The Role of Government

Energy Probe Research Foundation’s Presentation to Justice O’Connor

Public Hearing on the Provincial Government’s Functions and Resources

The Walkerton Inquiry

July 24, 2001

(A list of EPRF’s recommendations appears at the end of this presentation.)

Elizabeth Brubaker:

Our first and overarching recommendation is that the provincial government should limit itself to strictly regulating water and wastewater systems.

The provincial government’s role should be to establish the laws and regulations required to protect public health and the environment … and then to strictly enforce them. That sounds pretty simple. But in the past, governments have utterly failed to ensure that minimum standards were  enforceable. They have also failed to ensure that those laws that were enforceable were, as a matter of practice, enforced.

Gord Robertson [an investigator with the Ministry of Environment’s Investigations and Enforcement Branch] told us this morning that the IEB has been working well and efficiently, and that it doesn’t need fixing. The record indicates otherwise.

We know that, for decades, hundreds of water plants have failed to meet provincial standards. We also know that the province has very rarely prosecuted the owners or operators of those plants. We don’t exactly how many prosecutions there have been over the years, because the government doesn’t keep track of prosecutions by sector. But judging from what we heard in Part One of this Inquiry, they’ve been few and far between. There have been maybe two a year – even though there would have been hundreds of potential targets each year!

At least one other environmental group acknowledges that this problem long predates the Harris cuts. According to the Canadian Environmental Defence Fund, “MOE has maintained a de facto non-enforcement policy for municipalities spanning three decades.”

In fact, the non-enforcement practice is even older than that. The province has known nothing but. The expert paper that Jamie Benidickson prepared for the Inquiry indicates that the reluctance to force municipalities to clean up their acts dates back to the nineteenth century. The province had the power to ensure safe water as early as 1885. That’s when it gave the Provincial Board of Health the authority to approve sources of supply and to keep sewage pollutants out of water. Did it act? No. The municipalities didn’t feel like paying for safe water. So we ended up with outbreaks of typhoid fever.

Far from enforcing the law, the province has a history of thwarting citizens who sought the protection of the court when faced with damage to their water. The Ontario Water Resources Commission, later the MOE, owed its creation to a faustian bargain to strip property rights from users in return for a regulatory alternative. (This quid pro quo from which modern water regulation in Ontario originates goes unrecognized, much less examined, in the historical analysis presented by Nicholas D’Ombrain.)

The organizing principle of Ontario’s regulatory history related to water is that the purpose of policy has been primarily to shield water and sewage providers from costs. The record of financial involvement, enforcement activity and legal intervention all support this conclusion.

Chlorination eventually beat typhoid, but we haven’t found a fix to strengthen the will of our governments. At the first public hearing – the one on guiding principles – we suggested a reason for this lack of will: Our governments have been paralysed by conflicts of interest. Only by eliminating the many conflicts that now bind government can we free it up to regulate. The remaining recommendations that we’ll present today are designed to achieve this objective.

They are also designed to unbundle different functions from one another. Some intervenors advocate bringing functions together – say, through one mega-ministry. In contrast, we often recommend separating functions. Doing so allows for the application of different skills and cultures to different problems. It improves transparency. And it clarifies accountability.

Let me move now to our next recommendation. We recommend that the provincial government should adopt a coercive – rather than a cooperative – approach to the enforcement of laws governing public health and the environment.

Historically, the province has chosen a cooperative rather than a confrontational approach to water supply. We heard from Jim Jackson in Part One of the Inquiry that this approach dates back to the nineteenth century: “The legislature,” he said, “apparently expected people to do the right thing with respect to water works.”

Mr. Commissioner, expectations are not enough. We can see where they’ve gotten us. We have to force water service providers to provide safe water and clean discharge if they don’t live up to our expectations. It’s fine to educate them. It’s fine to cooperate with them in ways that don’t impair enforcement. But at the end of the day, if they aren’t providing safe water and clean discharge, we’ve got to force them to do so. It’s the law!

It’s also the most effective way to achieve compliance. The threat of enforcement creates powerful incentives to comply.

