Colombia Water

INTER-AMERICAN DEVELOPMENT BANK

REGIONAL POLICY DIALOGUE STUDY SERIES

Environment Network Economic Instruments for Water Management: Experiences from Europe and Implications for Latin America and the Caribbean

R. Andreas Kraemer Zulma Guzmán Castro Ronaldo Seroa da Motta Clifford Russell Authors

November 2003

Integration and Regional Programs Department Sustainable Development Department David Wilk, Ricardo Quiroga, Michael Toman, Sergio Ardila, Silvia Ortiz and Niels Holm-Nielsen supervised the preparation of the report and edited its final version.

The opinions expressed in this paper are the responsibility of the authors and do not necessarily reflect the official position of the Inter-American Development Bank.

Cover: Shell-shaped pendant belonging to the Quimbaya prehispanic Society. Gold Museum Collection – Bank of the Republic, Colombia

November 2003

Additional copies of this publication can be obtained from:

Secretariat of the Regional Policy Dialogue Mail Stop W-0610 Inter-American Development Bank 1300 New York Avenue, N.W. Washington, D.C. 20577

E-mail: [email protected] Tel: 202-623-2271 Fax: 202-312-4034 Web Site: http://www.iadb.org/int/drp Inter-American Development Bank Regional Policy Dialogue

The Regional Policy Dialogue was established in December 1999 by the initiative of the Board of Executive Directors. The objective was to create a forum of communication within the Bank to expand and enhance dialogue among the countries in the region by sharing experiences, preparing them to face the great challenges of globalization, and generating processes for regional cooperation. The Bank identified seven areas to be included on the Dialogue and created seven specialized networks in which government officials at the Vice-Minister level from Latin America and the Car- ibbean, who are responsible for decision making and public policy design, participate.

1) Trade and Integration; 2) Poverty and Social Protection Networks; 3) Education and Human Resources Training; 4) Macroeconomic and Financial Policy; 5) Public Policy and Transparency; 6) Natural Disasters Management; and 7) Environment.

STRUCTURE OF THE DIALOGUE

General Coordination Technical Coordination Integration and Regional Programs Department Sustainable Development Department Manager: Nohra Rey de Marulanda Manager: Carlos M. Jarque

Regional Technical Cooperation Division Legal Department Chief: Juan Manuel Corredor General Counsel: J. James Spinner

Coordinator: María Carmenza McLean, Research Department Senior Specialist NT/RTC Chief Economist: Guillermo Calvo

Secretariat

Marisa Taylor, Patricia Giovannoni and Rodrigo Salas

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Trade and Integration Network Environment Network Technical Coordinator: Robert Devlin, Deputy Manager INT/INT Janine Ferretti, Division Chief SDS/ENV Technical Coordinator: David Wilk, Natural Disasters Network Senior Urban Environment Specialist SDS/ENV Janine Ferretti, Division Chief SDS/ENV Technical Support: Niels Holm-Nielsen Technical Coordinator: Kari Juhani Keipi, Natural Resources Senior Specialist SDS/ENV Poverty and Social Protection Network Technical Support: Victoria Imperiale Carlos Eduardo Velez-Echavarria, Division Chief SDS/POV Technical Coordinator: Wanda Engel Aduan, Education and Human Resources Poverty Alleviation Specialist SDS/POV Training Network Technical Support: Sabrina Passos Technical Coordinator: Juan Carlos Navarro, Division Chief SDS/EDU Macroeconomic and Financial Policy Network Technical Support: Norma García Technical Coordinator: Arturo Galindo, Research Economist RES Public Policy Management and Transparency Network Norelis Betancourt, General Coordinator RES Technical Coordinator: Koldo Echebarría, Principal Public Sector Management Specialist SDS/SGC Technical Support: Ingrid Carlson

Foreword

The II Meeting of the Environment Network of the economic instrument is a complex process, signal- Regional Policy Dialogue, held on February 11 and ing the need for the expansion of knowledge and in- February 12, 2003 in Washington, D.C., focused its formation on the function and application of these attention on the application of economic instruments instruments. for environmental management. This topic was iden- The Inter-American Development Bank consid- tified as a priority by the Network members, who, as ers it important and necessary to disseminate the policy makers, recognize the importance of imple- conclusions of the discussions that took place at menting incentive-based mechanisms to effectively the II Meeting of the Environment Network, and and efficiently achieve environmental goals. hence to enhance the regional dialogue surround- For the most part, Latin American and Carib- ing this very relevant topic. This report is likely to bean countries have relied on the application of com- be of particular interest to those seeking to draw mand-and-control instruments as part of their lessons learned from global and regional experi- environmental management agenda, with limited suc- ences. Some cases described in the report may prove cess. In this regard, there is growing interest–but also useful by providing information about possible op- much to be learned–about how economic instruments tions for the design of economic instruments. The can properly complement and/or substitute tradi- extra-regional experiences discussed may be utilized tional command-and-control mechanisms. This was particularly with respect to economic instruments the central topic of the policy discussions at the II that have not been applied previously or have sel- Meeting of the Environmental Network. This report dom been applied within Latin America and the tries to capture the main elements of these discus- Caribbean. sions in the context of the water sector. The Regional Policy is pleased to release this re- The report presents a sample of documents that port in concordance with its objectives of sharing have been prepared by professionals with significant relevant technical material useful to member coun- experience in the areas of water resources and eco- tries while strengthening their capacities to respond nomic instruments. Their work shows that the se- to commonly-faced challenges and exploring oppor- lection, design and implementation of an appropriate tunities for regional cooperation.

Nohra Rey de Marulanda Carlos M. Jarque Manager Manager Integration and Regional Social Development Department Programs Department

Ta ble of Contents

ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT: EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN ...... 3 R. Andreas Kraemer, Britta M. Pielen and Anna Leipprand Functions of Economic Instruments ...... 3 A Taxonomy of Economic Instruments ...... 4 Global Experiences with Economic Instruments ...... 9 The European Water Framework Directive ...... 39 The Relevance for IADB Regions ...... 40 Conclusions and Recommendations ...... 47 Bibliography ...... 49

CASE STUDY: THE COLOMBIAN WATER TAX ...... 57 Zulma Guzmán Castro

SYNTHESIS OF REGIONAL EXPERIENCES: FROM THEORETICAL TO PRACTICAL ISSUES ...... 73 Ronaldo Seroa da Motta, Jose Gustavo Feres, Céline Nauges, Alban Thomas, Antonio Saade and Lilian Saade

DISCUSSION NOTE ON ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT IN LATIN AMERICA AND THE CARIBBEAN ...... 79 Clifford Russell

Introduction

Economic instruments have gained particular atten- countries and assesses which instruments described tion in recent years as an important tool for in the international literature and practiced in other reinforcing and implementing environmental legis- countries are potentially attractive for replication in lation while simultaneously contributing to the region. sustainable development. The advantages of eco- The second chapter contains a comprehensive nomic instruments, when used under specific case study of the Colombian experience with the use conditions, encompass the provision of incentives for of economic instruments for water management. It behavioral change, the generation of revenue for fi- includes a thorough description of the institutional nancing further environmental investments, the context within which the instruments have been ap- promotion of technological innovation, and the re- plied and an analysis of the policy process duction of pollution at the lowest costs to society. surrounding the implementation of the instruments. The objective of this report is to present the main It also depicts some of the environmental effects de- documents that were discussed during the II Meet- rived from the use of economic instruments as a ing of the Environment Network of the Regional management tool. Policy Dialogue in the context of the topic “Economic The third chapter outlines the conclusions of a Instruments for Water Management: Extra-regional more recent analysis of the Brazilian and Mexican experience and their applicability in Latin America cases and discusses the applicability of the French and the Caribbean”. experience in the Latin American context. The French The report has been organized into four chap- river basin system has been used as a paradigm for ters based on separate works of individual authors. Latin America experiences, mostly due to the fact that Each chapter reflects specific topics that the authors the French system was created by governmental man- were commissioned to produce for the Dialogue. date and implemented in a reasonable time with The first chapter of this report provides an over- immediate results. However, praising of this experi- view of the international literature and information ence has obscured the identification of its main on the application of economic instruments on wa- difficulties and constraints that, once recognized, ter management, with particular analytical emphasis could be of great value for those seeking to learn from on the European experience. The first section of this its example. chapter provides a brief description of the functions The fourth chapter critically discusses some of of economic instruments. The second section pre- the main issues raised in the other chapters of the sents a taxonomy of economic instruments in water publication. The author points out a lack of connec- management, introduces the available instruments tion between the focus of the environmental and defines their areas of applicability. Practical ex- economics literature on instrument design and the amples of experience with economic instruments in reality of instrument application reviewed by these water management in European and OECD countries studies. It is further argued that the attention given are described in the third section, while the fourth in that literature to the instrument’s ability–or lack introduces the European Water Framework Direc- thereof–to deliver the least-resource-cost solution in tive and looks at how the use of economic instruments response to the problem of meeting regional or na- is supported and promoted by European legislation. tional environmental quality standards is not The last section gives a brief evaluation of the cur- reflected in the selection and design of the real in- rent situation in Latin American and Caribbean struments.

