not just for the devel¬ opment. The next portion of this chapter explains in more detail about the city-wide aspects of the connection charge. 13 Public Pricing Theory The rationale for the connection charge is based on public finance theory and public utility economics. This section will explain these basic theories used in pricing municipal services and gives a justification for the connection charge. Public goods are those goods and services that are provided by the government. These goods may take two forms. One form is a pure public good which is available to all and cannot be provided in divisible units; and, therefore, no price can be charged to allocate its use, for example, urban fire protection. The second form is a quasi-public good, of which many can be sold in divisible units and prices may be charged for allocation purposes, such as sewer and water services. Obviously, the emphasis of this paper is on the second form of public good.3 According to public finance theory, the basis of pricing this divisible public good should be the “Benefit Principle” of public finance. This principle is that the price paid by the individual should be equal to the benefits received from the government service. Or payments should reflect benefits received.4 Pricing government services based on benefit is meant to improve the allocation of public resources and allow for a more equitable distribution of public services. Poor allo¬ cation of resources, or inefficiency, occurs if goods are provided free because they can be demanded in quantities at which the benefit to the individual is less than the cost of pro¬ duction. The price established for the service rations its use since, as for private goods, buyers of the service will adjust their use to the price level. Inequity occurs if general tax¬ payers are required to finance goods consumed by identifiable individuals when no special benefit accrues to the general taxpayer.5 14 Essentially, the benefit principle states that “the users of a public service should pay for its cost.” This principle is to bring about equity or “fairness in charging beneficiaries” and “efficiency in the use and production of public services.”6 Another theory called marginal-cost pricing develops further the concept of pricing public goods. In its most simple form, “marginal-cost pricing says that the demand price should be made equal to the marginal cost, with marginal cost defined as the incremental costs of production,” the cost of producing one more unit. This rationale claims that economic efficiency is promoted when customers continue to purchase a good or service up to the point at which the marginal benefit to the customer equals the marginal cost of production. “The equality of price and marginal cost ensures that consumers equate marginal benefits from this use of resources with real alternatives foregone elsewhere.”7 Many economists argue that marginal cost pricing could result in an optimal allo¬ cation of society’s resources because products would be evaluated by consumers with respect to their preferences and their budget constraints. Through this evaluation process, the price of a product is set in a competitive market equal to the resources that must be sacrificed for it. “If buyers are charged more than the marginal cost, they will buy less than the optimum quantity.” They will “refrain from making those additional purchases because the price to them exaggerates the sacrifice.” Conversely, “if the price is below incre¬ mental costs, production of the products in question will be higher than it ought to be.”8 Traditional utility economics bases its public pricing on average cost pricing. Average cost pricing, most commonly used by utility systems, “connotes that the price of the product or service is set equal to the average cost of producing the product.” This system of allocation is widely accepted because it allocates total system costs roughly in propor¬ tion to each user’s consumption and each user’s group cost of service. It is also widely accepted because of its clarity and feasibility.9 15 Critics of this pricing approach claim that this system misallocates resources by over or under pricing the service relative to its true costs. Their solution to this is a marginal- cost pricing. Connection Charge Theory The rationale for the connection charge is based primarily on the benefit principle of public finance and partially on the marginal-cost pricing theory. When a new customer hooks onto the utility system he immediately accrues a benefit. The benefit is a utility system that is available for his usage. The value of the benefit is based upon the new cus¬ tomer’s need or demand for the utility. The connection charge is the new customer’s payment for this benefit based upon the marginal cost of providing the utility. More specifically, the benefit equated to the connection charge stems from the con¬ nection to the general benefit facilities. General benefit facilities are defined “as those utility capital improvements that provide benefits to everyone,” i.e., treatment facilities, outfall and transmission pipelines, and reservoirs. Whereas, direct benefit facilities are those utility capital improvements that “provide exclusive direct benefits to specific prop¬ erties,”10 i.e., distribution and collection system, fire hydrants, service laterals. As men¬ tioned earlier direct benefit facilities are typically financed by the developer or customer. Therefore, the connection charge is the payment for the new customer’s proportion¬ ate share of