Valerie Gibbons stressed this in her review of international best practices for environmental compliance assurance. In her discussion of enforcement and abatement, she wrote: “regulatory enforcement can never be excised from an integrated compliance strategy. A credible threat to use enforcement is part of the government’s bargaining power to make voluntary initiatives work.” And then, quoting Michael Crow, she continued, “Absent the plausible threat of enforcement, cooperative approaches to achieving compliance seem to have only limited effect on regulated entities.” Later she cited a study by Krahn finding that “the fundamental factor inducing compliance … is strong enforcement.”

Tom Adams:

Our next recommendation identifies a way to achieve stronger enforcement: The provincial government should establish an Ontario Environmental Protection Agency under the Ministry of the Solicitor General. The enforcement of public health and environmental laws should be conducted as normal police operations under this agency.

Under the current regulatory system, policy-making, abatement, and enforcement all fall under the Ministry of Environment. There are three problems with this. One is cultural. The different functions demand different approaches and create different kinds of relationships. Abatement can be cooperative and pro-active. Enforcement should be coercive and reactive. These different values and cultures can clash, and they can inhibit one another. Moving enforcement out of the MOE would distance the policy-making and abatement cultures from enforcement.

Taken in its entirety, the justice system when it functions well is effectively pro-active by creating powerful incentives to comply with society’s norms. Viewed in isolation however, enforcement is reactive since a citizen should only become a suspect if some harm has occurred.

Today, the institutional voice for coercion is muted by the other priorities within the MOE. Unbundling the IEB from the MOE would create an opportunity for the coercion perspective to get clearer representation.

The second problem with maintaining the two functions in the same ministry is that enforcement can be undermined by the abatement division’s previous interactions with polluters. If abatement officers have been working cooperatively with a municipality, and haven’t sent the file over to the IEB, they may be seen to be approving the status quo. In such circumstances, charges against the utility could lead to “officially induced error” challenges. They don’t very often. But that’s not the point. The point is that the threat of such challenges inhibits enforcement officers from laying charges. They wonder, how can we prosecute now after letting the municipality get away with this violation in the past? Won’t the municipality use our previous inaction as a defence? An independent enforcement agency would have a greater detachment from such issues.

The third problem lies in the conflicts of interest that the different functions create. According to Julian Wieder, laying charges has been viewed as a negotiation failure. An enforcement action makes the people in charge of abatement look bad. This calls to mind Roger Martin’s expert paper. People and organizations act defensively. They want to avoid embarrassment. They want to cover up mistakes. When abatement and enforcement are in the same ministry, this fact of organizational behaviour creates serious personal and professional barriers to enforcement.

Moving enforcement to the Ministry of the Solicitor General would reduce the conflicts of interest that now impede enforcement. It would help de-politicize enforcement, making it more objective and less subject to fiat. It would transform enforcement into an independent, straightforward, policing function.

We’re proposing another new regulator as well. We believe that the provincial government should establish an economic regulator to oversee water and wastewater utilities.

Ontario’s water and wastewater systems require massive investments. We’ve heard different figures: perhaps $16 billion over 10 years; perhaps as much as $32 billion over 15 years. We also know that operating costs which cover costs like testing are going up, as new standards take effect. And there’s talk of introducing full cost pricing. We expect that all of these factors will leave consumers paying more.

This will be true whether services are provided by the public sector or by the private sector. Yes, competition among private firms will encourage efficiency and will result in lower capital and operating costs. But even so, many consumers will face significant rate increases.

Some submissions to the inquiry appear to deny the need for rate rationalization. The supplement to the CELA/OPSEU/CUPE report called Financial Management of Municipal Water Systems in Ontario says, “Capitalization of the assets, higher overall interest costs and return on investment may cause the overall costs to be considerably higher [when the water system is financed or operated by the private sector] than the present costs paid by consumers.” This narrow “rates only” perspective overlooks the costs of the status quo imposed on taxpayers and the environment.