Economic Instruments for Water Management: Extra-regional experiences and their applicability in Latin America and the Caribbean

R. Andreas Kraemer, Britta M. Pielen and Anna Leipprand

FUNCTIONS OF ECONOMIC or resources, EIs can also steer economic activities INSTRUMENTS towards a more eco-efficient use of resources, thereby promoting innovation and competitiveness.1 Finally, economic instruments may be capable The use of economic instruments (EI) in environ- of addressing diffuse pollution, an area where tra- mental policy has a number of advantages (Klarer, ditional command-and-control instruments often McNicholas and Knaus, 1999) that has made them fail. indispensable tools in many European and other Economic instruments for environmental man- countries around the world. Through EIs, environ- agement can be classified according to the principal mental or social costs can be incorporated into the objectives they aim to fulfill. The following para- prices of goods, services or activities that give rise graphs describes the main functions of EIs, and to them, thus sending price signals to users or con- provide a basic typology to classify EIs used in water sumers to reduce inefficient and wasteful use of management. resources and foster their optimal allocation. EIs are important tools for the implementation of the “polluter and user pays” principle, as they make the polluter, rather than society as a whole, pay for INCENTIVE FUNCTION the damage he causes. Moreover, EIs have the potential to be more cost efficient than traditional command-and-control instruments as polluters are In cases where the primary purpose of an economic given more flexibility in the way in which they instrument is to create the necessary incentives for achieve given targets. By raising costs of pollution behavioral changes, the mechanism can be categorized as an incentive-based instrument. Incentive taxes are levied with the intention of 1 The argument of increased competitiveness is based on the changing environmentally damaging behavior and Porter hypothesis. It is supported in part by theories of com- without the primary intention to raise revenues. In petitiveness that posit that any regulation that requires a com- contrast to regulations, charges, e.g. on emissions, pany to re-examine its production process generates a probability of innovation in that process, which may benefit can provide a continuous incentive for improvements overall competitiveness and reduce or even eliminate costs in abatement technology. The incentive function can, of compliance (Environmental Law Institute, 1999). however, only develop its potential if rates are set 4 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT sufficiently high for stimulating the source to invest helped to build up the necessary personnel ca- in emission abatement. The success of such a tax can pacities for water resource management. therefore be determined by the extent to which ini- ● It created a need for a continuous updating of tial revenues from it fall as behavior changes (Speck information and documentation on water ab- and Ekins, 2000). straction and consumption. This provided an opportunity to strengthen the information bases for administrative purposes. ● At the same time, it introduced many elements FISCAL AND FINANCIAL FUNCTION of control and enforcement usually associated with revenue raising. It thus helped to formalize communications between the administration and When the primary aim of an environmental charge water users and to increase the frequency of feed- or tax is not to create incentives but to raise revenue, back. This also strengthened the administrations’ the relevant distinction lies in whether the revenue position in cases of conflict. is earmarked or simply added to the general government budget. If the purpose of a tax is merely to gain The functions of economic instruments are not money for the national budget, the economic instru- mutually exclusive and, as the fourth section will ment can be categorized as a fiscal environmental tax show, most instruments fulfill more than one func- (RIZA, 1996). A charge (or tax) fulfils a financing tion. Charges designed to recover the costs of a function if the revenue is allocated for specific envi- service can raise the customer’s awareness of its value ronmental purposes (earmarked), e.g. if the money and may prompt a more careful or economic use. raised from water supply charges is spent on public On the other hand, taxes introduced primarily to pro- water management costs. While it is argued that the vide an incentive to change behavior will also raise economic rationale for such schemes is weak, they revenue. may nevertheless play an important role in enhancing the acceptability of the taxes and charges in question in the public opinion, and in providing funds for environmental expenditures.2 A problem with financing related public services through earmarking A TAXONOMY OF ECONOMIC is that the level of finance for public services may INSTRUMENTS have to adjust to changes in revenue, rather than to changes in demand and needs (see Box 1). The application of economic instruments in the water sector can basically occur along the entire water cycle. The extent to which they are used and the ex- SOFT FUNCTIONS periences gained differ across countries. While water prices and sewerage charges are common instruments in all European countries, tradable permits find no Aside from the functions outlined above, economic application at all, and, for that reason, one must draw instruments can have additional results such as, for on experiences from OECD countries. The different example, capacity building and improvements in instruments are presented in Figure 1 and positioned implementation (“soft functions”). Kraemer (1995c) along the water cycle. identified several soft functions in relation with the German water abstraction tax. Some of these are:

● It provided the environment ministries in the WATER ABSTRACTION TAXES Länder3 with a source of finance that they either control directly, or have relatively strong claims on in competition with other ministries. It thus A water abstraction tax is a certain amount of money charged for the direct abstraction of water from ground or surface water (Roth, 2001). In some cases 2 Source: http://www.mst.dk. only ground water abstractions are charged to reduce 3 Germany is a Federal Republic with 16 states, or Länder. the price differential between surface and ground- EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 5

BOX 1

EARMARKING OF REVENUES Earmarking can be implemented in the following ways:

● The simplest form of earmarking involves allocating resulting revenues to the group that paid for the originating taxes. Usually, different formulae are used to raise and disburse revenues. Such simple earmarking usually has little environmental effect and transaction costs can be high. However, such systems can be useful, for example, in mutual insurance schemes. ● More complex is the French model of raising “redevance” (see Global Experiences with Economic Instruments section) which is recycled grosso modo back to those who contributed to the revenue of the Agence. In fact, those who contributed have a moral claim on their contribution and can expect a subsidy when it is their turn to make pollution control investments. Such system can be useful to spread the burden of heavy investments, especially in the context of comprehensive investment programs implemented over a long period of time. Depending on the degree of solidarity among the water users within a river basin area, such schemes can either work for the basin as a whole or be segmented according to sectors or regions. ● Beyond these possibilities, earmarking can be relaxed so that money does not go back to those who paid, but is used instead to finance typical governmental functions, such as water and groundwater monitoring, modeling, research and technical development, or information disbursement. In this case, earmarking produces a double- dividend. Firstly, because of the incentive function on the revenue side, and secondly, by financing activities that are beneficial to the environment. Earmarking has economic advantages and disadvantages and can be politically useful.

● Earmarking can, if badly designed, favor capital-intensive investments over others because of the availability of capital. Similar to the Averch-Johnson effect, it can thus lead to over-investment. ● Earmarking should not be used to subsidize activities that have significant negative externalities. Instead they should only be used to compensate for positive externalities (external benefits) that cannot be captured through the market or regulated prices or charges. ● Experience has shown that earmarking is useful to raise political acceptance for the introduction of economic instruments. ● Over time, earmarking tends to be relaxed, so that general water management functions are financed first, and later the revenue from originally earmarked charges is treated as general revenue and becomes part of general taxation. Contrary to the principles of public finance, earmarking has proven to be a useful tool in environmental policy.

water abstraction, while in others, ground and sur- In many countries, revenues generated by ab- face water abstractions are taxed, however often at straction charges are earmarked for explicit water different rates. management purposes, so that tax proceeds are in- Besides their revenue-generating function, wa- directly returned to those liable to pay. Water ter abstraction taxes can act as incentive measures. abstraction taxes may be set to reflect the relative Effective water abstraction taxes can induce a scarcity of water and may vary by regions. change in user behavior resulting in lower water demand and a reduction of water leakage. If the tax is set to reflect marginal costs of water abstraction, it enhances the cost effectiveness of the service pro- WATER PRICES vided. In general, water abstraction policies should consider both surface and groundwater in order to limit negative effects that more efficient pricing for The water pricing instrument has the primary goal one water source will have on the other (European of financing water supply infrastructure. Accord- Commission, 2000a). ing to the European Commission (2000b), water 6 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

FIGURE 1

ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT (ADAPTED FROM KRAEMER 1995B)

Surface Water Ground Water

Tradable Abstraction Permits

Abstraction Taxes

Self Supply Public Water

Water Prices

Taxes on Water Supply

Subsidies for Water Industrial Use Saving Measures Municipal Use

Severage Charges

Subsidies for Pollution Control Taxes on Severage Charges

Effluent Treatment Effluent Charges Severage Treatment

Tradable Discharge Permits

Surface Water/Sea

prices should be set at a level that ensures the re- ● Social costs: With respect to water services, the covery of costs for each sector (agriculture, house- direct or indirect social benefits (for instance in holds and industry) and to allocate costs to those the field of public health) vary largely with re- sectors (avoidance of cross subsidies). In principle, spect to the specific contextual settings. water prices should relate to three types of cost: Calculating these costs and comparing them direct economic costs, social costs, and environmen- across cases is, therefore, not feasible, which pro- tal costs. The estimation of each type of cost in- hibits their incorporation into a comparative volves a different set of problems (Kraemer and study. Buck, 1997): ● Environmental costs: The environmental costs of a certain economic activity are generally not re- ● Direct economic costs: Full recovery of the eco- flected in the prices established in the market, nomic costs of water services will require that but appear as externalities. Conceptually, the non water prices include (1) operation and mainte- inclusion of negative environmental costs in price nance costs of water infrastructure, (2) capital fixing mechanisms can be discussed under the costs for the construction of this water infrastruc- heading of subsidies. In practice, though, there ture, and (3) the reserves for future investment are great difficulties linked to the establishment in water infrastructure. of benchmarks for costs caused by environmen- EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 7

tal degradation, and to the inclusion of these costs polluters (Roth, 2001). Pollution charges may set into market-based mechanisms. Still, the prin- incentives in terms of pollution abatement promo- ciple of full cost recovery requires that these costs tion. In cases where the revenue generated by the be taken in consideration. Given the method- charge is earmarked for measures to improve water ological problems involved in calculating quality, a pollution charge additionally fulfils a finan- environmental externalities, the inclusion of an cial function for such improvement . environmental component into water prices will Designing optimal pollution taxes that minimize be backed by political rather than economic the total cost of pollution (damage costs plus control arguments. costs) is a difficult task, as it requires the existence of a reasonable database and information on pollution In addition to their financing function, water damages. The exact calculation of taxes requires in- pricing policies often fulfill an incentive objective as formation about the exact quantity and quality of the well. Water prices which represent full costs (eco- discharged wastewater (Kraemer, 1995a). nomic and environmental costs) provide price signals to users resulting in a more efficient water use and generate the means for ensuring a sustainable water infrastructure (Hijum, n.y.) SUBSIDIES

