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Attachment D levies, the most direct mechanism for recovery of capital expenditures is through utility rates, as Roseville does currently. 2. Rates should be designed to promote an efficient use of resources. This principle reflects the goal that rates should send an appropriate price signal to customers by reflecting the cost of serving them. Stated another way, an efficient allocation of resources takes place when the value a customer places on a product is equal to the cost of producing the product.3 This concept is generally referred to as "cost-based" rates. There are several issues to consider, which I address separately below: • not recovering costs incurred by each rate class from that rate class (inter-class subsidies); • the rate design of the base charge and the variable rate; and • recovering fixed costs through the base charge versus the tax levy. a. Inter-class subsidies An inter-class subsidy occurs when the revenue collected from one class of customers fails to recover the cost of serving those customers, and the difference is made up by over- recovering costs from other customer classes.4 To send the proper price signal, it is appropriate to minimize inter-class subsidies within a utility rate structure. However, in the interest of fairness and affordability, it is not unprecedented to have large, non-residential customer classes subsidize smaller and residential classes. From discussions with Finance Director Miller and review of his rate analysis, it is my understanding that Roseville's residential class water usage is subsidized by approximately seven percentage points. That is to say that the single-family residential class water usage revenues account for approximately 44 percent of total revenues collected, yet actual usage is approximately 51 percent of City-wide water usage.5 The situation is similar for sanitary sewer usage with a subsidy of approximately 14 percentage points. Regarding inter-class subsidies related to base charges for water, it appears that the residential class is subsidized by approximately nine percentage points. However, the residential base charge for sanitary sewer subsidizes the multi-family and non-residential classes by three percentage points. When extrapolated over the actual revenue dollars, the effect is basically a net wash.6 For context, the current percentage shifts for water and sanitary sewer usage results in a $2.77 per residential customer shift to multi-family and non-residential customers on a 3 Id. Page 3. 4 Page 10, Peirce Direct Testimony, filed June 5, 2014, in Xcel Electric's most recent rate case in Docket No. E002/G R-13-868. 5 See attachment for calculations. These numbers are based on 2015 utility rate analysis are meant to be illustritive, as they will change from year to year. 6 Id. Page 2 of 5