The Economics of Urban Rainwater

Lack of natural drainage in urban environments can lead to flooding and pollution.   Economics can help find appropriate solutions.

There is a furore in Maryland, USA, where many residents will soon have to pay a “stormwater management fee” based on the area of impervious surface on and around their homes (roofs, driveways, car parks, etc).  The measure is prompted by the condition of Chesapeake Bay, an important fishery and recreational resource that has been degraded by polluted rainwater run-off.  Critics have dubbed it a “rain tax”: the first word is perhaps misleading, but as for the second, if it looks like a tax and smells like a tax … For a flavour of the debate, here is a news item (1), a case for (2), and one against (3).

Let’s look at the issue of urban rainwater run-off from an economic perspective.  Run-off from A’s property to B’s can affect B’s welfare.  There is an externality, with the following characteristics:

  1. The amount and pollutedness of water running off from A’s land to B’s depend partly on variables outside A’s control.  But A can affect it in several ways.  One is by having impervious surfaces, which prevent natural drainage and, less obviously, result in pollution of run-off by deposits of airborne pollutants originating from cars and power stations (4).
  2. What matters for B’s welfare is the aggregate effect of the water arriving from all sources. Small amounts of water from each of many sources can combine to flood B’s land.
  3. Downstream, run-off from many sources may come together in large flows with the characteristics of a “public bad”.  If B’s land is flooded then his same-level neighbours’ will be too, regardless of some having interfered with their natural drainage less than others.
  4. Eventually, run-off may arrive at a large water body such as a lake or river estuary.  Here the aggregation of pollutants brought by water from many sources may, as in Chesapeake Bay, degrade the natural ecosystem with adverse consequences for users.

What policy instruments can address such a complex externality?  A network of stormwater sewers funded by charges to households can significantly reduce the risk of flooding.  Economies of scale in network provision point to local monopoly provision, with regulation to ensure standards and prevent over-charging.  Given the externality and “public bad” characteristics of run-off, individual households should be required to pay and to connect to the network except in unusual circumstances.  Without compulsion, many upstream households at little risk of flooding would opt out, rendering the network less effective in preventing flooding and/or increasing costs to other households.

Here in London, a household which can show that none of its rainwater enters the public sewer network can obtain a “surface water drainage rebate”, meaning that it need not pay the stormwater drainage element within its overall water services charge (5).  The justice of this is dubious, since the sewer network may still protect such a household from flooding by run-off from higher ground, and if its rainwater runs instead into a natural stream, it could contribute to downstream flooding.  To allow such a rebate is to treat the sewer network simply as a service to those households whose rainwater it carries away.  Instead, it should be regarded as a practical response to a complex externality.

An unintended effect of a sewer network is to transport any pollutants carried by the rainwater into the water body in which it discharges (I ignore here situations in which combined sewers carry both rainwater and domestic sewage to a treatment plant prior to discharge).  For serious pollutants such as hazardous chemicals, a combination of regulation and liability law is warranted to prevent their entry to the network.  What can be difficult is to find an appropriate policy for low-level pollutants such as nitrogen from garden fertilizers and atmospheric deposition which can cause harm when channelled in large quantities into a water body.  This problem appears to be particularly challenging in the circumstances of Chesapeake Bay, which has a population of 16 million within its watershed and only a narrow outlet to the open sea, limiting dispersion of its pollutants (6).

A key question is whether in an economic sense the water body is over-polluted.  The relevant test, in principle, is whether the damage to the water body from a marginal unit of pollutant exceeds the benefit from the marginal activity resulting in that unit of pollutant.   Damage here should include both economic loss to users of the water body and loss of non-market values relating to recreation, ecosystem services and biodiversity. For a pollutant that may cause harm over many years, damage should be calculated on a present value basis, with allowance for its rate of decay or dispersion and an appropriate rate of time preference.  This test is not easy to apply.  It requires: reliable scientific knowledge quantifying the links between activity and pollutant and between pollutant and harm; reliable estimates of non-market values; and identification of marginal activity where there are many sources of pollutant involving different types of commercial and household activity.

