Water Subsidies, Water Transfers, and Economic Efficiency
Kanazawa, Mark T., Contemporary Economic Policy
Why does inefficiency pervade water use in the western United States? Two reasons have received much attention in recent years: (i) Price distortions--that is, prices not reflecting social marginal cost--are ubiquitous. This in itself would not be so bad if the old adage that "water is different" really were true. If people viewed water as a non-economic good, they presumably would not care how much it costs and incorrect prices would not matter very much. The "problem" is that water is not all that different and people do care how much it costs, so that incorrect prices may matter a lot. (ii) Throughout the west, water transfers seem absurdly difficult. Congress, state legislatures, state and federal agencies, courts, and state constitutions all have placed obstacles in the way of transfers, even ones that make economic sense. With so much water securely fastened on low-value existing (mostly agricultural) uses, many high-value new and emerging (mostly municipal and industrial) uses go wanting. And this is not simply western cities and businesses spouting the self-interested party line. Countless gallons of ink have been spilled by (more or less) disinterested academics deploring the same sorry state of affairs (Meyers and Posner, 1971; Anderson, 1983; Gardner, 1983; Frederick, 1986; Candee, 1989; Wahl, 1989).
At the center of controversy over western water sits the federal government, or, more specifically, its main arm in western water development, the Bureau of Reclamation. Since the turn of the century, the Bureau has been supplying oceans (or at least, very large lakes) of water to western farmers at heavily subsidized rates while imposing numerous restrictions on subsequent water resale. Many believe this double whammy is responsible for considerable welfare losses (Anderson, 1983; Rucker and Fishback, 1983; Congressional Budget Office, 1983a, 1983b; Wahl, 1989). Cities that are ready, willing, and able to buy Bureau water from farmers are blocked from doing so. Farmers who are unready, unwilling, or unable to sell Bureau water that they got dirt cheap over-use it. Since developing new supplies likely will be extremely expensive, many economists have prescribed some variant of the following policy reforms. First, reduce or eliminate Bureau subsidies to discourage water use by farmers and to bring water value in agriculture more into line with its value elsewhere. Second, ease restrictions on transfers of Bureau water to allow farmers to sell it to cities and industry.
This paper critically examines some fundamental precepts in current discussions of Bureau policies and discusses the possibilities for reform. The analysis centers on an important feature of Bureau water supply contracts: "entitlement ceilings" on the quantity of water farmers receive in a given year. These ceilings have some important positive and normative implications, yet analysts do not fully appreciate them. Overlooking these ceilings may lead analysts to exaggerate the efficiency losses resulting from Bureau pricing subsidies and transfer restrictions. The analysis here also sheds light on the likely desirability and effectiveness of various policy reforms that currently are the subject of vigorous debate.
II. BUREAU PRICING AND TRANSFER POLICIES
The Bureau heavily subsidizes western farmers. Most importantly, farmers buy Bureau water under long-term contracts that exempt them from repaying interest costs that the Bureau incurs in developing the water. In practice, the Bureau often further expands the subsidy by shifting the costs of multiple-purpose projects away from farmers and reducing farmer payments in economic hard times (Rucker and Fishback, 1983; Congressional Budget Office, 1983a). At present, farmers continue to buy Bureau water for as little as $3.50/acre-foot (af). In a 1980 study of 18 irrigation districts throughout the West, the Department of Interior calculated the magnitude of the subsidy. …