Even if it is accepted that in many instances rates must rise, this acceptance does not answer the question of what the proper rates should be and how they should change over time. Some process is needed to ensure a durable sense of legitimacy for any rates and changes to those rates as conditions warrant. A good deal of expertise is required to determine just and reasonable rates – more than can be found in most municipalities. The principle of user pay is easy to say but making it operational will take appropriate principles and institutional structures. The issues surrounding revenue requirements, cost allocation, and rate structures are very complex. Consumers need assurances that their rates are fair – that they cover no more than the full costs of a safe system. And if we privatize, investors will need assurances that their capital will be returned. These are not matters for politicians to decide. We need an independent system of economic regulation.

We’ve learned a lot about economic regulation in our dealings with the Ontario Energy Board. We’ve found that the model that worked best was the one used to regulate private natural gas distribution utilities between the 1960s and 1998. With that model in mind, we make several specific recommendations:

An independent, quasi-judicial economic regulator should be charged with determining just and reasonable sewage and water rates and protecting the public’s economic interests related to the provision of these services.

• Public participation in the regulatory process should be encouraged.

• Due process protections should be available to all parties.

• The regulator’s decisions should be subject to judicial review.

Regulatory costs should be recovered from users.

Our support for judicial review does not imply that we think regulators should be continuously second-guessed by the courts. We believe that there is a sweet spot between excessive and insufficient judicial attention that might be called the point of “judicial deference.” The regulatory system should be structured such that regulators would shield themselves from judicial meddling by the obvious justice of their decisions.

There’s another possible role for an economic regulator as well, and that’s the oversight of operating contracts between municipalities and private firms. At our expert meeting on privatization, several parties raised concerns that firms might try to take advantage of small, inexperienced municipalities. A regulator could watch out for the consumers’ interests.

The Manitoba Public Utilities Board regulates the rates of most of the water and sewer utilities in that province. It hasn’t had any experience with privatization yet. But its executive director has speculated that if a municipality wants to contract out operations, or to sell assets, it’ll have to demonstrate to the Board that the contract is the least cost alternative or that the sale is in the public interest economically. We think that’s something Ontario should look at too.

Elizabeth Brubaker:

Tom mentioned a moment ago that rates should cover the full costs of a safe system. That brings me to our next recommendation, that the government should phase out all direct and indirect subsidies to water and wastewater systems.

Both the federal government and the province have subsidized our systems very generously. In some cases, provincial subsidies have been as high as 92.5 percent of capital costs. Unfortunately, subsidies – large and small – have perverse effects, both on municipalities and on consumers.

Let’s look at municipalities first. There, subsidies discourage proper planning. In some cases, they encourage excessive investment. When virtually free money is available, municipalities may overbuild their infrastructure – sometimes to the point where they can’t even afford to operate it. Subsidies generally dampen efficiency and innovation. With someone else footing the bill, there’s no incentive to become more efficient. Accountability is weakened.

In other cases, subsidies encourage under-investment. They reward municipalities that haven’t maintained their systems and that haven’t invested in health and environmental safety. Indeed, under some programs, only non-compliant municipalities have been eligible for grants. That kind of provision creates dangerous incentives – incentives to allow systems to deteriorate. Subsidies have also rewarded bad financial planners – the municipalities that haven’t built in allowances for depreciation or haven’t built up reserves. Under some programs, big reserves have meant ineligibility for grants. Again, this creates all the wrong incentives.

Subsidies also affect consumer behaviour. When they’re not paying the full costs, people lack economic incentives to conserve water. So they use too much of it. Overuse can deplete scarce resources. And it can create demand for excess treatment capacity. Subsidies also skew people’s decisions about where to live, or where to establish their businesses. If people don’t have information about the costs of their resource use, they can’t make efficient choices about where to locate. Of course, that’s one of the reasons behind urban sprawl.

Subsidies also raise equity issues among taxpayers. They generally involve large transfers of wealth from urban residents to those living in smaller towns. Those living outside of towns – who may be equally needy – don’t benefit: They have to bear the full costs of their own wells and septic systems. There’s no particular reason that their tax dollars should go towards lowering the costs of water in a nearby town.

