Rent Dissipation Through Electricity Prices of Publicly-Owned Utilities

Economists have long advised pricing electricity at marginal cost. In the case of public utilities producing from hydraulic sources, this would ordinarily generate a rent that could be used to finance public projects or to lower taxes. But marginal cost pricing by public utilities is rarely observed in practice, the potential rent being dissipated through low electricity prices. This paper offers an explanation of such a phenomenon by using a public choice model. It is shown that if (i) government revenues are raised through proportional taxes, (ii) median income is less than mean income, and (iii) the share of a consumer's spending on electricity decreases with income, then the price resulting from a majority rule and universal voting is below marginal cost. Its level can be determined by a modified Ramsey rule which takes into account the population income distribution. When a fixed subscription fee is charged to the consumers, this fee is set as low as possible, generally reflecting fixed distribution costs exclusively. It is also shown that publicly-owned utilities must be able to exploit a resource rent in order to break even, suggesting that utilities operating under constant or increasing returns to scale would normally be private or be privatized in the future. Empirical evidence of these results are obtained from the observation of the Canadian electric industry in general and of the pricing policies of Hydro-Qu‚bec, one of the major Canadian public utilities, in particular.