the costs of the general benefit facilities. This proportion is based on the amount of potential usage of the total facility that the new customer will obtain or the new customer’s share of the total capacity of the facility. The new customer’s capacity could either come from the existing general facilities reserve capacity or from expansion of the existing general facilities capacity. The main purpose of the connection charge is to apportion equitably the cost of the general benefit facilities to those demanding the services. If the new customer hooks onto 16 the utility system and utilizes the existing system reserve capacity, then the new customer accrues the benefit of a system capacity for which the historic or past utility customers have paid the cost. Therefore, the connection charge equalizes the new customer’s invest¬ ment into the general facilities with the historic customer’s investment. The same rationale is applied in the case where the new customer’s demand for service requires an expansion of the existing general facilities. The new customer pays for his share of the expansion costs along with his share of the existing facilities. If the expansion of the general facility is not needed nor used by the existing customer, then the expansion does not benefit the existing customer. As the new customer receives full benefit from the facility expansion, he should pay the full cost of expansion. Therefore, through the con¬ nection charge, equity between the existing customer and new customer is achieved.11 This connection charge, derived specifically from the cost of system expansion, is analogous to marginal cost pricing. Tire new customer demands an incremental or marginal utility system capacity. The new customer’s connection charge is equal to the incremental cost of constructing the new customer’s increment of the utility system capacity.12 Benefit The connection charge is an assessment for the benefit of the availability of the utility. This section of the chapter reviews the analysis of this benefit by public utility literature. Stephens theorizes that private benefit can be measured in two ways: market value increase and use.13 The concept that the availability of utilities is a benefit to property owners is established in the municipal planning literature. As Downing notes, “property owners often realize enhanced land values when utilities abut or cross their property.” He continues, “the availability of water and sewer services may be viewed as a site character¬ istic which enhances the revenue potential of individual sites.”14 17 When a local or central government acts to construct public works or improvements which increase the value of land, it is called a windfall. Hagman describes the situation of the landowner outside the city limits who watches the city expand. The landowner “sits and does nothing while roads are made; services are improved; and water is brought from reservoirs miles away.” The owner does not contribute to any of these improvements, “yet by everyone of them his value of land is enhanced,” a windfall occurs. Hagman pro¬ poses that the windfalls should be “captured” as “the community is asking only for a return of wealth it creates.”15 Neuner supports this concept also; he suggests that property owners do not gain bene¬ fit by consumption of water but rather by availability of water to their property. He con¬ tinues: “The benefit received is in the form of an increased value of the property, and it is on this basis that the property should pay for his service.”16 This concept of benefit has been recognized by state and local governments in their use of special assessment districts and general obligation bonds in the past to finance public improvements, even though presently, these forms are questioned for their equity in that frontage of lots and lot sizes are not good measures of benefits.17 Efficiency and Equity Not only can the connection charge bring about equity but it can also promote economic efficiency, especially in cases of required system expansion. This is supported by the marginal cost price theory. When the costs of expanding the utility system are included in the utility rate, the development of more remote property, which is initially attractive because of lower land costs, is encouraged by a subsidy from existing rate payers. By instituting connection charges to recover the costs of facilities necessary to expand service, new customers are compelled to weigh the higher expansion costs for more remote property against the 18 higher property cost of more centrally located land. This encourages an economically effi¬ cient system expansion.18 In a study of two municipalities in California, the effect of municipal service pricing for growth-required capital improvements upon urban development was analyzed. The study evaluated six different pricing policies based upon two criteria. One was the “equity criterion” which is the ability of the policy to place the burden of the costs of service expansion on new development; the second was the “efficiency criterion” which is the ability of the policy to charge a developer only for the costs of service that he receives. Average incremental pricing and average incremental zone pricing both met these two criteria. Average incremental pricing was defined as the averaging of capital costs over the expected number of service users. Average incremental zone pricing was defined as being the same policy as average incremental pricing except the costs are averaged over particu¬ lar zones of the