Markets for clean water

Last month, the Environmental Protection Agency published a memo encouraging states, tribes, and local governments to look to markets for help in solving stream quality issues. Traditionally, the federal Clean Water Act has been implemented with a command-and-control approach: first, pollution limits are set for a stream; then individual permittees are regulated to meet them. But this bureaucratic process can lead to clear inefficiencies: demanding one source reduce pollution at exorbitant cost while ignoring another source’s cheaper opportunity to do so. The net result is to drive up the cost of improving water quality.

Water quality trading can lower these costs and, thereby, unleash new opportunities to improve water quality. For instance, the regulatory approach distinguishes between “point sources” (traditional, direst sources of water pollution, like a waste pipe) and “non-point sources” (everything else but, most importantly, urban and agricultural runoff). The former are individually permitted and, therefore, closely regulated. The latter are not and have been slower to mitigate their pollution. Water quality trading can take advantage of this low-hanging fruit, by letting nonpoint sources sell credit to point sources based on the nonpoint sources’ pollution reductions.

In the 1990s, for instance, North Carolina communities, with the help of the EPA, Environmental Defense Fund, North Carolina Environmental Management Commission, and other state agencies, established a water quality trading program for the Tar-Pimlico River. As Bruch Yandle explained in a 2008 PERC Report, “[t]here were large gains from trade.”

In some cases, a farmer could spend $13 to reduce a unit of nitrogen discharge that would cost a [water utility] nearly $35 to accomplish. To get reductions, farmers installed buffer strips along creek sides and found ways to use discharge from swine operations for fertilizing pastures. By way of improved [water utility] operations and contracting with farmers, the Tar-Pamlico River Basin Association achieved major reductions in point- and nonpoint-source nutrient discharge.

Unfortunately, these programs have been infrequently tried because of high transaction costs imposed by the federal bureaucracy. The new EPA memo aims to lower those costs by giving states, tribes, and communities flexibility to develop the water quality trading regime that works for them, rather than dictating a one-size-fits-all model from DC.

The memo announces six principles EPA intends to use as it reviews proposed water quality trading programs. Importantly, these principles lower the initial costs necessary to establishing a trading program by, for instance, accepting that anticipatory modeling won’t be as precise as data developed over decades of implementation. They also encourage states to allow permits to be banked, so that mitigation can be implemented today in anticipation of future trades as standards are increased.

Together, these reforms could make it easier to establish water quality markets and more profitable for landowners. That’s good news because these markets, by lowering the cost of pollution mitigation, can unlock new opportunities to improve stream health.