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King County, WA, uses a simple system to keep its regulatory and financial acts together. By Thomas T. Karston Virtually every solid-waste management system in the world, whether public or private in nature, needs to rationally determine the prices it charges to end users. In some cases the process by which this is done receives remarkably detailed scrutiny by the public and the press. Often there are also several outside advisory boards involved. Recognizing such realities, this article suggests an effective, simple, and transparent model for setting user fees, taking into account the numerous financial and regulatory requirements that are usually associated with solid waste operations. For those readers who already have far more sophisticated systems in place, this discussion might be a helpful comparison. For others who are currently looking for a system or a guide to developing their own in-house model, the approach suggested here might offer some material assistance. This method is currently used by the King County Solid Waste Division, which handles about one million tons of waste per year for the area surrounding, but not including, Seattle. To see how this approach to rate setting works in practice, it is helpful to consider that in virtually all aspects of its mandate the division works cooperatively with 37 quite diverse suburban and rural cities, and on a monthly basis receives advice from three distinct outside committees that, taken together, represent elected officials, professional haulers, technical specialists from the cities, and interested citizens—including retired Boeing engineers. Since solid waste operations across the country can vary considerably in the range of services they offer, a few comments about the scope and philosophy of the King County system might also help place the following rate model in some context. For one thing, the division still operates its own landfill, which is currently expected to function until at least 2016. For many years the operating framework has in effect incorporated the very modern concept of “extended producer responsibility” in that when waste is turned over to the county the price paid by customers is calculated to cover the entire future life cycle of all costs involved with disposing of the waste, including landfill development and closure, landfilling per se, gas recovery, regulatory compliance, and also 30 years of post-closure maintenance. The intent is that current users of the system cover their full costs, so that future generations will never be paying to care for waste that was disposed with the county decades earlier. The division sets aside cash on a regular basis to cover the full cost of all future equipment replacements. Unlike private-sector operations, which calculate depreciation largely for tax purposes but generally do not use actual sinking funds, the division calculates and transfers cash from its operating fund into a capital equipment replacement program (CERP) to ensure that virtually all rolling stock and construction equipment, as well as staff vehicles, can smoothly be replaced at the end of their useful lives. The possible thin opportunity cost involved with earnings on this fund is considered a small price to achieve rock-solid stability and continuity in the funding of ongoing operations. Many other organizations operate differently, of course, but then may periodically encounter awkward spikes in budget requests and/or debt requirements, especially in a public sector where politics is about making very public choices among innumerable pressing needs competing for funding. Given this framework, which might be more financially and managerially demanding than some other solid-waste systems, the rate-setting process involves the interaction of five related financial models. Collectively, these seem to satisfy the needs of local elected officials, their technical staff specialists, the press, and a wide variety of concerned citizens. The components of this system are:
In setting future rates clearly, the logical first step is to forecast the solid-waste tonnage expected over the forecast period, which may typically be three years in length. While these projections might involve a bit of econometric razzle dazzle, the end product is, of course, simply tons by type of waste, by location within the service area, by year throughout the rate period, and perhaps for some 20 years further, to encourage a serious look at longer-term trends. Using these inputs, and skipping ahead to the final step by way of overview, the financial model compares revenues and projected expenses at different hypothetical tipping fees to solve for a required minimum fund balance at the end the last year in the rate period. By testing a range of values for the tipping fee, a solution is easily forthcoming—assuming that several intermediate steps have been carefully executed: projecting costs, capital requirements, and non-tip-fee revenues. So, step two involves forecasting the future costs of operations. However, this first requires a clear understanding of exactly what level of services the organization will provide to its customers, the nature of its labor relations environment, and how—or if—the budget of the solid waste operation relates to other aspects of local government. Once these more philosophical issues have been resolved, it is relatively easy to predict future short-run operating expenses. In solid-waste organizations, these costs often can be divided into three categories: operations, or the expenses of actually doing the daily work; administration; and transfers to other funds. Operations costs are often straightforward to forecast over the forthcoming rate period, because they have to be grounded in budget numbers for the current year. But in looking several years further out, or certainly when considering a 15- or 20-year horizon, it is important to distinguish between “fixed” costs and those that are variable. Fixed usually means that any increases are due to inflation alone, a major exception usually being debt service. In contrast, variable costs might go up sharply with tonnage but also rise with inflation. If a simple cost-per-ton approach is used for forecasting variable expenses, it is important to not also apply this method to the fixed costs, which could result in serious overestimates.