municipal service. The average incremental zone pricing policy was con¬ sidered even more efficient than the other average pricing because by isolating expensive service areas “this policy brings service price more closely in line with service cost.”19 Another policy called general revenue pricing, which allocated costs of service expansion across the entire community, did not meet either criterion. The connection charge is similar to both of the average increment pricings. The fact that latter are efficient and equitable affirm the connection charge theory. The typical utility user rates, on the other hand, are comparable to the general revenue pricing policy, and the study affirms the contention that typical utility rates are not efficient nore equita¬ ble when dealing with the cost of growth. Incidental Benefits Other justification for the connection charge are based on what Gatlin calls “Inciden¬ tal Benefits.” One of these benefits is the capability to serve responsibly existing customers. 19 He mentions that connection charges “provide an alternative source of capital that can reduce bonding requirements and enable a utility to have financial resources to extend service to new customers when it otherwise would not be feasible.”20 This enables the utility to use the regular capital funds to renew and replace existing facilities and to meet water quality standards which better serve the existing customer. Also the utility can sup¬ port growth by providing the necessary utility expansion from the connection charge revenue. The utility expansion can support an adequate supply of development to match the market demand which controls the increase in property prices. Another incidental benefit is the role that connection charges can play in a com¬ munity’s growth and development policy. Catlin states: While controling growth or directing development should not be an explicit ob¬ jective in determining charge levels, capacity charges [connection charges] can provide an inducement for more centralized development or the use of available housing. This influence is exerted on an equitable and economically rational basis rather than through artificial controls or charges which discriminate on the basis of location.21 This theory is also supported by other literature in the planning area. The writers theorize that efficient connection charges will discourage urban sprawl or leap frogging and encourage compact, efficient growth.22 If expansion capital costs are paid through user rates then this average cost pricing method will equalize the cost of development among all areas and tend to encourage sprawl and scattered housing inclusive of development of capi¬ tal expensive areas. Conclusions The connection charge is based on established economic and public finance theory. When a new customer connects to the utility system, he accrues a monetary benefit from available utility services. The connection charge is equal to the marginal cost to provide these general facilities. This fee creates equity between the existing and new customer. It 20 promotes efficiency in that the actual expense of providing this service is paid by the bene¬ fiting individual. The initiation and growth of the usage of the connection charge reflects the national trend of pricing more and more public goods. The charge reflects the evolution occurring in utility rates. Currently, more distinctions in classes of utility users are being recom¬ mended in order to reflect the usage or benefit received. The connection charge is another step in accurately pricing a public product. 21 Footnotes 1 David S. Arnold, ed., The Practice of Local Government Planning, Municipal Manage¬ ment Series (Washington, D.C.: International City Management Association, 1979), p. 131; William K. Ferry, “Connection Charges: OneWay to Finance System Expansion,”/ownm/ of the American Water Works Association, 71 (January 1979): 2-4. 2 William E. Korbitz, ed., Urban Public Works Administration, Municipal Management Series (Washington, D.C.: International City Management Association, 1976), p. 383. 3 Richard A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill Book Co, 1959), pp. 9-14. 4 Douglas Greenwald, The McGraw-Hill Dictionary of Modern Economics (New York: McGraw-Hill Book Co, 1973), p. 49. 5 Selma J. Mushkin and Charles L. Vehorn, “User Fees and Charges,” Governmental Finance, November 1977, p. 43; Oregon, Bureau of Governmental Research and Service, The Use of Service Charges and Fees to Finance Local Government in Oregon, Finance Bulletin No. 10, January 1980, p. 31; Dr. Joseph F. Humphrey, “New Source of City Revenue: A Case Study of Fees and Service Charges in Los Angeles,” San Francisco Home Loan Bank, 1977, p. 1. 6 Selma Mushkin, td., Public Prices for Public Products (Washington, D.C.: The Urban Institute, 1972), pp. 28-29. 7 Ibid, p. 33; Patrick C. Mann and Donald L. Schlenger, “Marginal Cost and Seasonal Pricing of Water Service,” Journal of American Water Works Association 74 (January 1982): 6-7. 8C. W. Corssmit, “What to Include in Utility Rate Structure Design,” Am enow City and County, November 1981, p. 50; A. E. Kahn, The Economics of Regulation: Principles and Institutions (New York: John Wiley and Sons, 1970), Vol. 1, p. 66. 9Corssmit, p. 50. 10 Wyoming and Wyoming Association of Municipalities, Utility Financing Handbook for Wyoming Communities, James M. Montgomery, Consulting Engineers, Inc, May 1982, p. 4.2. 