Many municipal-owned water and wastewater utilities have maintained "inside-outside" rate differentials. In such situations, customers of such systems located outside of municipal boundaries are charged higher rates than rates charged municipal residents of the same class. Often the outside rates are a multiple of the inside rates.
Such inside-outside rate differentials clearly constitute discrimination, which can be justified only if the costs to serve outside customers are shown to be higher than the costs to serve inside customers of the same class. Rate differentials can be supported only by cost of service studies. See Massachusetts Municipal Wholesale Electric Company v. City of Springfield, 726 N.E.2d 973 (Mass. App. 2000); Village of Niles v. City of Chicago, 558 N.E.2d 1324 (Ill. App.1990). "[A}though not obligated to serve non-residents in the absence of a contractual relationship, a municipality is prohibited from discriminating unreasonably in rates or manner of service when it elects to serve non-residents." Schroeder v City of Grayville, 520 N.E.2d 1032 (Ill. App. 1988).
However, at least two cases have held that the burden of proof is on the outside customer to show that the rates charged it do not reasonably reflect actual costs of service. See City of Novi V. City of Detroit, 446 N.W.2d 118 (Mich. 1989; Farley Neighborhood Association v. Speedway, 765 N.E.2d 1226 (Ind. 2002).
Some conclusions may follow:
1. Water and wastewater rates, and their design, should be based upon full cost of service studies-regardless whether inside or outside rates.
2. In setting rates, applicable rate-making principles should be followed per the law, bond ordinances and AWWA manuals.
3. Outside customers may have the burden to prove their rates are unreasonable, which effort may involve costly litigation and expert witnesses.
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