The OECD (1996) defines subsidies as “government SEWERAGE AND EFFLUENT CHARGES interventions through direct and indirect payments, (INDIRECT EMISSIONS) price regulations and protective measures to support actions that favor environmentally-unfriendly choices over environmentally-friendly ones.” This Sewerage charges are tariffs paid for the discharge of definition includes direct subsidies in the form of used water. A sewerage charge is the amount of money direct payments by the government to certain users, paid for indirect discharges, that is domestic sewage and indirect subsidies. Even in the absence of “ex- or effluents discharged into the sewer system. Fore- plicit monetary transfers” one can speak of (indi- most, sewerage charges have the objective of rect) water subsidies if the system of water prices in providing environmental authorities with financial place does not adequately reflect all costs involved resources for water management activities (financial in delivering that service. Thus the effective imple- function). Furthermore, these charges may fulfill an mentation of the principle of “full cost recovery” in incentive function and are in accordance with the the formation of water prices in turn would elimi- polluter-pays principle by internalizing treatment nate water subsidies (Kraemer and Buck, 1997). This costs into the decision process of users through ad- conceptual perspective highlights the close relation- equate price signals (Kraemer and Piotrowski, 1995). ship between water subsidies and water pricing practices. Further indirect subsidy schemes include tax concessions or allowances, guaranteed minimum prices, preferential procurement policies and cross WATER POLLUTION CHARGE subsidization. Generally, subsidies can have two main objectives: either they are instituted to compensate users A water pollution charge takes the form of a direct for a cost they incur in response to a required action payment based on the measurements or estimates of or a prohibition, or subsidies are put in place so as to the quantity and quality of a pollutant discharged to set the necessary incentives for achieving a desired, a natural body of water (not a sewer). Pollution but not required, action. charges are an important step towards the realization Subsidies can be of a fiscal nature and paid out of the polluter-pays principle even if their calcula- of public funds, or take the form of parafiscal cross tion is not based on estimates of damage costs. By subsidies through redistribution between urban ar- levying a charge on pollution, a clear signal is given eas. From an environmental perspective, a subsidy that society is no longer willing to bear the costs of consists of the value of uncompensated environmen- pollution and that at least part of the costs of the tal damage arising from any flow of goods or services damages caused should be recovered directly from (Barg, 1996). As environmental damage is usually 8 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT not included in water prices, de facto subsidies often of (surface) water quality. Such pollution rights exist. can relate to point or to non-point sources, and Subsidies are economic instruments that may trades can even be arranged among different lead to inefficient situations. However, they can cre- kinds of sources; ate the necessary incentives to stimulate a change in ● Tradable permits to use or consume water-borne user behavior towards environmentally friendly con- resources, such as fish or the potential energy of duct or induce investments in environmentally water at height or the kinetic energy of water friendly production techniques, thereby mitigating flowing. or eliminating negative effects. In some cases, like flood alleviation, for example, subsidies may provide Further distinctions can then be made within a relatively cheap option for governments, especially each of these fields of application. In relation to trad- considering the reduction in losses that may be able water rights, distinctions can be made regarding achieved through adequate flood proofing (Otter and the “intensity” of trading, which can be permanent van der Veen, 1999). There is, however, a danger or temporary (seasonal) or even one-off. With regard that over the longer term, resources may be chan- to water pollution rights, further differentiations can neled to solve problems that are no longer a high be made in relation to the polluting substance (or priority. class of substances) in question (Kraemer and Banholzer, 1999). Several prerequisites must be met for the successful implementation of a tradable permit system. TRADABLE PERMITS First of all, property rights must be well defined and specified in the unit of measurement (Kraemer, Interwies, Kampa, 2002). As a second point, water If disagreement exists over the allocation of water rights must be enforceable to secure the net ben- from shared resources among segments of the popu- efits flowing from the use of the water rights for the lation, a potential instrument is the creation of rights holder. In an ideal case, transferable water transferable rights to use/pollute water and the cre- rights should be separate from land use in order to ation of efficient markets in which the rights can be create exposure to the opportunity to realize higher traded. The rationale behind water allocation through valued alternatives (Pigram, 1993). Finally, an effi- tradable rights is that in a perfectly competitive mar- cient administrative system must be in place to ket, permits will flow towards their highest value use ensure market operation (Armitage and others, (Tietenberg, 2000). Permit holders that gain a lower 1999). benefit from using their permits (for example due to Situations in which the conditions may not be higher costs) would have an incentive to trade them adequately met include the possibility for monopoly to someone who would value them more. A sale will market power, the presence of high transaction costs result in a situation of mutual benefit: the benefit the and insufficient monitoring and enforcement permit holder reaps from selling his permit will ex- (Tietenberg, 2000). However, even in the presence ceed the benefit he derives from using it, while the of these imperfections, tradable permit programs buyer gets more value out of the permit than he has can be designed to mitigate their adverse conse- to pay for it. quences. When discussing tradable permits systems relating to water, three fundamentally different fields of application can be discussed (Kraemer and Banholzer, 1999): LIABILITY FOR DAMAGE TO WATERS

● Tradable water abstraction rights for quantitative water resource management. These water rights Environmental liability systems intend to internalize can be permanent and unlimited (property rights and recover the costs of environmental damage to the water resource) or temporary and limited through legal action and to make polluters pay for (transferable rights to use water without right of the damage their pollution causes. To that extent en- abuse); vironmental liability laws are a fundamental ● Tradable discharge permits, or tradable water pol- expression of the polluter-pays principle. The inten- lution rights, for the protection and management tion of environmental liability laws can be twofold: EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 9 first of all they aim at inducing polluters to make classifies them according to the scheme set out in more careful decisions about the release of pollution the second section of this report. according to the precautionary principle, and, second, they seek to ensure the compensation of victims of pollution. While liability systems assess and recover damages ex post, they can nevertheless provide GLOBAL EXPERIENCES WITH incentives to prevent pollution, as long as the ex- ECONOMIC INSTRUMENTS pected damage payments exceed the benefits from noncompliance. For liability to be effective, there needs to be one The following chapter complements the description or more identifiable actors (polluters); the damage of economic instruments for water management by needs to be concrete and quantifiable; and a causal providing examples of their application in European link needs to be established between the damage and and other OECD countries. Case studies are presented the identified polluter (European Commission, in the boxes that follow and they exemplify interest- 2000c). Thus, liability is not a suitable instrument ing practices and highlight the respective functions for dealing with widespread pollution, a situation in each instrument fulfills. which it is impossible to link the negative environmental effects with the activities of certain individual actors. The environmental liability instrument, there- WATER ABSTRACTION TAXES fore, conveys several advantages4:

● Liability rules control pollution through the de- In the following section, three examples of the imple- centralized decisions of polluters to act in their mentation of water abstraction taxes in The own interest. Polluters will control pollution up Netherlands, Germany and Denmark are presented. to the point where the marginal pollution dam- Abstraction taxes often combine an incentive with a age equals the marginal cost of control, thereby revenue raising function. In many cases, the tax rate minimizing their total costs for compensating is volumetric, that is based on metered abstraction, victims and controlling pollution. which is necessary to provide an adequate incentive ● The provision that polluters must pay for the to save water. As the comparison of the two examples damage they cause provides great incentives to from Germany shows, abstraction tax schemes may avoid environmental damage. The higher the differ in whether the tax is levied on the actual anticipated payment in case of a damage, the amount of abstracted water, or whether it is linked higher the incentive for taking preventive mea- to abstraction permits, so that the maximum amount sures (precautionary principle). of water for the abstraction of which a permit has ● Environmental liability laws constitute a been given is taxed. The incentive structure imposed significant step towards the application of the by the latter system is slightly different and can cause polluter-pays principle. water users to review their water needs and consider ● Environmental liability will also be reflected in the potential for water savings and for increasing the prices and is thus an important contribution to- use efficiency. wards realizing the principle of “ecologically By differentiating tax rates, the relative consump- honest prices.” tion of ground water and surface water may be influenced. The abstraction of small quantities of water is often exempt from the tax, and there can be tax exemptions or reductions for farmers or indus- CLASSIFICATION tries in order to limit the impact of the tax on their competitiveness. In Denmark and the Netherlands, the revenue of Table 1 summarizes the economic instruments dis- the tax is fed into the general government budget. cussed with respect to their main objective and The levy may be part of a green tax reform and compensate for a reduction in other taxes (income tax in Denmark). In the case of Germany, the taxes tend to 4 Source: http://www.eeb.org. be at least partially earmarked and the revenue is of- 10 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

TABLE 1

CLASSIFICATION OF ECONOMIC INSTRUMENTS

Economic Function Instrument Advantages Disadvantages

Incentive Water abstraction Adjustment of price signals to reflect Low charges/prices have a minimal Functions charges actual resource costs; encourage new impact on user/polluter behavior technologies; flexibility; and can lead to resource-over- generation of revenue that can be utilization used for water management activities Pollution charges Same advantages as water abstraction Same disadvantages as water charges; polluter-pays principle abstraction charges Fiscal Subsidies for Induce a more eco-friendly behavior at Rely on measurability of single Functions environmental R&D, any rate; easily understandable components; regional aspects are tax differentiation difficult to consider; high monitoring costs Pollution taxes Encourage the development of cleaner Low willingness to accept by the techniques; leave the choice to sources public and the target group between paying taxes or investing in concerned cleaner technology; fulfill an additional incentive function Financial Water prices; In accordance with the user-pays Functions sewerage charges principle; may convey an incentive function in addition to financing or cost-recovery by reflecting the true costs of a product or service Financial subsidies Popular with recipients, promote Require funding, may lead to eco desirable activities rather than nomic inefficiencies, may encourage prohibiting undesirable ones rent-seeking behavior Earmarked taxes Reduce the opposition to the tax as Rely on the measurability of single or charges those liable to pay benefit in turn from components; regional aspects are the revenue difficult to consider Liability Liability legislation Assess and recover damages ex-post Require an advanced legal system; Laws but can also act as prevention high control costs; burden of proof incentives; provide strong incentives

Based on OECD, 2001a; Stavins, 2000; UNEP, 2002. ten spent on environmental subsidies, such as com- The national groundwater abstraction tax (GAT) pensation payments to farmers for restricted land use. was introduced in 1995 as one of several “green taxes.” The objective of this tax is twofold. First, it The Netherlands was intended to act as an incentive and to reduce

In the Netherlands, the water abstraction charging scheme comprises two different taxes: one tax that is 5 The provincial tax on the commercial use of groundwater is charged by the provinces and an additional national a revenue raising tax, which generated a revenue of €20 mil- 5 levy on groundwater abstraction. In our example, lion in 2000. The revenue is earmarked and used for ground- the focus will be on the national charge. water research and pollution abatement (Speck, 2000). EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 11 groundwater use in favor of surface water by narrow- ter abstraction less profitable than surface water ab- ing or eliminating the price differential between straction. The large number of exceptions also limits ground and surface water. Ground water is cheaper the scope of environmental effects related to the in- in the Netherlands due to lower treatment costs and troduction of the tax. However, it is believed that it amounts to 70 percent of the country’s water sup- the determination of the tax rate on the basis of me- ply. Second, the tax has a revenue raising function tering did have an incentive effect, and that some and was partly initiated to increase the national tax water-saving investments have been made in re- yield. In 1992, a further increase of the fuel tax was sponse. suspended, in light of the adverse effects an addi- Box 2 summarizes information on the ground- tional increase in fuel prices would have on energy water abstraction tax in the Netherlands as described intensive industries. To compensate the general bud- above. get for resulting forgone revenues, the GAT was instituted (Mostert, 2000). Germany The Dutch groundwater abstraction tax is a national tax set by national law. The revenue generated Water resource taxes on the abstraction of water from by the tax goes into the general government budget. the natural environment were introduced at Länder The tariff is set per cubic meter and its level is mainly level after earlier discussions at federal level in the determined on the basis of political considerations 1950s and 1960s failed to bring about the imposi- (Mostert, 2000). In 2000 the tariff per cubic meter tion of a federal tax. Water resource taxes were was r0.166 for public water supply companies, and introduced not as alternatives to command-and-con- r0.12 for other users. The tax generated a total rev- trol instruments but as their complement, and they enue of r163.4 million (Speck, 2000), and it followed the general movement of environmental is administered and collected by the Ministry of Fi- policy from direct regulation by prohibition and pre- nance and the Central Environmental Tax Unit in scription towards the use of economic instruments Rotterdam. as a means of regulating activity (Kraemer, Strübin There are several exemptions to the general GAT. and Hansen, 1998). For example, companies abstracting less than 40,000 On January 1, 1988 Baden-Württemberg became cubic meter per year and using pumps with a capac- the first German Land to establish a tax on water ity of less than 10 cubic meter per hour are exempted; abstraction, the so-called “Wasserpfennig.” The tax furthermore, the draining of building sites is ex- was established in order to finance compensations to empted if less than 50,000 cubic meter per month farmers for restrictions on fertilizer use in water catch- are extracted for less than four months a year; skat- ment areas. Similar links exist between water resource ing rinks and draining and mining capacities at depths taxes and environmentally motivated subsidies in greater than 500 meters; and emergency extractions other Länder. (for example, fire) are exempted. Finally, there exists The case of Baden-Württemberg is exemplified an exemption for the use of groundwater for rinsing in Box 3, as it has the longest experience with ab- reusable packaging. straction taxes in Germany, and its regulatory Besides the resulting changes in water price, the framework has been copied by many other German tax influenced the competitive structure of the in- Länder. dustrial sector on two levels. It influenced compe- The case of Hamburg, which introduced a tax on tition between industries supplied by water water abstraction in 1989, is presented as a industries as opposed to those abstracting for them- second example where different regulating principles selves. Also, its influence on industries varies ac- are applied. cording to the type of abstraction they use, the While the tax in Baden-Württemberg is levied surface water abstraction being favored by the tax on actual water abstraction, in Hamburg a different (Ecotec, 2001). scheme is applied by levying the charge on the quan- In most cases, the price differential between tity of water for which an abstraction permit has been groundwater and surface water abstraction is not given. Accordingly, different incentive structures sufficiently reduced by the tax to make groundwa- emerge, as the following case study will exemplify (see Box 4). In general, two main effects can be discerned 6 All currencies have been converted into Euro in accordance from the history of water resource taxation in Ger- with the standard conversion tables. many. First, there was horizontal policy learning: 12 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

