How the civil service responded to our proposal for changing the pricing system for Scottish Water

Water is one of Scotland's most vital and largest industries. It is an input into all other forms of economic activity as well as being part of every family's expenditure. It is therefore important, both for living standards and for the economy, that the pricing of water in Scotland is taken extremely seriously and that efforts are made to have an appropriate, sustainable charging system. Since 2002, when the office of the Water Industry Commissioner for Scotland was established, we have analysed the various methods used to determine water charges, and have shown that each of the various methods have major faults. In 2008, the Cabinet Secretary for Finance raised with us the problem of capital charges on the water industry: it was expected that changes in Treasury policy would make water capital charges an increasing real burden to the Scottish government budget. As a result of both this concern and our 2007 Commentary paper, (which had set out the problems with the current method of setting water charges), we proposed a new charging system for Scottish Water, details of which we published in the Fraser of Allander Commentary in February 2009. Under our proposed charging system, net new capital formation financed from customer charges would be regarded as being paid for by a notional loan from the customer base as a whole to Scottish Water. We suggested that the body of customers as a whole would then earn a return: this would be in the form of a rebate, equal to historic cost interest and depreciation on the notional loan. In our paper, we showed how this approach would be fully sustainable, and would lead to significantly lower charges for customers than the present regulatory capital value pricing system. The approach would also have had significant benefits as regards the capital charge which, (when the paper was written), the Treasury levied from departments on the capital assets of public corporations. Although we received no response from the Water Industry Commission for Scotland, (WICS), or the Scottish government civil service with responsibility for water to this or our earlier paper, it transpires that the civil service did provide a briefing on our paper to Ministers. In the summer of 2010 we were given a copy of the brief which had been put to Ministers by the civil service, commenting on our proposal. This brief was originally prepared for Ministers in 2009, and a slightly revised version was put to Ministers again in mid 2010. It is the later version of the brief which has now been given to us. This paper represents our critique of the civil service comments on our proposal. We will demonstrate that the advice put to Ministers was seriously flawed: in several respects the advice was factually wrong – and we believe that there were major omissions relating to matters which should have been covered in advice given to Ministers. Our conclusion is that Ministers would have found it impossible to make a properly informed decision about the relative properties of different charging methods, or about the merits of our specific proposal, on the basis of the civil service brief