11 Thomas Catlin, “Try Capacity Charges to Generate Water Utility Capital,” Ameri¬ can City and County, February 1981, p. 61; Ferry, p. 2; R. F. Banker, Black and Veatch Consulting Engineers, “Alternative Mechanisms for Financing Debt Service on Reserve Capacity,” Paper presented at the Technical Conference of the Association of Metropoli¬ tan Sewerage Agencies, St. Paul, Mn, 30 July 1980, p. 6. 12 Corssmit, p. 50. 13 Ross G. Stephens and William N. Kinnard, Jr, Financing the Hartford Metropolitan District (Storrs, Conn.: Institute of Urban Research, 1964), p. 11. 22 14 Donald A. Downing, The Role of Water and Sewer Extensions Financing in Guiding Urban Residential Growth, Report No. 18 (University of Tennessee: Water Resources Research Center, 1972), pp. 50 & 62. 15 Donald G. Hagman and Dean J. Misczynski, eds., Windfalls for Wipeouts: Land Value Capture and Compensation (Chicago: American Society of Planning Officials, 1978), pp. 15-18. 16 Edward Neuner et ah, “User Charges vs. Taxation as a Means of Funding a Water Supply System,” Journal of the American Water Works Association 69 (January 1977): 39. 17 Stephens, p. 10. 18 Catlin, p. 62. 19 Lawrence Dougharty et ah, Municipal Service Pricing: Impact on Urban Develop¬ ment and Finance (Santa Monica: Rand Corp., 1975), pp. 5-6. 20 Catlin, p. 62. 21 Ibid. 22 U. S. Dept, of Housing and Urban Development, Local Capital Improvements and Development Management, Analysis and Case Studies, by American Society of Planning Officials (Washington, D.C.: Government Printing Office, 1980), p. 25. 23 CHAPTER 3 SURVEY OF MUNICIPAL USAGE As the connection charge is a relatively new type of municipal utility user fee and tends to be used in Western United States, information in the professional journals and publications about the connection charge is very limited. Published articles deal only with a particular city. None analyze the extent of use of a utility fee such as the connection charge. To understand the importance and potential of a connection charge to a municipal utility, it seems necessary to know the scope of present usage of the connection charge and in what manner the cities are administering this charge. From the preliminary review, no Montana cities have introduced this type of charge. So it is important to know where and how the connection charge is used. However, while specific publications have mentioned that cities in Oregon, Colorado, California, and Florida have enacted a type of connection charge, no further details are presented.1 Not only is there a lack of information about its usage, but there is also a lack of information about the methodology of determining and administering a connection charge. This need for information led to a general survey of select municipalities. This chapter explains the contents and format of this survey. It concludes with an examination and discussion of the results. Survey The purpose of this questionnaire survey was to gain general information about this charge or fee. The questionnaire (see Appendix A) was developed to gain information about the usage and administration of the connection charge. 24 The key points in the questionnaire survey reflected the same goals of this paper: to gain information on the usage of the connection charge, how the charge is calculated and administered, what the theory and justification are behind the charge, and what impact collecting the charge has on the building industry and the local utility finances. Additional information through ordinances, reports, etc., about the connection charge was solicited. This material was the best source of detailed information. Also, a letter (see Appendix A) was sent with the survey to introduce the concept of the connection charge and to explain the purpose of the survey. This material was sent to the administrator of each city as iden¬ tified in The Municipal Yearbook in 1982.2 Originally it was planned to send the survey to about twenty to twenty-five cities in order to get a wide geographic spread of cities and to obtain a controllable amount of information. As this information was intended to be relative to Montana, cities were selected mostly in the Western United States. From preliminary research, it was deter¬ mined that Colorado, Oregon, and Wyoming had some cities that were using this charge. Cities in other parts of the United States to which reference had been made were also selected. The survey was sent originally to twenty-two cities and then to an additional thirteen more cities suggested by respondents (see Appendix A for complete listing of cities that were sent a survey). Survey Results Out of the thirty-five surveys sent out twenty-nine were returned, amounting to an 85% response rate. This high rate of response is considered an excellent percentage for mailed surveys, and probably indicates a high interest in the connection charge. Table 1 shows the results of the survey. Most of the survey information shows the actual types of connection charges employed by the different cities and the remainder deals with T ab le 1. C o n n ec ti o n C ha rg e S u rv ey -1 9 8 2 . 25 -a o Si « .2 Q « o g 5/1 r. ^3 o T3 .ts § O [l. o< ^ M S' O O C3 ^ U a eu *3) oo .S o ^ X O ON > «N X Q a o U c S .2 o o ^ oo c U *2 *3) •S co J o W OS « w ^ O +-> a s ■g o. £ o co b b 0} *0 o. > C cfl O 3 O g, b C 5/5 o c > >—t c § -a I co E ^ i c 1 | S > « ^ 2 CO ^ b « -d c c O 3 U b oS «« - 5P •3 ° ^ Cd W5 *-H o !s ’3 .is Q. ’0 05 E b -2 ^ 5 rr 3 e o ■< co 3 b c 3 O O M •tn 5 g E ^ E ? lx '3 K (DO O cj CO b CO b O £P b •O 33 O 3 O oa X 60 .a .ts S s m b **' 3 w .tS i P 3 3 ^ ^3 b 5. 00 b KO O tN Z! 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