BOX 2 BOX 3

THE WATER ABSTRACTION TAX THE WATER ABSTRACTION TAX IN THE NETHERLANDS IN BADEN-WÜRTTEMBERG Objectives of the tax: According to the water abstraction taxing scheme of ● To r aise revenue (financing function) and provide Baden-Württemberg, the abstraction of small quan- incentives for water saving; tities (= 2,000 cubic meter per annum) is exempt ● To r aise revenue for fiscal reform and to protect the while a deduction of 50 percent is applied to abstrac- scarce groundwater resources of the Netherlands, tions between 2,000 and 3,000 cubic meter per an- which account for 70 percent of its water supply; num.7 Furthermore, the tax is not applied to water ● To reduce the price differential between ground and abstractions that do not require a license according surface water. to the federal Water Management Act or the Water Act of Baden-Württemberg, nor to cases where spe- Specific tax base: cific exceptions have been granted. The tariff struc- ● Groundwater: extraction by water works or other ture (see table below) allows for a differentiation ac- entities. cording to the origin of water (surface or ground Tax rate (2000): water) and its use (public water supply, heat pumps, ● Water companies: €0.16/m3 cooling, irrigation, and other uses). ● Industry/ Agriculture: €0.12/m3 Water Abstraction Tax Rates in ● infiltrated groundwater: €0.025/m3 Baden-Württemberg: Revenue collecting authority/ administration Surface water Ground water ● Administration and collection: Ministry of Finance Use: [in €/m3] [in €/m3] and the Central Environmental Tax Unit in Rotterdam. Public water ● Monitoring of water abstraction by water compa- supply 0.051 0.051 nies. Self-monitoring abstractors are subject to Heat pumps 0.005 0.005 occasional verification by water companies. Cooling 0.005 0.051 Irrigation 0.005 0.051 Exemptions Other uses 0.020 0.051 ● Sprinkling and irrigating land (if less than 40,000m3 per year is extracted). Rebates of up to 90 percent are available for water- ● Draining of building sites (if less than 50,000m3 per intensive agricultural, forestry, and industrial enterprises month is extracted for less than 4 month a year). which might otherwise be affected in their competi- ● Small pump capacity (less than 10m3 per hour). tive position. This rebate is conditional on taking all ● Emergency extractions (e.g., fire). available measures to save water and to use surface ● Extractions for skating rinks. instead of ground water. Similar rebates can be granted ● Draining and mining (at depths greater than 500m). if they are in the interest of the public. ● Use of groundwater to rinse reusable packaging. When the water resource tax was proposed in Baden- € ● All surface water abstraction. Württemberg, an annual revenue of about 81.8 million was projected. This level was achieved in the first Effects three years. Since then, the revenue has fallen to €71.6 ● Competition between: million and is now assumed to have stabilized. Part of industries supplied by water industries as opposed the revenue goes to farmers as compensation for land to those abstracting for themselves; use restrictions. those abstracting ground water and those abstracting surface water (favors the latter); Source: Kraemer and others, 1998a ● Price differential between groundwater and surface water is not sufficiently reduced to make groundwater abstraction less profitable;

● Limited environmental effect due to exceptions, but 7 Originally in the Act amending the Water Act for Baden- metering plays an incentive role and it is believed Württemberg of July 27, 1987; now in Article 17a to 17f, that water-saving investments have been made. Water Act for Baden-Württemberg (Wassergesetz für Baden- Württemberg) as amended on July 1, 1988. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 13

BOX 4

THE GROUNDWATER ABSTRACTION CHARGE IN HAMBURG The German Free and Hanseatic City State of Hamburg has enforced a ground water license fee since July 1, 1989. The fee is levied on the basis of abstraction rights held by water users, namely the maximum quantity of water a user is licensed to pump per year. If that preset quantity is exceeded, the fee is set on the basis of the actual use. Exceptions are made for some abstractions that do not require a license according to the federal Water Management Act, for small quantities (< 10,000 cubic meters per annum) and for water used for heat pumps. A fee schedule is applied in the case of quantities between 10,000 and 20,000 cubic meters. Public water suppliers pay a reduced rate and, in addition, benefit from a blanket reduction of 65 percent.

TABLE 2

GROUNDWATER ABSTRACTION FEE RATES IN HAMBURG

Groundwater quality ‘Good Groundwater’ High chloride groundwater near [in r/m3] the surface [in r/m3] 1989–90 1990–93 1994 1989–90 1990–93 1994 Public water supply 0.026 0.051 0.056 0.00 0.026 0.020 Other uses 0.051 0.077 0.087 0.026 0.051 0.051

Hamburg distinguished between public water suppliers and all other users, and between “good” groundwater (that is from deep and relatively well-protected aquifers) and water from aquifers near the surface (less than 35 meters of depth) that might be polluted or affected by the tidal river Elbe (salt intrusion). When the fee was adopted, a first increase in the rates was already included. A second increase took effect in January 1994. As of 1994, the blanket reduction for water suppliers was to be lowered to 60 percent.

The fee provided water users with a stimulus to review the water needs and their holdings of water rights, and to consider the potential for water savings and substitution. The “environmental effect” the fee was designed for was not primarily a reduction in water use but a reduction in the water rights held by users. Between 1989 and the end of 1993, more than one third of all water rights (103.8 million cubic meters) were renounced and thus made available for re-allocation for public use.

The legislation was revised on the basis of these results. The focus appears now to be shifting towards setting incentives to save water (rather than to retire water rights), both directly through rate increases, and indirectly through the decrease in the blanket reduction allowed for public water suppliers.

Source: Kraemer, Strübin and Hansen, 1998.

the Länder, acting in an area not regulated at the Denmark federal level, tried a variety of instruments, shared experiences and modeled their programs after oth- In Denmark the “tap water tax” is applied to water ers. Second, as already described, water resource abstraction and is fully passed on to users and added taxation dramatically increased the capacity, com- to their water bill. It was introduced in 1993 as part petence and information resources of the Länder of a green tax reform to reduce income taxes. The administrations involved overcoming one of the key tax is initially levied on the water companies, which weaknesses that sparked the development of such then, in turn, collect the payments from households, taxes in the first place (soft functions) (Kraemer, so that the tax is in effect paid by the ultimate users. 1995c). Water companies must pay the tax on 90 percent of 14 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT their abstracted water, independent of the actual and France. Sewerage services will be discussed in amount of water supplied to customers. The tax thus the next section so that components of water prices provides an incentive for water companies to ensure can be studied in greater detail. For detailed infor- a low level of leakage, in order to retrieve the costs mation on the European experience with water incurred by the tax.8 With the tax being fully passed pricing policies regarding the industrial or agricul- on to households, it was further intended to act as a tural sector the interested reader is referred to the resource protection by limiting water demand from relevant OECD publications (OECD, 1999a, 1999c households. and 1999d) Households pay the tax on actual metered water Most European economies have an access rate to consumption. Since January 1, 1999 it is mandatory potable water supply of 100 percent. For the few to have a water meter installed. Before that date, the European countries that fail to guarantee complete tax for households with no metering appliance was coverage, geographical characteristics and the pre- based on an assumed water consumption of 170 cu- sumed inefficiency of linking rural households to bic meters.9 This estimated consumption level was existing networks is generally the constraining fac- deliberately set high in order to provide an incentive tor (OECD, 1999d). Denmark is one of the few for consumers to install water meters.10 mature European economies that exhibit an access In 1998, the charge per cubic meter of water sup- rate below 90 percent. plied was r0.67 (including a 25 percentVAT) and the Tariff structures for domestic water provision total revenue generated amounted to r214 million. vary significantly among OECD countries. However, Consumers pay the tax through their water bills where the majority of countries relies on a combination of it is listed separately to make it clearly identifiable. fixed and variable charges (OECD, 1999d) and in The water companies then forward the revenue to some cases on an additional connection fee. A gen- the Customs and Tax Agency. The revenue generated eral trend can be observed towards more economically by the tax is not earmarked for water management viable pricing and the implementation of incentives activities but instead constitutes an additional source for water conservation. This trend manifests itself in of finance for the general government budget. a decreasing application of fixed-price and decreas- Several exemptions exist, such as those for the ing block-tariff structures and a move towards agriculture and industry sectors, which can deduct the volumetric pricing and increasing block-tariff struc- tax from their VAT liability. Service sector businesses, tures (OECD, 1999d).11 however, are not entitled to a similar tax refund. From 1989 to 2000, the Danish water bill doubled France from about €1.60 to €3.36 per cubic meter. About half of this increase can be attributed to this tax. The Administration tax is believed to have led to an increased development of water saving appliances. Since 1994, total In France, the organization of potable water supply water consumption in Denmark has declined by 13 is under the responsibility of municipalities or groups percent, while leakage from water works decreased of communities, while the role of the state has been by 23 percent. Box 5 summarizes information on the Danish water abstraction tax.

