20 November 2005

Limits To Growth: Water Law

While impact fees to pay for new school construction are often inadequate, the same cannot be said for tap fees to add new homes to the water supply system, although the differences from locality to locality have far more to do with the intricacies of water deal making than they do with fundamentals of available water supplies.

Across the United States, many cities charge less than $1,000 for a new residential water hookup. In Colorado, the fees range much higher.

Denver, which bought its water rights long ago, charges $4,795 for a home with an average lot. Boulder charges $7,345 for a typical single-family home with two bathrooms. Some cities charge $10,000 or more for water service, and tap fees in fast-growing Denver suburbs have rocketed as high as $20,000.

In Broomfield, the fee has nearly tripled to $24,424 since it hired Harrison [a water broker] - and is projected to rise to $36,000 in the next 30 years.

The water market in Colorado lacks transparency.

Though the water courts treat water rights like real property, they do not require owners to document their holdings in public records such as those required of land transfers.

Counties keep no index of water sales. State officials know where water rights exist but not who actually owns them today. When the legislature instructed the state Division of Water Resources in 2003 to impose a new fee on water rights owners, its efforts to find and bill them proved disastrous. The fee was repealed.

As a result, cities that pay huge sums to water brokers don't even know how much went to the middle man and how much went to the people from whom the water was bought. Like any market with poor information, it makes poor decisions. Generally speaking, this lack of information tends to favor status quo owners, mostly farmers, who enjoy very cheap and abundant water supplies, while harming would be buyers, like growing municipalities, that pay much higher prices for water.

In short, Colorado's water market is a classic example of the Coase Theorem, developed by Ronald Coase in 1960 which provides that "in the absence of transaction costs, all government allocations of property are equally efficient, because interested parties will bargain privately to correct any externality. As a corollary, the theorem also implies that in the presence of transaction costs, government may minimize inefficiency by allocating property initially to the party assigning it the greatest utility."

Here, Colorado's water law has done the opposite. The state's lack of a transparent and/or low cost system of conducting water transactions (for example, Broomfield's water broker "estimates he incurred more than $2.3 million in legal, title, office and other expenses" over six years to arrange transfers of water rights to Broomfield a single source), keep transaction costs exceptionally high. And, the historical reality of Colorado's water law, which may have been optimal at the time under the Coase Theorem, has had the effect of putting water rights in the status quo in the hands of very low utility agricultural uses, with marginal returns on this valuable resource, rather than in the hands of high utility municipal and recreational users. Thus, the negative effects of these high transaction costs are maximized.

This poorly crafted system could ultimately prove to be a significant barrier to growth in Colorado. Colorado has enough water to support something on the order of 40 million municipal users, more with reasonably straightforward conservation efforts like mandatory xeriscaping and limits on golf course construction. But, even the far more modest growth that is realistically possible requires a major shift of water resources from marginal farmers to municipalities. Reality has a long way to go in Colorado before it catches up with the economic theory ideal.

Hat Tip to Coyote Gulch.

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