Balancing Equity and Efficiency in Electricity Tariff Design


The growth of distributed energy resources (DERs), such as rooftop solar, raises significant distributional justice and equity concerns about who has access to DERs and their benefits. DER compensation is critical to incentivize widespread adoption. And, because net metering–the most common form of DER compensation-relies on the underlying retail rates, tariff design is key to advancing equity. However, traditional tariff design approaches suffer from the assumption that economic efficiency and equity must necessarily trade-off. Moreover, due to an exclusive focus on recovering utility costs while designing electricity tariffs, the state-of-the-art approaches do not account for externality implications of tariffs, such as the climate and public health harms that result from energy production. Our paper describes a comprehensive tariff design framework that incorporates both economic efficiency and equity objectives to determine electricity tariffs. We offer recommendations on how efficient tariffs can be designed without sacrificing equity, and the role of spatio-temporal granularity in tariff structures to achieve equity.

Current Practice

Currently in the US power sector, tariffs are determined by the public utility commissions based on the technological and economic considerations of the system. The technical constraints for reliably operating the power distribution system include balancing the supply and demand of electric power at all times, while complying with voltage and power flow limits of feeders. Economic objectives include the economic considerations of the stakeholders, including revenue adequacy for the power utility. Economic considerations are often modeled using the surpluses of the power utility and consumers, while revenue adequacy allows the power utility to recover its operational and capital costs along with a pre-negotiated rate of return. The public utility commissions decide the type and level of retail electricity tariffs by balancing the often-conflicting economic objectives of the stakeholders. The current tariff design approaches do not fully account for the system’s equity or externality impacts and are therefore agnostic on the distribution of costs and benefits of electricity in the society.

However, electricity tariff design is not only a techno-economic problem, but a social and political one as the acceptability of the designed tariff is also important for its adoption. For example, in 2017, 45 states in the U.S. proposed or adopted changes to tariff design practices. Such extensive overhaul efforts show that there is a consensus among stakeholders that current electricity tariffs and DER compensation mechanisms need to be revised. With the extent of transformation needed, it is even more important that we make equity an operational goal for tariff design.

Equitable Tariff Design

We propose to incorporate equity as a distinct design objective for designing electricity tariffs. While there are multiple ways to define equity, our paper defines it in the broader sense of fairly distributing the costs and benefits of electricity, including externalities. We use affordability of electricity, global climate change damages, and impacts on public health as the three criteria for analyzing the distribution of costs of electricity production across different socio-demographic groups.


We use ‘energy burden’ as a metric for affordability. Energy burden is the percentage of household income that a particular household spends to procure electricity. For Manhattan, the test system used in our study, our results show that a single system-wide flat tariff would overburden the consumers with lower household incomes. So, introducing temporal and spatial granularity into electricity tariffs (different tariffs for different consumer groups) is necessary to enable a consistent energy burden throughout the system.

Global Climate Change and Public Health Damages

Electricity tariffs have the potential to influence demand, which in turn, increases or decreases production. Pollutants are emitted into the atmosphere via energy production and can be divided into two main categories — global and local pollutants. This distinction is based on the nature of damages caused by such pollutants. Global pollutants, such as carbon-dioxide, have global climate change effects, irrespective of their location. Therefore, a single global value can monetize the damage caused by each ton of carbon-dioxide emitted into the atmosphere. However, local pollutants, such as sulfur-dioxide, oxides of nitrogen, and particulate matter (PM2.5), have locally concentrated effects. The impact of local pollutants on population health therefore depends on the location of the polluting source and varies with distance and atmospheric conditions. Therefore, localized social costs of such pollutants are calculated based on chemical transport models. For example, for a coal-fired power plant, social costs of local pollutants would be higher in the vicinity of the power plant, and lower as we move away from the source of emissions, given uniform atmospheric conditions. Thus, local pollutants directly contribute to the inequitable distribution of costs of energy production. It is imperative to understand which parts of the system contribute to the increase in demand and which parts bear the costs of local pollutants generated in response to this increase. To this end, we incorporate the global climate change damages and social costs of local pollutants as two additional measures of equity in our tariff design framework.


Based on the analysis of our proposed tariff design framework on the real-life 11-zone New York and 7-zone Manhattan power networks, we recommend the following:

1. Tariff design approaches should incorporate equity along with techno-economic considerations in the tariff design frameworks. The metrics of equity should include locational social costs of emissions, global climate change damages, and socio-economic and demographic profiles of consumer groups. Such comprehensive tariff design approaches ensure the availability of affordable energy, and an equitable distribution of costs and benefits of electricity in the society.

2. Regulators should move from flat volumetric tariffs to temporally- and spatially-granular tariff structures. Our results show that maximum equity and efficiency outcomes are achieved for locational hourly tariffs (i.e., tariff changes in each hour for each zone in the system), with the minimum energy burden to consumers. For example, in Manhattan under flat volumetric tariffs, the lowest feasible energy burden for maximum equity and efficiency gains is 10%, whereas it is 6% under locational hourly tariffs.

3. While transitioning to ideal temporal and spatial granularity, regulators should introduce intermediate tariff structures with lower time and/or location resolution to enhance the efficiency while reducing consumer energy burden, as compared to the status quo. Time-of-use (TOU) tariffs perform better than flat volumetric tariffs at a lower energy burden. Similarly, locational TOU tariffs (i.e., a different TOU tariff for each zone of the system) perform better than the system-wide TOU tariff.

By Hafiz Anwar Ullah Khan, PhD candidate in Electrical Engineering at New York University studying energy justice in electricity markets.



Policy Integrity at NYU Law
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The Institute for Policy Integrity is a non-partisan think tank using law and economics to protect the environment, public health, and consumers