The recent, rapid rise in electricity prices is a prominent component of the discussion over “affordability.” Americans now pay an average power bill of $265 a month, 12 percent more than last year, according to the Century Foundation, a progressive public policy group. Electricity rates have increased 30 percent since 2020, twice the rate of inflation. And many experts predict rates will escalate sharply in the future because of the growth of electricity-hungry artificial intelligence data centers, the pursuit of a clean-energy agenda, and the ongoing, expensive modernization of the power grid.

One quarter of low-income households spend over 15 percent of their income on energy, which is much higher than the percentage for other households, according to the American Council for an Energy-Efficient Economy (ACEEE). Therefore, we should expect utilities to expand their energy assistance (EA) to low-income customers in the future.

What to Do?

Three broad approaches to the “energy affordability” problem are possible: increase the incomes of poor households through transfers; reduce the share of the utility bill for which the customer is responsible; and reduce the customer’s energy usage. EA initiatives focus on the latter two while cash supplements fall under the first.

Most economists favor supplementing the income of poor households via cash subsidies or providing in-kind assistance funded through general revenues, for example in the form of “energy stamps” that directly subsidize power use. Such policies are superior from an economic-efficiency perspective to subsidizing the poor through utility rate cross-subsidies, which raises the rates of the non-poor to aid the poor.

While economists’ recommendations are consistent with textbook economic theory, the public is less supportive. Thus, public utilities redistribute less visibly, what Richard Posner described as “taxation by regulation.” Most customers pay higher rates to subsidize lower-income households. Most EA initiatives reduce energy bills for eligible households either by lowering the effective price of utility service or by reducing energy consumption.

Six Criteria for Smart EA

Regulators should achieve “affordability” goals with the least possible negative effects on economic efficiency and the utility’s financial health.

Six criteria can detect the effectiveness of EA initiatives. Regulators should consider positively any action that satisfies most (if not all) of these criteria, and they should be wary of actions that do not. The six criteria are: EA recipients should receive maximum benefits relative to the dollars funded by utility customers; consumer education should make eligible households aware of available assistance and how to reduce their energy bills; EA should avoid large efficiency losses and cross-subsidization; EA should have reasonable administrative and implementation costs; funding should have a tolerable financial effect on the rates of those who pay the subsidies; and EA should lower collection costs, service disconnections, arrearages (unpaid balances), and debt write-offs.

Efficiency losses from subsidies arise when the subsidized price lies below the utility’s marginal costs, and the benefits to targeted low-income households are less than the subsidy cost funded by the utility or other customers. For example, there are efficiency losses when utility customers pay $12 million to subsidize low-income households that benefit by only $10 million.

Some EA programs are more efficient than others. For example, lump-sum payments are preferable to rate discounts because the latter’s discounted price encourages inefficient consumption. Charge the full or cost-based rate to all customers and then transfer some of the revenues to eligible low-income households. Refund amounts can link to a specified income-percentage formula. (States with percentage-of-income plans include Illinois, New Hampshire [a modified version], New Jersey, Ohio, and Pennsylvania.) For example, eligible households should not have to pay more than 10 percent of their monthly income to heat their homes in the winter. Another way to minimize efficiency losses would be to discount the monthly charge (which California recently initiated) or other inframarginal component of the bill.

The principle of “spreading the burden” across many utility customers reduces the financial burden on each funder. This raises some questions: Which utility customers should fund the subsidies (e.g., all utility customers, only non-poor residential customers)? At what point does the “subsidy” cost become too large for ratepayers?

Some EA actions attempt to induce disconnected customers to settle their arrearages and get reconnected, and delinquent customers to settle their arrearages and stay connected. In most jurisdictions, utilities first try to work out a payment plan with customers supplemented by available outside financial assistance before proceeding to collect any shortfalls (i.e., debt write-offs) from general rates.