8 The tax is not levied on 100 percent of abstracted water as WATER PRICES there is always a leakage, regardless of the level of maintenance. 9 OECD, 1999b: A government declaration of 1996 imposes an obligation on water utilities to ensure that as of January As outlined, water pricing policies generally address 1999 all properties connected to the public water supply have three distinct sectors, namely households, industry a water meter installed. Furthermore, payment for water de- and agriculture. The water bill paid by users con- liveries must be made via a combination of a fixed charge sists of several elements. For households it includes and a volumetric charge. 10 Source: http://www.mst.dk. a charge for piped water supply and for sewerage 11 An increasing block structure implies that supplementary collection and treatment. The following case studies units of water increase in price, while a decreasing block will give an overview on the systems of pricing piped structure stands for regressive prices with increasing con- supply of potable water to households in Germany sumption. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 15

BOX 5

THE WATER ABSTRACTION TAX IN DENMARK Objective of the tax ● To allow for a decrease of income taxes ● To reduce water demand from households (environmental resource protection function)

Specific tax base ● Piped water at delivery

Unit of measurement ● cubic meter (tax is imposed on metered water delivered to the customers; in cases where no metering is in place, a standard consumption of 170 m3/ year is assumed)

Tax rate ● €0.67/m3 in 1998 (including 25% VAT)

Revenue collecting authority/administration ● Customs and Tax Agency and its Regional Offices

Use of Revenue ● General government budget (revenue raised in 1998/99: €214 million)

Comments and exceptions: ● Exceptions: Farmers and industry (most enterprises can deduct the tax from their VAT liability; excludes service sector businesses)

Effects ● From 1989 to 2000: water bill doubled, from about €1.60/m3 to €3.36/m3. The water tax is responsible for about half this increase, while the other half is due to increased water supply tariffs, increased sewerage costs and the waste water tax ● 13 percent reduction in water consumption since 1994 ● Development of water saving appliances ● Leakage from water work decreased by 23 percent

Sources: Ecotec, 2001; Speck, 2000. limited to water law enforcement (OIEAU, 2002). Due years, while the “lease” type contracts last from five to historical factors, there are still more than 36,000 to 20 years (OIEAU, 2002). communes in France nowadays with their elected municipal councils and mayors (Barraqué, 1999). Tariff Structure and Rates There are altogether more than 15,000 undertakings for water supply, some of which are very small mu- There is no national tariff regulation. When the municipal water works serving one or two communes. nicipality is responsible for collecting a part of the Due to the fact that local authorities, while en- price, as is the case with “lease” delegation, it has the joying strong political sovereignty, often have little ability to set rates on a yearly basis. In the event of economic power, they often choose to delegate ser- the municipality being under contract with an out- vice provision to varying extents to private side operator (through a concession agreement), operators. The delegation can either take the form prices are set for the duration of the contract and not of a lease, where the community makes investments determined on a yearly basis. In both cases public and only entrusts the operation of installations to a participation in establishing tariffs is indirect, con- private supplier, or of a concession, where the pri- ducted by public officials responsible for public vate company also builds installations. The duration budgets. In addition, at a regional level, the Prefect of a concession agreement may vary from 20 to 50 can block price increases with public interest in mind. 16 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

Charges mostly include a component calculated Germany on the basis of metering. Tariffs structures fall into four basic categories (Buckland and Zabel, 2002): Administration

● Two-part tariffs with a flat rate: the consumer pays According to Article 28 of the German Basic Law, a flat rate that entitles him to consume a certain municipalities are guaranteed self-governance on all amount of water. Any excess amount is charged local issues, including water supply, so that the pro- on a volumetric basis; vision of water services is the responsibility of ● Two-part tariffs with no flat rate: in addition to a municipalities. To date there are a multitude of insti- standard fixed rate, a volumetric charge is ap- tutional arrangements with the most common plied to actual consumption; undertakings being municipal enterprises. Compa- ● Single tariffs: the consumer is charged purely on nies act like private companies but are in effect consumption (cubic meters); publicly owned by municipalities. Municipalities oc- ● Fixed rate tariffs: the charge for water supply is casionally seek private input, capital or otherwise. independent of consumption. The range of undertakings is as follows:

Most undertakings currently use the two-part ● Regiebetriebe and Eigenbetriebe: Municipal man- tariff with flat rate (48 percent) (Buckland & Zabel, agement and ownership; 2002). Since a 1992 law banned all flat rates for ser- ● Eigengesellschaften: Companies subject to private vices, fixed rates can still apply to meter rental and law, where the municipality holds majority reading and thus continue to be found. Tariffs also shares; may vary according to the type of water used, for ● Private companies; example surface or groundwater, and there is a re- ● Inter-municipal associations: Zweckverbände and duced VAT rate for drinking water. Wasserverbände; Between 1991 and 1996, public water supply ● Water and ground associations; prices have increased by 31 percent. In 1996, the ● Individuals. weighted average of volumetric rates and of the average fixed charge was equal to r1.23 per cubic meter To date there are approximately 6,000 undertak- of which the fixed charge made up for 20 percent12 ings, of which 96 percent are community owned, 3 (OECD, 1999d). In 1998, the average volumetric percent are of mixed ownership, and 1 percent is pri- charge was r1.30 per cubic meter, no data is avail- vate. Drinking water quality and pricing is regulated able on the fixed component for this year. In 2000, by municipalities, often set by the local elected Town the average price paid by households for water sup- Councils. Local health authorities are responsible for ply was r151.54 per year (Schönbäck and others, the control of drinking water quality. 2002). Tariff Structure and Rates Pricing Principles Charges for water services provision are predomi- Water laws include a system based on the polluter- nantly based on metered water consumption and pays principle as well as a framework for water metering is extensive. Ninety-one percent of the charges used to improve water quality and prevent charges are related to volume and 9 percent are stand- deterioration (Hamada, Interwies and Kraemer, ing charges (Hamada, Interwies and Kraemer, 2002). 2002). There is thus an attempt to achieve full cost Excessive water use is discouraged by some compa- recovery in water services, although there is some nies through the use of progressive charges, that is debate as to whether or not France achieves this tar- through raising the charge rate as volume increases. get given the presence of subsidies. Charges are established under the framework of the Kommunalabgabengesetze (Municipal Charges Laws, KAG) and are levied by the community-owned utility or mixed enterprise, but not by private operators. 12 This figure was obtained by the addition of the average of Private companies must set prices according to pri- different utilities’ fixed charge elements to the average of their volumetric rates, transforming the former into a “volumet- vate law. In actuality, these, too, are often set according ric-equivalent” by assuming a typical household consump- to KAG formulae. Customers have an indirect role in tion rate (OECD, 1999d). setting tariffs via representation on local city coun- EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 17 cils and utility boards, regardless of the private or amounting to population equivalents of 117.4 mil- public legal status of the utility. VAT is charged on lion (including small commerce), were connected to the services and locally elected town councils usu- sewerage systems, producing 9.9 million cubic meters ally set rates. per day of sewage, which was treated in 10,390 treat- In 1997, the price of drinking water was equal to ment plants, 88.6 percent of it biologically (Rudolph €1.50 of which the fixed charge constituted 9 per- and others, 1998). Sewerage services are a sovereign cent13 (OECD, 1999d). service in Germany and municipalities provide this service in order to maintain adequate living condi- Pricing Principles tions for the local population (Buckland and Zabel, 2002). Public drinking water services are governed by the As Länder Water Laws differ, various organiza- principle of full cost recovery. Water companies must tional structures for sewerage services have emerged ensure that water prices cover costs of supply, that in the country. Sewage collection and treatment customers pay for their consumption levels (user-pays has traditionally been integrated in municipal principle), that tariffs are determined by a cost struc- administration, or has been independent only to a ture, that there be a return on capital, and that the limited degree. The current trend is to move away real value of assets should be maintained. from municipal operations included in the general budget (Regiebetrieb) toward separate municipal entities which operate on their own clearly defined budgetary allotments (Eigenbetrieb). In line with this PRICES AND CHARGES IN (PUBLIC) SEWAGE trend, cities are increasingly gravitating toward COLLECTION AND TREATMENT forming private-law organizations (privatrechtliche Organisationsformen) to run their sewerage systems, and accordingly toward shifting the infrastructure Citizens pay for the provision of sewerage services and personnel off their own budgets. This step has in all EU member states. Calculation of the charge largely been motivated by growing financial is often volumetric and based on metered water con- problems and is due to the fact that revenue sumption, although there are alternative systems surpluses are not easy to produce in the sewerage (Austria). In addition to the volumetric charge, there sector. may be a fixed component that serves as a contribution to the investment cost of the initial Charge connection to the sewerage system (Denmark’s connection fee, France). The collection of sewerage In Germany, discharges of water to the sewerage sys- charges most often aims at recovering the costs for tem by households are subject to user charges. The operating and maintaining the sewerage system. The charge is based on metered freshwater consumption, sewerage charging systems of four representative but in general municipalities are free to collect fixed countries (Germany, Austria, Denmark and France) contributions regularly (in some Länder even basic are presented next and an overview is included in monthly charges) in addition to the volume-based Table. charges (€ per cubic meter, or in the case of rainwater € per square meter) (Speck, 2000). Germany Four basic principles guide the setting of charges (Buckland and Zabel, 2002): Administration and Organization ● Charges are set in proportion to the services pro- In 1995 in Germany, around 72.5 million inhabit- vided (metered consumption); ants (approximately 92 percent of the population), ● Charges reflect the benefit a user derives plus the costs incurred in providing the service (charges for new connections are borne by the property owner); 13 This figure was obtained by the addition of the average of ● Charges should not differentiate between different utilities’ fixed charge elements to the average of their volumetric rates , transforming the former into a “volumet- users; ● ric-equivalent” by assuming a typical household consump- Charges should be set at cost recovery rate, that tion rate (OECD, 1999d). is revenue should not exceed costs. 18 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

