DO "INSIDE-OUTSIDE" RATE DIFFERENTIALS CONSTITUTE UNFAIR DISCRIMINATION?

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.

DISCRIMINATION IN RATES: FREE SERVICE AND DISCOUNTS

Historically, utilities frequently have provided service without charge to public and governmental buildings and uses, such as administrative offices, libraries, schools and even churches. Utilities have attempted to explain such free service on public relations-good will grounds or as a franchise concession.

However, free service cannot be justified by cost of service ratemaking principles and is unreasonable discrimination on its face. So, for example, a New Jersey court held that a contract was unjustly discriminatory because an electric utility agreed to provide free lighting service to municipal buildings. City of Plainfield v. Public Service Electric and Gas Company, 412 A.2d 759 (N.J. 1980). The Wisconsin Public Service Commission has prohibited a municipal owned water utility from providing free or discounted service to municipal departments. City of Westby, 2-U-5017; City of Brodhead, 2-U-5092, 1958 WL 7484. An Indiana court has held that the state regulatory commission could set telephone rates to be charged a city even if the franchise granted the telephone company called for free service. Winfield v. Public Service Commission, 118 N.E. 531 (Ind. 1918).

Discounted rates, such as for senior citizens or for lifeline programs have been held to be invalid discrimination in some states. For example, see Mountain States Legal Foundation v. Utah Public Service Commission, 636 P. 2d 1047 (Utah 1981). Along lines similar to discounted rates, a Massachusetts court held that a disproportionate large water rate increase to one industrial customer compared with other industrial customers was illegal discrimination. Massachusetts Municipal Wholesale Electric Company v. City of Springfield, 726 N.E. 2d 973 (Mass. App. 2000).

Some states have approved economic development discounted rates as legal discrimination when the evidence shows all customers will benefit from the assumed additional load and revenue. Re Northern Indiana Public Service Company , 96 PUR4th 267 (Ind. U.R.C. 1988).