Administration costs are straightforward and usually vary only with inflation—and with any reorganizations that can be expected, as these are often a normal part of any larger operation. However, the third cost component, transfers to the other funds, is more interesting. The operating fund is often the melting pot that brings together the cost implications for activities occurring in the four closely related areas mentioned above. Figure 1 illustrates an example. In it, the tonnage forecasts feed into the financial model, and when multiplied by the preliminary tipping fees generate a revenue estimate, to be refined shortly. On the cost side, one of the key elements is the transfer out to the construction fund, which in turn calculates and then feeds back into the financial model any debt service that might be relevant in future years. This could be a significant number if major capital investments for facilities are being planned, but fortunately, by working closely with the relevant engineers, it can be relatively straightforward to project the required volume of bond issues and to approximate their annual debt service costs. For operations that do not own and manage their own landfill, the landfill reserve fund might seem a bit odd. This model calculates the annual transfer needed from the operating fund to construct and care for the existing landfill during its years of operation and to also build up a trust fund so that when the facility is closed there will be sufficient reserves to monitor and maintain it in all respects for at least 30 years. This is one of the financial implications of the operating philosophy mentioned above. In a related system, unlike most private-sector operations, the division calculates and sets aside cash on a regular basis to fully fund the replacement of some 350 major pieces of equipment. This CERP-fund model takes into account its opening balance, the interest it earns, the cash it needs to steadily fund new purchases, and the salvage value of assets being retired. The result is the required transfer each year from the operating fund. After these inputs are prepared and entered into the financial model, two more steps are useful before solving for the main tip fee. One is simply forecasting the total cash flow that will be received from all sources of non–tip fee revenue. These ancillary items might include grants, interest earned on existing fund balances in the operating fund, revenue from the sale of recycling materials, “judgments, settlements and fines,” and any related items. As a last preparatory step before solving for the main tipping fee, it is useful to project the revenue streams that can be expected from the smaller “product lines,” such as those generated by yardwaste, special waste, and any other categories that pay a fee based on tons but where the total revenues involved are perhaps only 5% or 6% of what is generated by the main tipping fee. Using only historical numbers to forecast such ancillary prices is perhaps too easy. Projecting these future rates based on a spread to the basic fee might be more accurate, to help establish a realistic environment for setting the basic fee itself. After an optimal value is found for this main price, it is then easy to go back and appropriately fine-tune the rates for the smaller categories of waste, using whatever relationships to the main fee might be relevant in each case. For example, with the category “special waste,” the extra costs, on average per ton, that are involved with handling these materials should be added to the basic fee to get the appropriate price per ton. In another case, yardwaste is now increasingly taken to a private composting facility, even if it first comes to a public-sector transfer station and pays a fee set by the relevant governmental unit. Therefore, this yardwaste fee per ton should be determined by starting with the basic tipping fee, subtracting the cost of hauling to the landfill, and also subtracting the cost of disposal at that landfill, but then adding the cost (public or private) of hauling the material to the private compost facility and also adding any fees involved with processing it there. After having determined the basic fee, it is often useful to compare its past and projected values with the rate of inflation, starting perhaps in 2000 and extrapolating out some 20 years into the future. As an example of how this comparison can be quite practical, King County Executive Ron Sims several years ago made a commitment that the rate of increase in the main tipping fee will be lower than the rate of inflation as long as the county landfill remains in operation. In this particular longer-term forecast it is expected that the local landfill facility will close in 2016 and that a shift to another disposal method, likely to be long-haul rail exporting, is projected to be quite a bit more expensive. In this context, regularly examining the longer-term horizon in some detail can be quite productive in planning for such substantial future shifts. It can also be useful to calculate the impact of any increase in the basic fee on the hypothetical average one-can curbside customer over the particular rate period under consideration. This number would, of course, reflect only the influence of a change in the disposal component of curbside costs, not any change in the collection or overhead costs of commercial haulers that might be involved. In the King County environment, with a million tons per year and with the advantage of a publicly owned (and often award-winning) landfill, this disposal-related impact of a change in the basic tipping fee is expected to be only about 80 cents per month for the hypothetical average one-can customer, even though 2008 will likely see the first rate increase since January 1999.
A word about tonnage forecasts: A major consideration in any longer-term tonnage projection is the recycling rate that is assumed and, in particular, how this rate might evolve over the planning horizon. How aggressive any governmental unit wants to be in promoting bans, price increases (or subsidies) involving waste reduction is a separate matter, but in shaping these policies the elected leaders can find it quite helpful to know the consequences on future tonnage levels from different recycling rates. Figure 2 shows one possible type of presentation, where a hypothetical community would move from a recycling rate of, say, 43% to 50% and then perhaps to 60%. It can also be useful to provide at least some rough estimate of the timing on how such a transition will evolve, rather than leave this important aspect up in the air. If a region is at, say, 43% in 2007, it might be reasonable to assume that over the next six years a one-percentage-point improvement per year can be accomplished, reaching 50% by 2014. If the community and its leaders want to be more aggressive, one could assume a 2-percentage-points-per-year improvement over the subsequent five years, leading to a 60% recycling rate by 2019. In each case, the resulting amount of waste to process via a landfill or incinerator is easily calculated by subtracting the projected recycling amounts each year from the forecast of total tonnage expected to be generated in the service area. The use of some or all of this five-part system, and perhaps several of the presentation graphics suggested here, can provide elected representatives with considerable input regarding the merits of any proposed rate increases, and the full impact of waste-management activities over the rate period under consideration. In addition, use of these concepts, together with an open and transparent review process involving the relevant cities, professional haulers, and interested citizens, may also further bolster confidence that this important public health responsibility is being prudently managed, in the context of an extended long-run horizon. Thomas T. Karston is chief economist for the King County (WA) Solid Waste Division.
MSW - May/June 2007
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