In 1997, the average sewerage charge was resource protection since the 1980s the Danish gov- €2.36 per cubic meter of fresh water consumption. ernment has demanded both a stricter application The collection of charges is set in the Kommunalab- of the cost-recovery principle for capital and opera- gabengesetze (Municipal Charges Laws, KAG) of the tional costs and an acceleration of investment in various federal Länder on principle of cost-recovery: sewerage services. the revenues collected by a particular community may not exceed the actual costs of the sewerage services, Charge and conversely, the charges should be set at such a level that no deficit arises. The Danish sewerage charge consists of an initial In recent years the unit prices for sewage treat- connection charge plus a charge for sewage collec- ment plants have been reduced due to a general tion and treatment. Municipalities are free to establish downward trend in costs for construction and equip- calculation methods for tariffs and charges but must ment, technological advancement, and the cost-cutting respect the cost-recovery principle (Rudolph and oth- pressure of competition and rationalization. Further ers, 1998). potential for limiting the continued increase in costs and charges for sewerage services can be found par- ● Sewerage connection fee. For households, the ticularly in the conceptual phase of construction or charge covers the connection to a double sewer- expansion projects of sewerage installations. age system consisting of a system for sewage discharge and one for gutter and runoff. For en- Revenue Generation and Use terprises, the fee is calculated based on the area 14 of the premises. In general, municipalities are able to finance their ● Annual sewerage fee. For the annual sewerage fee investments in sewerage systems and operational actual amounts of sewage are approximated by costs through revenue from contributions and sew- metered water consumption, as measurement and erage charges. A legal right to state or federal control of water usage is much easier. For house- government subsidies does not exist. holds without meters, the fee is based on an estimated water use of 170 cubic meters. How- Denmark ever, since January 1, 1999, all households should install meters with only minor exceptions. In gen- Administration and Organization eral, the fee should be the same for all user groups connected to the same system. A specific sur- Around 90 percent of the Danish population is con- charge may however be imposed on enterprises, nected to primary and secondary treatment of based on a pre-defined formula, which consid- sewage. Since the 1970s the Danish municipalities ers the content of certain pollutants (e.g., total are responsible for designing plans for sewage dis- amount of lead or phosphorus discharged) in the 15 posal and for financing them through municipal sewage. taxes and charges. However, Danish sewerage services are not exclusively carried out by municipal Charges can vary considerably between munici- authorities as a significant portion of the sector is palities. The sewerage charge amounted to an average dealt with privately by property owners or by neigh- of €1.56 per cubic meter in 1997 (Speck, 2000). borhood community groups. The basic principle Table 2 displays the development in average user guiding the financial arrangement of sewerage ser- fees over the 1995–1997 period. Developments prior vices in Denmark is the proposition of economic neutrality or self-sufficiency (Hvile-i-sig-selv) which is equivalent to the cost-recovery principle. Costs TABLE 2 and revenues may be balanced over several years so that revenues and costs may be accumulated over AVERAGE USER FEES FOR SEWERAGE SERVICES, 1995–1997, IN €/M3 the years. Due to a generally slow progress in water Type of annual fee 1995 1996 1997

Sewage fee 1.37 1.42 1.56 14 Source: http://www.mst.dk. 15 Information is based on data from http://www.mst.dk. Source: www.mst.dk EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 19 to 1995 showed significant increases in the sewerage Charge fees, attributable mainly to the implementation of the Action Plan for the Aquatic Environment. Compli- The consumption of fresh water forms the basis for ance with the Plan meant that a number of sewage the calculation of sewerage charges. Water meters are treatment plants undertake major investments, the customary in France and the trend is moving towards costs of which were recovered through user fees. measuring each household’s consumption separately. In the French system, there exist sewerage charges Revenue Generation and Use depending on consumption (in 1998, the average charge was €1.32 per cubic meter), (Schönbäck and The replacement costs of the Danish collection sys- others, 2002 ), nonrecurring contributions to the tem amount to around €27 billion in 1998 (Rudolph initial investment cost for connection, as well as in- and others, 1998). The annual revenue generated by creased charges for heavy polluters and reduced the sewerage charge amounts to approximately €590 charges for entities producing sewage, which is par- million (Speck, 2000), and is earmarked for the fi- ticularly inexpensive to treat (Rudolph and others, nancing of sewerage and collective treatment plants. 1998). In addition, a pollution charge (redevance) is Since 1989, sewage discharge and treatment are fully levied, which is used to create the assets of the Agences financed through user fees. de l’Eau (River Basin Agencies) which in turn are used to finance water resource protection projects. Between Exceptions and Comments 1992 and 1996 the sewerage charges rose by 90 percent, while the water price grew by only 31 percent. Since the 1980s, no direct subsidies have been pro- In 1996, the average yearly sewerage bill for a stan- vided for the Danish sewerage system. However, low dard household (consumption of 120 cubic meters interest loans are at times granted for investment in of water) amounted to €148.49 (Rudolph and oth- sewage collection improvement or replacement. Since ers, 1998). By 2000, it increased to €166.05. The 1989 the Danish sewerage services are subject to the average yearly costs of sewerage disposal per person full 25 percent VAT. in 2000 were €69.19 (Schönbäck and others, 2002). In examining the prices and charges for organi- France zational dependency, one will notice that the privatized systems (or systems delegated to private Administration and Organization enterprises) in 1996 were 16 percent more expensive (23 percent more expensive in 1991) than the In France, municipalities are responsible for sewer- systems operated by municipalities. This finding may age services but are free to choose between result from the fact that privatization has generally self-provision (direct management) and delegation taken place in mid-sized cities which carry higher to private enterprises, as mentioned earlier in this per capita costs, and may have been at a point in time chapter. In a number of cases inter-municipal when investments became necessary or when associations have been formed. The municipal au- sewerage services became too expensive for the mu- thorities are required to apply the principle of nicipality. In addition, profit seeking on the part of cost-recovery and to make no profit. Depreciation private enterprises is seen as a further reason for the costs should be reflected in their charges to ensure increase in charges. the necessary financial means for replacement and investment. There is no central regulatory au- Revenue Generation and Use thority responsible for sewerage charges, but municipalities are obliged to set tariffs themselves In 1996, the total annual revenue generated by the as well as fix delegation contracts with private pro- sewage charge amounted to €1.5 billion. The revenue viders. Private operators provide an estimated 75 is earmarked to finance water resource protection and percent of all customers with services, and approxi- investments in water supply equipment. mately 60 percent of all municipalities have chosen delegation of water services as their operational form Exceptions and Comments (Hamada, Interwies and Kraemer, 2002). There exists an oversight committee, comprising national Subsidies continue to remain quite important in the governmental institutions, to which parties can ap- French system. Forty percent of the financial means peal in case of contract abuse. of the Fonds National pour le Developpement des Ad- 20 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT ductions d’Eau (FNDAE) is spent on sewerage sys- or on population equivalents. Industrial indirect tems and 98 percent is alloted to subsidies for emitters generally pay the same charges as house- investments (Rudolph and others, 1998). Sewerage holds. In general, charges are mainly based on the services are generally not subject to VAT payment; metered supply of water. In 2000, the charge for however, municipalities can pay a reduced VAT on sewage treatment was between €0.30 and €2.88 per sewerage services and at the same time reclaim VAT cubic meter of drinking water provided, €1.73 per paid on goods and services bought in. Applied rain- cubic meter on average. In cases where the charge water collection and treatment are also under is calculated according to the size of the built-on municipal responsibility. The resulting costs must be area, rates varied between €0.58 and €10.39 per absorved by the general municipal budgets and may square meter (average €0.79 per square meter). In not be included in the calculation of sewerage charges. the Land of Tirol, there is also a nonrecurring fee for connection to the sewerage system of €726 Austria (Schönbäck and others, 2002). With charges differing widely across municipalities, the average Administration and Organization yearly costs of a fictitious household17 for sewage disposal was €209.68 in 2000. The average yearly Austria has comparatively low connection rates (only costs of sewerage disposal per person amounted to 75,7 percent of the population is connected to the €83.87. sewer system) and higher sewerage charges. These findings can partly be attributed to the fact that the Revenue Generation and Use Alps cover 60 percent of Austria’s surface area, and 56.7 percent of the population lives in communities There is no detailed information available on the use with less than 10,000 inhabitants. Due to its geogra- of the revenue generated by the Austrian sewerage phy, Austria’s connection rates vary quite noticeably charge. It is designed as a cost-covering charge, how- from region to region. It is assumed that an overall ever, and thus the revenue is likely to be used in the connection rate of 85 percent is the maximum to be sewerage and wastewater treatment sector. achieved within economically feasible boundaries (Rudolph and others, 1998). Exceptions and Comments In general, water management is the responsibility of the federal Ministry of Agriculture and For- Government subsidies are intended to keep the sew- estry. However, legal matters pertaining to water are erage charges per household below the politically under the jurisdiction of the districts, and sewerage significant level of r363.36 per year. Municipalities services are under the responsibility of municipali- carry the cost of rainwater collection and treatment ties. The Water Law allows for the formation of lo- (as far as applied). cal water associations (Wassergenossenschaften, WG and Wasserverbände, WV) when these prove more effective in achieving objectives regarding water. Around one half of all municipalities are members COMPARISON OF WATER BILLS of such an association.

Charge In order to assess how different environmental economic instruments such as water taxes and charges The structure of sewerage charges varies greatly play out when considering them as a whole, it would even within the various Austrian Länder: Styria be interesting to compare the water bills of represen- alone has 29 different models. On the one hand, tative users such as households, agricultural farms water meters are quite common, allowing a volu- or industrial firms in the different countries under metric charging system. Yet on the other hand, there are alternative systems in Austria with charges being independent of consumption. In Lower Austria 16 Under this circumstance, for instance, owners of vacation (Niederösterreich), for example, the sewerage homes who may not regularly consume water nonetheless charges are based on the size of the home, not on regularly pay for the fixed costs of sewerage services. 16 water consumption. There are also charging 17 Size of flat 80m2, two adults, one child, one toilet, one bath- schemes based on the number of toilets in a home room, yearly consumption of 150m3. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 21

(Continued on next pag

83.87 209.68 on average;

€ €

363.36)

€

Sewage charges varySewage between

Government subsidies are Government

charges per household belo significant level the politically

Collective treatment plants are treatment Collective

About 90% of the population

Construction and operation

●

Use of

revenue

finance sewerage“fictitious” household costs of a

OPEAN COUNTRIES

enue plants treatment is connected to primar

590 million. of sewerage the revenues by

collected on used to finance charges financed by completely

€

of wastewater costs per capita the yearly

1.73/m

€

0.30 Municipalities is Revenue

€

10.39/m

of drinking used to probably the yearly in 2000, municipalities;

€

AND TREATMENT IN SELECTED EUR TREATMENT AND

0.58 and

1.57/m

on average; or betweenon average; collection and were €

Niederösterreich,

€

Länder.

of drinking in (e.g., municipalities the sewerage intended to keep

SEWAGE COLLECTION SEWAGE

umber of toilets

of the home charge) m water provided chargessewerage dirtywater and rainwater based on the size a also leviedwith are of n in a house

en within the various

Austrian

charges varies greatly ( water provided Styria alone has 29 additional built-on area; treatment were different models):different the between differ fees ev

●

management of sewagecharge is determined b an annual and sewerage funds) (no government to local authorities:a connection charge annual basis; generated by collective and secondary treatment (fixed amount on initial(fixed connection to treatmenttax: the approx. of the plants is financed solel plant) and a combined charge for sewerage and sewerage charge for user financed charges – fully treatment servicestreatment

