Can an economist find happiness setting public utility rates

Alfred E. Kahn describes his applications of economic theories to rate level regulatory policies during his career as a public utilities regulator. Two shifts in regulatory thinking have responded to the intent to have rates set to reflect rising costs that will be occuring while the rates are in effect rather than on past costs and have recognized that varying the allowable rate of return can be as effective as changing the rate base. Pressures have been exerted on economists to place too much emphasis on regulatory lag, full-cost pricing, sunk cost, and other factors affecting capital formation. A rational policy recognizes differences between the needs of individual companies to raise capital and the variations that occur during a given accounting period. Rates based on trends that recognize returns over a time span is one solution. Anticipated cost increases have been included in rate levels so that automatic cost adjustments can be made during times of inflation. Because of increases in the marginal cost of capital, regulators must decide how to selectively vary cash flow during construction periods in a way that will give adequate signals to consumers. Situations in which a water company is associated with a real estatemore » developer can avoid a double recovery of investment by granting rate increases in relation to cost over time.« less