Our final concern about subsidies is that they discourage private sector participation in the water industry. Private firms have to know that they can recover the costs of providing safe water. They have to know that politicians won’t intervene to keep costs low. They need stability and predictability. Our subsidy programs – where the rules change every few years – are anything but.

For all of these reasons, subsidies to systems can be extremely destructive. But the fact remains that some people simply can’t afford high water bills without some help from government. We recommend that if particular users cannot afford to pay the full cost of water and wastewater services, the provincial government should provide these individual users with cash subsidies unrelated to their usage. Municipalities don’t use water, consumers do. The government could divert dollars now sent to municipalities and instead send cheques to the needy. But it shouldn’t give people, even poor people, artificially cheap water. Even the needy should have incentives to use their water efficiently and to make rational decisions about where to live.

Tom Adams:

At the last public hearing, you addressed us with a question about potential price shock. You asked whether Energy Probe would consider a one-time “catch-up” as an acceptable exception to the principle of full cost pricing. I replied that the cost of service did not have to reflect the immediate recovery of the capital budget but should be spread over time with debt. On reflection, we have some points to add.

Any price increase caused by strict user pay would also be naturally moderated by the ramp-up time required to build utility assets.

Recognizing the need for a socially acceptable solution, the pure user pay solution has potential advantages. It would mark a clean break with the past. A policy of strict user pay might help lower the long-term cost of capital by signalling the investment community about the firmness of the policy commitment to rationalization. Apparently respectable authorities are suggesting capital requirements so substantial that the capacity of government, which has many competing demands for funds, to make a meaningful dent, particularly if subsidies are scattered widely, might be limited. Allowing past practices to carry on for a time-limited period might create a slippery slope to extending those practices ad infinitum.

Even if the Commission decided that it would be appropriate to set aside the principle of user pay until the infrastructure deficit is overcome, Energy Probe is sceptical that this strategy would work. Historical experience has proven that government funding through grants and loans has failed to keep up with the need. Historical experience has also demonstrated that grants and loans can be subject to poor administration.

The condition today of the province’s physical plant means that consumers today benefit little from the contributions of consumers in the past. That situation contrasts with the situation in gas where much useful plant is highly or complete depreciated. One of the principles of sound rate-making widely accepted by regulators and utilities is to match as closely as possible the benefits of service with the costs of service. The beneficiaries of good quality service are consumers now and in the future and therefore is would be just and reasonable to charge the cost of this service to consumers.

Ontario’s water service needs to be put on a solid footing. Leaving the system beholden to political influence until some future date perpetuates the fundamentally flawed structures that have caused the deficiencies in the existing system.

Elizabeth Brubaker:

Just as the province should withdraw subsidies to water and waste water providers, it should also withdraw another kind of support, and that’s the support provided by the Ontario Clean Water Agency, or OCWA. Our recommendation on this matter reads, the provincial government should not operate water and wastewater facilities. It should disband the Ontario Clean Water Agency.

Our recommendation stems from a number of concerns. First, OCWA performs poorly. It  provides consistently substandard service. According to OPSEU, more than a third of OCWA’s water plants didn’t comply with provincial standards last year. That may look good compared to the municipal record, but the fact remains that it’s not nearly good enough. Nor is OCWA’s sewage record any more acceptable: In 1999, approximately 35 of its sewage facilities failed to meet provincial laws or guidelines.

A second problem is that OCWA is too close to the government. It is not exaggerating to say that OCWA is an embodiment of a conflict of interest. It’s government-owned and government-backed in terms of its risks and liabilities. It’s supervised by the government, with deputy ministers filling its board. Its employees initially came from the government, and senior managers continue to travel between the two organizations. These relationships create serious conflicts of interest that would not be solved to finding outside directors to sit on its board.