Objective Unit of rate Tax Revenue authority/ Comments

Cost-covering models exist Different between 2000: charge of sewerage (structure and 2.88/m

charge waste water Cost-covering for payable Charges are tariff was average 1997: Municipalities; are Revenues

CountryAustria of charge measurement (in Euro) collecting administration etc) (exception,

Denmark

TABLE 3 22 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

166.05

€

69.19

€

(continued)

Use of

revenue

esource capita were

equipment

OPEAN COUNTRIES

olvement; r

1.5 billion

Municipalities is Revenue costs of a the yearly In 2000,

sector finance water costs per the yearly on average;

1996: € Municipalities are Revenues

1.32/m

€

1998; OECD, 2002; Schönbäck and others, 2002 Schönbäck and others, 2002; OECD, 1998;

1997: r2.36/m

AND TREATMENT IN SELECTED EUR TREATMENT AND

amount and an with private to earmarked household were standard

unicipalities may treatment

of freshwater; finance collective m collect additional fixedcollect additional infrastructure contributions

SEWAGE COLLECTION SEWAGE

Objective Unit of rate Tax Revenue authority/ Comments

esource generated in water supply

or water consumption) revenue and protection

charge; fixed Cost-covering Charges consist of a 1998: generation amount based on water of revenue usage (metered inv f r management objectives charge consumption metered to earmarked Cost-covering Main charge is based on

rance

Country of charge measurement (in Euro) collecting administration etc) (exception,

Germany

TABLE 3

Sources: Speck, 2000; Buckland and Zabel, 2002; Rudolph and other 2002; Buckland and Zabel, 2000; Speck, Sources: EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 23 observation. It might be of particular interest to evalu- When looking at Tables 4 to 6, it is also impor- ate the affordability of water services by looking at tant to note that affordability measures, which might the ratio of water prices to average disposable income, be of particular interest to Latin American and Car- that is to assess how strongly charges affect users ibbean countries in relation to poverty issues, are under the given system. based on average bills and average incomes only and However, there are a variety of well-founded thus mask regional differences and income distri- drawbacks or issues in such a comparison. The main bution. difficulty is that the necessary data are not readily When comparing household bills across coun- available in a comparable format, and that their com- tries, the problem arises that the “typical” or pilation requires a substantial research effort and is “standard” households for which statistics are calcu- subject to large potential errors. lated differ between countries (number of persons, The charging systems may differ in (Rudolph and amount of annual water consumption/sewage dis- others, 1999; Kraemer and others, 1998b): posal, size of area) (Kraemer and others, 1998b; Schönbäck and others, 2002). So it is often more con- ● The extent of services and costs comprised in venient to refer to bills per capita. the water bills; Because of the substantial difficulties outlined ● Relative contributions of fixed and consumption- above, it was not feasible within the scope of this dependent components; study to newly collect and evaluate data for a com- ● The presence or absence of nonrecurring con- parison of water bills. Therefore, the following nection fees; paragraphs will give an overview of available data. ● The type of taxes/charges applied; The interested reader should refer to the studies ● The objectives of the charges applied (cost re- cited for more in-depth information on this subject covery, incentive); (OECD, 1999d; Kraemer and others, 1998b; ● The role of state subsidies; Rudolph and others, 1999; Schönbäck and others, ● Whether water prices are subject to VAT, and 2002). what its level is; ● The extent to which depreciation of installations Sewerage Charges is in the price. A study comparing European sewerage charges con- Data quality and availability in general also vary ducted earlier by Ecologic in cooperation with the between countries. As Rudolph and others (1999) Beratungsbüro für Wassertechnik und Management, point out, it is easier to collect comprehensive data Wien (Rudolph and others, 1999) uses the annual in centralized systems, whereas in federal states like bill for sewerage services per year and per capita con- Germany, charges and bills already vary greatly be- nected to the sewage collection system. Table 4 shows tween regions. the relevant data for several countries of the Euro-

TABLE 4

ANNUAL SEWERAGE CHARGES PER CAPITA IN SOME COUNTRIES OF THE EUROPEAN UNION (1996–1998)

Germany Denmark France Austria

annual charges in € per capita connected 109 93 68 154 to sewerage system GNP/inhabitant*annum (€) 20,605 21,348 17,852 19,803 annual charges in % of GNP 0.76 0.58 0.68 0.72 annual harmonized charges in € per capita connected 122 123 117 142 to sewerage system

Source: Rudolph and others, 1999. 24 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT pean Unionfrom 1996 to 1998 (first row). To pro- bill per household and per capita. This table may vide information about the level of the charges in serve as an illustration for the aforementioned chal- relation to income, the same study presents the an- lenges to data compilation. The values are not directly nual average sewerage bill per person as a percentage comparable, since they are not available for each of per capita GNP (third row). In the fourth row, the country for the same year. Moreover, mean values annual charges are corrected for several distorting fac- were not calculated by the same method in all cases. tors, such as direct or indirect subsidies, connection Because of the limited data availability, it is likely fees, VAT rates, and others. that the interval of charges within countries is actu- From the systems reviewed, clearly Austria and ally higher than indicated here. Nevertheless, the Germany have the highest average sewerage bills, figures should give some idea of the scale of prices both in absolute figures and in percentages of GNP. and annual bills. There are, however, no dramatic differences in bills It is interesting to note that Germany, while or in affordability. having relatively high water prices per cubic meter, The harmonized annual charges, which give an does not differ significantly from other countries with estimation of what the different charges would respect to annual bills. This suggests that water con- amount to under the same circumstances, differ consumption in Germany is more economical than in siderably from the original data. This is an indicator other EU countries (Kraemer and others, 1998b). of the underlying variability of charging system and Table 5 also shows that the variability of prices thus of the challenges posed to any attempt to com- within countries is greater than the variability between pare these data. countries. It appears that regional differences within or between EU countries have greater influence on Water Supply Prices the costs of water supply and water prices than legal and institutional differences between those countries. In 1998 a report was prepared by Ecologic on Euro- A study published by the OECD in 1999 (OECD, pean prices for water supply (Kraemer and others, 1999d) compares the average affordability of house- 1998b). Table 5 shows water prices in terms of both hold water supply bills across countries by relating average value and estimated maximum/minimum them to GDP per capita and to household income, value for each country, as well as the average annual respectively.

TABLE 5

WATER PRICES AND AVERAGE ANNUAL BILLS IN SOME COUNTRIES OF THE EUROPEAN UNION

Water prices in r/m 3 Average bill in r/annum

per per persons per Country Year Interval Mean value household capita household

Denmark 1993 0.18 – 0.84 0.41 N.A. 28 —

Germany 1996 0.93 – 2.02 1.46 130 72 1.8

England 1995 0.51 – 1.43 0.87 138 59 2.3 and Wales

France 1994 0.06 – 1.86 1.02 133 54 2.5

Italy 1992 0.10 – 0.67 0.36 112 38 2.9

Netherlands 1995 N.A. 1.38 174 69 2.5

Spain 1992 0.005 – 1.28 0.20 N.A. N.A. —

Source: Kraemer and others, 1998b. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 25

TABLE 6

AVERAGE AFFORDABILITY OF WATER PRICES AND SEWERAGE CHARGES

Average prices for Sum of average water public water supply prices and sewerage for a family of four, charges as proportion of relative to GDP, based Prices for public water household incomes (Y) or on IWSA data (1996), in r supply in r/m 3 (year) expenditure (E) (1997/98)

Hungary 3.62 0.28 (1997) > 3%18 (Y) Portugal 2.25 Czech Republic 2.17 0.35 (1997) Germany 1.32 1.50 (1997) Luxembourg 1.30 0.89 (1994) 1.0–1.5% (Y) Netherlands 1.13 1.31 (1998) 1.6% Austria 1.13 0.94 (1997) 1.0–1.3% (Y) France 1.12 1.23 (1996) Belgium 1.09 1.49 (1997) (Flanders) England 1.05 1.23 (1998–9) 1.3% (Y) and Wales Spain 1.02 0.59 (1994) 1.0%19 (Y) Finland 0.97 1.16 (1998) Denmark 0.68 1.00 (1995) Sweden 0.59 0.89 (1998) Norway 0.45 Italy 0.43 0.40 (1996)

Source: OECD, 1999d.

The first column of Table 6 relates to water sup- Water prices per cubic meter are listed in the sec- ply prices only. Data are based on a 1996 household ond column. water bill survey which was conducted by the Inter- The third column presents information from the national Water Services Association (IWSA) to country submissions in response to enquiries made establish the average public water supply bill of a for the study. The figures in this column include both standard four person household in a number of cit- water supply prices and sewerage charges. They are ies in each of the participating IWSA members. The presented as percentages of household incomes or results exclude VAT and other consumption/sales expenditures. taxes. The average bill for a household of four in each country is then divided by the GDP per capita for the same year. While the absolute magnitude of 18 Figure exceeds 3 percent “in many regions” in the low- the resulting data series is not relevant, it provides income categories. an indicator of relative average affordability across 19 Barcelona only (which has relatively high charges within the OECD. Spain). 26 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