Where a water body is assessed as over-polluted, an appropriate policy objective in most cases will be a reduction in the amount of pollutant entering the water body, bringing about a progressive reduction in the stock of pollutant it contains and eventually reaching a position in which, so far as can be assessed, marginal damage roughly equals marginal benefit.  In some cases this may usefully be accompanied by the sort of restoration suggested by the term “clean-up”, involving the application of physical, chemical or biological processes to the water body.  It is unlikely to be economically optimal to reduce the stock of pollutant as fast as possible.  Where polluting activities are subject to diminishing returns or diminishing marginal utility, a given reduction in pollutant will reduce their benefits by less overall if spread over several years than if concentrated in one year (compare having a 20% smaller car park for five years with having no car park at all for one year). An optimal restoration path will balance the benefit saved by spreading the reduction in pollutant against the extra damage from a longer period of over-pollution (7).

Taxes are likely to be the most suitable policy instruments to reduce the scale of the polluting activities.  Regulation would be too inflexible and heavy-handed for matters such as the area of a household’s driveway.  As a market-based instrument, a tax on areas of impervious surface would allow a household to have a large driveway and pay the associated tax if it wished.  Another household for which a driveway was of less value given its lifestyle might choose a smaller one or none at all.  Alternative market-based instruments are marketable permits and subsidies.  The former are probably too complicated to use at the level of individual households.  Subsidies could have a role to play in supporting activities which reduce run-off, such as soakaways and tree cultivation, and could also work in conjunction with taxes (see this post), but are unlikely to be the main policy instrument.

However, taxes do have disadvantages.  The extent to which a given rate of tax will reduce polluting activity will not be known.  Achieving a desired reduction may require a trial-and-error approach to rate-setting with consequent uncertainty for taxpayers.  Taxes needs to be suitably targeted, and for some polluting activities a suitable target may not be available.  Provided that the science linking impervious surfaces to pollution is well-established, area of impervious surface is an appropriate target: relevant to the objective;  easy to measure; and hard to conceal.  It is difficult however to identify a suitable target relating to garden fertilizers.  A tax on quantity used would be impossible to enforce, and a tax on sales, limited to the relevant watershed, could be easily avoided by buying elsewhere.  This creates a problem.  Considering an activity in isolation, it may seem that an economically appropriate rate of tax per unit of activity should roughly equal (with allowance for the needs of any restoration path) the damage resulting from the pollutant associated with a marginal unit of activity.  However, if some types of polluting activity are difficult to tax at all, there could be (although the economic assessment would be quite complex)  a “second-best” case for a higher rate of tax on those that can be taxed.  Addressing polluting activities that are difficult to tax through education and product labelling could perhaps mitigate this sort of situation.

One point about a tax is clear.  An economic case for a tax designed to reduce polluting activity need make no reference to how the tax revenue would be used.  Using it to pay for schools or reduce a deficit would not prevent a well-designed tax from being an effective policy to reduce pollution. There should be no presumption that revenue from a tax on current polluting activity should be spent on cleaning up the effects of past pollution.  Any expenditure on clean-up activity or other pollution-related purposes should be justified in cost-benefit terms in comparison with alternative uses of the funds.

Notes and References

1. The Baltimore Sun, 29 March 2013  Howard council approves new stormwater fee,0,7762933.story

2. The Washington Times 23/4/13 Chesmar J Chesapeake Bay Foundation on Maryland Rain Tax: Time to own up

3. Gazette.Net Maryland Community News Online, 5 April 2013  Lee B The’Rain Tax’

4. US Environmental Protection Agency 2007 Development Growth Outpacing Progress in Watershed Efforts to Restore the Chesapeake Bay Report No. 2007-P-00031 p 5

5. Thames Water  Apply for a surface water drainage rebate

6. US EPA, as above p 2

7. The dynamic stock pollution model applied in this paragraph is set out in Perman R, Ma Y, McGilvray J & Common M 3rd edn 2003  Natural Resource and Environmental Economics  pp 548-553

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