A third problem is that OCWA is neither transparent nor accountable to the public. It won’t even release a list of the plants it operates, saying that that’s commercially confidential information. And it closely guards its financial information. It appears to be sitting on a huge wad of cash. That’s because when it was established, the province sold it a loan portfolio – sold it at a big discount, I might add. As the loans are repaid, OCWA’s account gets bigger and bigger. At the end of 1999, it had 131 million dollars in cash on its books. What’s it going to do with all that money? Why doesn’t it give it back to provincial taxpayers? Nobody knows! As one reporter said, “there is a brick wall around OCWA.”

Private firms see OCWA as a serious barrier to the creation of a competitive environment in Ontario. Several complain that the agency enjoys a host of subsidies – subsidies that give it an unfair advantage over them. In his expert paper, Nicholas d’Ombrain confirms that OCWA enjoys a number of advantages over its competitors: It pays no corporate taxes; it’s exempt from collecting GST; it doesn’t usually post performance bonds; and it’s backed by the province’s financial guarantee.

OCWA masquerades as a competitive provider. But it’s not competitive without help. It’s not independent. It’s certainly not private. But it’s not unabashedly public. It’s one of those monstrous hybrids that Jane Jacobs condemns in Systems of Survival – it’s somewhere between the government and the private sector. Jacobs criticizes such hybrids for being unworkable, both morally and economically. We agree. (That reminds me of a comment I read in the National Post a few weeks ago – something about an agency with the head of socialism and the heart of capitalism. A monstrous hybrid indeed!)

So we think that OCWA should go. In case the commission or the government doesn’t share our opinion, we’ve made several recommendations regarding changes to the agency. We’re recommending that if the government choses to maintain OCWA, it should level the playing field to avoid undermining competition and discouraging private-sector involvement in the industry. It should create an arms-length relationship with the agency, withdraw all subsidies to it, impose a dividend policy that requires it to turn over surplus cash to the public, and hold it accountable for its performance by strictly enforcing environmental and health standards at its facilities. We’re also recommending that if the government does not remove OCWA’s special privileges, and if it insists on maintaining the agency as an operator of last resort, it should allow it to take jobs only if there is insufficient competition among other bidders.

Our remaining two recommendations regarding the government’s functions concern issues that will be addressed in upcoming hearings. One is that the provincial government should grant no one the right to contaminate a source of water. We’ll talk about this at the source protection hearing. The last recommendation is that the provincial government should encourage the privatization of municipal water and wastewater utilities. We’ll provide more detail on this at the final set of hearings.

Energy Probe Research Foundation’s Recommendations Regarding

The Provincial Government’s Functions and Resources

The provincial government should limit itself to strictly regulating water and wastewater systems.

The provincial government should adopt a coercive – rather than a cooperative – approach to the enforcement of laws governing public health and the environment.

The provincial government should grant no one the right to contaminate a source of water.

The provincial government should establish an Ontario Environmental Protection Agency under the Ministry of the Solicitor General. The enforcement of public health and environmental laws should be conducted as normal police operations under this agency.

The provincial government should establish an economic regulator to oversee water and wastewater utilities.

• The independent, quasi-judicial economic regulator should be charged with determining just and reasonable rates and protecting the public interest.

• Public participation in the regulatory process should be encouraged.

• Due process protections should be available to all parties.

• The regulator’s decisions should be subject to judicial review

• Regulatory costs should be recovered from users.

The government should phase out all direct and indirect subsidies to water and wastewater systems.

If particular users cannot afford to pay the full cost of water and wastewater services, the provincial government should provide these individual users with cash subsidies unrelated to their usage.

The provincial government should not operate water and wastewater facilities. It should disband the Ontario Clean Water Agency (OCWA).

If the government choses to maintain OCWA, it should level the playing field to avoid undermining competition and discouraging private-sector involvement in the industry. It should create an arms-length relationship with the agency, withdraw all subsidies to it, impose a dividend policy that requires it to turn over surplus cash to the public, and hold it accountable for its performance by strictly enforcing environmental and health standards at its facilities.

If the government does not remove OCWA’s special privileges, and if it insists on maintaining the agency as an operator of last resort, it should allow it to take jobs only if there is insufficient competition among other bidders.

The provincial government should encourage the privatization of municipal water and wastewater utilities.

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