Comparison of Different Utility Programs

Bill-assistance programs, as a general rule, distribute lump-sum payments to pay down a customer’s utility bill. The income-eligible customer pays the same rates as other residential customers but receives a discount on his total bill. If a customer’s utility bill is $200, for instance, an assistance payment of $50 would reduce what the customer pays to $150. A real-world example is California’s Alternate Rates for Energy (CARE) program. This program of the state’s large utilities provides eligible low-income customers with a 30–35 percent discount on their electric bills. All other utility customers fund the CARE program through a rate surcharge. Some utility programs determine the amounts distributed based on a household’s income, the number of people in the household, and a household’s utility bill. Because they do not affect a customer’s decision to consume electricity at the margin, bill-assistance programs tend to minimize distortions in energy usage. They commonly provide a one-time-only benefit, which may be inadequate when low-income households have an acute ongoing need.

Lifeline rates (or inverted rates) encourage energy efficiency as well as provide customers with lower marginal prices for “essential” electricity use. They feature an inverted tiered rate structure in which consumers pay higher marginal prices at higher tiers of energy consumption. One problem with lifeline rates is that many low-income customers consume above-average amounts of electricity. Many wealthy households also consume a relatively small amount of energy, in part because of their financial ability to invest in energy efficiency and have multiple homes. Ironically, using lifeline rates to assist the poor may be counterproductive in assisting poor households. Non-targeted lifeline rates (i.e., eligibility does not depend on a household’s income) can especially benefit high-income, low-energy-use customers. They can therefore result in benefits being accrued randomly across households with wide-ranging incomes. Energy usage varies widely across households, not necessarily because of income differences, but because of other factors such as household size and consumer preferences. Lifeline rates can also increase the risk that a utility will under-recover its fixed cost because it unevenly collects those costs through the higher rate tiers where the greatest amount of usage volatility occurs. Finally, lifeline rates are discriminatory when the different tiers fail to reflect the utility’s marginal cost. In California this rate distortion has led to utility customers investing in excessive rooftop solar generation because of the above-cost “top tier” rates they were paying. Low-income as well as other customers had their rates increase to compensate the utility for the lost fixed-cost recovery from solar customers. That perverse outcome is counter to the intent of lifeline rates to benefit low-income households.

Another example of a utility program is a rate discount, where eligible low-income households receive a discount of (say) 30 percent on rates the utility charges other customers. If other customers pay a price of 10¢ for each additional kilowatt hour (kWh) consumed, low-income households would pay 7¢. One form of rate discount provides larger discounts for smaller energy use. A household, for example, receives a discount of 40 percent if it consumes fewer than 500 kWh per month, while its discount falls to 30 percent if it consumes more than that amount. From the standpoint of economic efficiency, rate discounts are probably the least desirable form of EA. A better alternative would be to give eligible low-income households monetary assistance in the form of a lump sum or in some other form that leaves unchanged the marginal price.

Common across states is a form of EA that offers customers leniency and flexibility in making payments for overdue accounts. The utility might absolve a customer’s arrearages or waive reconnection charges. These cost waivers, funded by general ratepayers, reduce the costs of service disconnections. Their major purpose is to help low-income households stay current on their bills and either avoid disconnection or have utility service restored. The underlying premise is that, in the absence of cost waivers, disconnected customers may find it financially impossible to pay all their unpaid bills to have service restored. Some jurisdictions allow forgiveness of all past unpaid bills when a customer makes timely payments over a specified period (commonly one year). One drawback is that, after the utility absolves customers of their past debts, the customers may revert to accumulating unpaid bills in the future, reasoning that they will also be absolved. This reflects what economists call a “moral hazard” problem. Some observers would also consider forgiveness violating principles of personal responsibility and fairness; for example, those low-income customers who fully pay their utility bills on time would pay higher rates.

Takeaway for Regulators

Even though economists recommend no-strings cash transfers to the poor rather than cross-subsidies, utilities engage in the latter. Utility EA initiatives should achieve utility-service “affordability” at least cost and with as little efficiency reduction as possible. Lump-sum payments should be the favored utility-initiative EA program, while rate discounts are plagued with efficiency problems and lifeline rates fail to restrict beneficiaries to low-income households and stimulate uneconomic decisions by customers like in California.