The comparison of affordability and absolute charging systems of the four countries studied which water prices draws attention to the fact that low prices clearly differ in their main objective. The German in international terms (Hungary, Czech Republic) can and the Danish systems have an incentive focus, while actually represent high water charges relative to per the French and the Dutch charging systems mainly capita incomes (GDP). Similarly, water supply charges aim at revenue generation.21 that are high in international terms (Denmark, France, the Netherlands, England and Wales, Swe- Germany den) do not necessarily reveal water charges that are the highest in relation to per capita incomes. The design of the German effluent charge seeks to In terms of analyzing the effects of economic in- provide strong incentives for pollution abatement. struments, it would be revealing to disentangle the Industrial plants of all sizes with any quantity of dis- contributions each instrument makes to the total charge are subject to the effluent charging system. household bill, that is how taxes and charges that do Sewage treatment plants are equally liable to the ef- not directly apply to household users, such as ab- fluent charging scheme and no reductions or straction taxes and effluent charges, are passed on to exceptions apply to them. Their costs are recovered them through their water bills. However, this would through the sewerage charges paid by households. require further research and is beyond the scope of The municipal authority issues permits for small this review. discharges and the regional administration for larger discharges that is large sewage treatment plants or industry. The conditions for permits for industrial discharges are based on general emission limit val- PRICES AND CHARGES IN INDUSTRIAL ues (ELV). These ELV depend on the “Best Available EFFLUENT DISPOSAL Technologies” (BAT). BAT-derived emission standards make considerations for the state-of-the-art technologies available for production processes and pollution Charges for the discharge of effluents into natural abatement in the various industrial sectors. The en- waters are collected in seven countries of the Euro- vironmental quality of receiving waters plays a pean Union.20 Four of these systems will be reviewed complementary role. here, namely the cases of Germany, France, Denmark In Germany, effluent charges are levied on direct and the Netherlands. Denmark and Germany levy discharges of effluents into natural waters. The defi- charges only on direct discharges, leaving operators nition of direct discharges includes: of sewage treatment plants to pass the cost of the charges on to their clients, the indirect emitters. ● Industrial effluents; France and the Netherlands follow a conceptually ● Agricultural discharges; different approach by charging indirect emitters di- ● Discharges from sewage treatment plants (STP); rectly and either exempting the operators of sewage ● Discharges and leakage from landfills; treatment plants from paying effluent charges ● Direct rainwater discharges; (France) or granting generous reductions (the Neth- ● Minor effluents such as domestic sewage from erlands). Either way, the indirect dischargers are decentralized treatment facilities. brought into the charging system and have to pay their share. No effluent charge is levied on rainwater from In general, all of the four countries base their industrial plants not exceeding the size of three hect- calculation of effluent charges on the amounts of cer- ares. Rainwater from railway is exempted likewise. tain pollution parameters discharged within a To provide adequate incentives for being effec- specified period of time. However, the charging sys- tive in directing and encouraging pollution control tems differ considerably with regard to the exact measures, charges must be set sufficiently high. calculation methods applied and the substances in- Charging levels in Germany are set high enough for cluded. Furthermore, the types of effluent subject to effluent charges and the actors obliged to pay differ between the effluent charging systems. 20 Belgium, Denmark, Germany, Spain, France, the Nether- As introduced in the fourth section, economic lands and the United Kingdom. instruments can have different functions. This prepo- 21 Unless stated otherwise, the information presented in this sition is exemplified in the case of the effluent section is based on Hansen and others, 2001. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 27 acting as deterrents to water pollution and have mo- the competent authorities for water management and tivated considerable investment in pollution legislation, they are the recipient authorities and in abatement measures. The charge of €35.79 (1998) addition responsible for the distribution of revenues. per pollution unit22 is uniform across the entire Revenues from the effluent charge are earmarked for country. Individual charges are based on the values a range of water management activities, such as sub- stated in the permit and based on the following gen- sidies for the investments in water pollution control eral formula: and cost coverage for other quality improvement measures. The revenue is thus used to maintain and

EC = f (ai; pui) 1 ≤ i ≤ n improve water quality and also fulfils a financing function. where EC is the effluent charge for one year, ai is the charge rate for a certain pollutant, pui stands for the France number of pollution units discharged in one year and n is the number of pollutants entering into the calcu- The French effluent charging system has been estab- lation. Dischargers conduct self-monitoring and the lished to raise funds for water quality management, permit-issuing water authority has the responsibility and for covering water pollution control by the au- of inspection. The frequency of compliance moni- thorities and investments into sewage treatment toring by the water authority depends on the plants. Therefore, the design of the system aims at authority except for sewerage treatment plants, for providing a financing function. To a lesser degree, it which the Urban Waste Water Treatment Directive sets incentives to reduce water pollution by further- specifies the monitoring intervals. The German sys- ing the adoption of BAT and the building of sewerage tem allows for rate reductions in several cases: treatment plants. The French effluent charging system applies to ● If effluents meet the BAT-derived ELV, the charge direct discharges into surface waters and indirect dis- is reduced by 50 percent, which creates strong charges into the public sewer system. Indirect incentives to invest in abatement technologies; industrial and household discharges into the public ● Charges are reduced when the monitored values sewerage system are thus included in the effluent are lower than stated in the permit; charging system. Nondomestic dischargers (large in- ● Pollutants that are subject to the effluent charge dustries) are charged for direct discharges, while but do not exceed specified threshold values households and small and medium sized enterprises or dilution factors are not included in the calcu- (SME) are charged indirectly (water companies pay lation; the charge for their clients and pass the incurred costs ● Charges can be offset against investments in pol- on to them). lution abatement or expenditures for sewage The responsibility for issuing discharge permits treatment plants, to promote the removal of dan- depends on the type of discharger. The Regional Di- gerous substances from industrial discharges and rectorates for Industry and Environment (DRIRE) to support the adoption of BAT. issue permits for industrial dischargers, while the Préfets de Département are responsible for sewage The total revenue generated by the effluent treatment plants. The permit conditions for indus- charge is quite high (€365 million in 1999), espe- trial discharges are based on sector-specific ELV (set cially given the possibilities for offsetting the charge by a ministerial decree) and the water agencies pro- against investment, resulting in reduced revenues. vide incentives to introduce BAT through bonuses. At present, of the countries considered here, only Pollution fees are collected from the households by Germany operates a system where revenues gener- the municipalities (or concessionaires in case of del- ated by the effluent charge may under certain egation) via the water bill, while the water agencies conditions be sufficient for offsetting investment in collect the pollution levy from industry. water resource protection and management. Revenues Several exemptions exist with regard to effluent are collected on an annual basis. As the Länder are charges:

● municipalities with less than 400 inhabitants are 22 1.5 pollution units approximately correspond to the ‘toxic- exempted from the charges; ● ity‘ of the untreated waste water generated by one inhabitant dischargers from sewerage treatment plants into per year. natural waters are exempted from the charge. 28 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

French effluent charges differ across the six re- with x, y and z being equal to the total amount of gional water agencies and also according to the size Nitrogen (Ntot), Phosphorus (Ptot) and biochemical of the urban area (Buckland and Zabel, 2002). oxygen demand (BOD5) discharged per year. Charges Charges differ between regions. For industry, charges are calculated on the basis of actual measurement as are based on the quantity and quality of effluents dis- determined by self-monitoring and compliance moni- charged23 and are calculated on the basis of actual toring; charges for small discharges are based on measurement as determined by self-monitoring and standard rates (estimates). Only in Denmark are compliance monitoring. charges for major discharges collected on a quarterly In total, the French effluent charging system basis, while revenues collected for minor discharges generated a revenue of €1260.0 million in 1999 are transferred to the regional offices of the Ministry (OECD, 2002). The authorities receiving the rev- of Taxation once a year. enue are those issuing the permits. The money from By setting high charges for nitrogen and phos- all effluents is collected into one “basket,” so that phorus, the Danish effluent charging system promotes the revenue is relatively high and used for a variety the reduction of nutrient in natural waters. BOD5 re- of purposes, such as the building and upgrading of duction is not effectively promoted, as its effluent public sewerage systems, water management in gen- charge is relatively low.24 eral, monitoring and measures to improve water In 1999, the effluent charge generated a revenue quantity and quality. The earmarking is hence rela- of €37 million. The recipient of the revenue is the tively general. Danish Ministry of Taxation rather than the authori- In the French system premiums for good envi- ties competent for water management and regulatory ronmental performance can be granted, which sets aspects. Revenues generated by the effluent charge additional incentives for pollution abatement. are thus not earmarked in Denmark, but constitute a contribution to the general budget. Denmark Netherlands The Danish effluent charging system seeks to provide strong incentives for pollution abatement. It is a The main objective of the Dutch effluent charging fiscal instrument as the revenues generated by the system is the generation of revenue for quality man- tax are not earmarked and added to the general gov- agement of local and state waters. The division of ernment budget. tasks and responsibilities for water management and The municipal authorities issue permits for regulation in the Netherlands is unique, with the type small discharges and the regional administration for (size) of the receiving water being the determining larger discharges, i.e. large sewage treatment plants factor. While the Water Management Authority or industry. The conditions for discharges empha- (Rijkswaterstaat) is responsible for the state waters size the importance of the environmental quality of (that is, the main rivers), the management of regional receiving waters in addition to the consideration of waters is carried out by the water boards. ELV. Like in Germany, effluent charges are only lev- The division of the competence to issue permits ied on direct dischargers of effluents into natural for discharges mirrors the division of responsibilities waters. for water management. Hence the Water Management There are several exemptions to the Danish ef- Agency issues permits for discharges into state wa- fluent charge. The discharges from mussel plants, ters, while issuance of permits for discharges into fish farms and overflows from combined sewage col- regional water is under the authority of the water lecting systems and stormwater discharges are boards. Like in the Danish system, the conditions for exempt from all payments. Furthermore, rates re- discharges emphasizes the importance of the envi- duced by 70 percent to 97 percent exist for entire ronmental quality of receiving waters in addition to sectors, namely the fishing, cellulose, vitamin, and pigment industries.

The Danish effluent charge is calculated accord- 23 ing to the following equation: For an exact equation, please refer to Buckland and Zabel, 2002. 24 This argumentation builds on the fact that it is not possible € € to control for single parameters separately but only to influ- EC = 2.67 * x kg N tot + 13.35 * y kg Ptot € ence the composition of effluent output of a production pro- + 1.47 * z kg BOD5 cess. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 29

)

(Continued on next pag

AbwAG

stormwater discharges

dischargers:

35.79 effluent Any (§10

into not that are areas of water supply source

€

OPEAN COUNTRIES

culated

Phosphorus, units located in Mussel plants,

into all types of cal

All direct dischargesAll direct 1998:

effluent releases under certain conditions. and domestic sewerage.

(State into natural waters per pollution discharger. that has not been Water

axation) collect except rainwater taking formula industrial plants, or groundwater

Skatteministeriet

T charges from discharged directly. pollution load dischargers and surface water. the tax is

Umweltministerien der Länder

delegate the rainwater, discharges, and discharged into collection of charges agricultural artificial waters. to the municipalities.minor discharges, Discharge of rainwater

INDUSTRIAL EFFLUENT DISPOSAL IN SELECTED EUR

Effluent charging Collecting Effluents / rate Tax

37 million;37 collect effluent account connected to the and the receiver

ederal effluent charge

ederal effluent charges act

Effluent tax introduced Regional offices of discharges All direct Charge is All direct Discharge of rainwater in 1997. Direct dischargers Direct in 1997. pay on the basis of volumepay (Danish Ministry of natural waters to according treatment sewage and discharges of solids discharged into all types of natural waters; calculated and industry and of collected on a quarterly STP operators. and Nitrogen build-up sparsely the if farms, fish € basis; total revenue in 1999: total revenue basis; Local councils BOD Instrumental-incentive small charges from (see text) system. sewer identical. are charge. dischargers direct

F introduced in 1976 introduced

(charge collected Environment (including unit (pu) changed in character or since 1981). Ministries) groundwater): use. Incentive charge.Incentive also may they industrial and STP mining used for Water F last amended in 1998.

CountryDenmark system authority tax base paying Actors Exceptions

Germany

TABLE 7 30 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

educed.

)

continued

(

or SME and

are charged for are

and households and SME are charged indirectly – water utilities pay the charge pay f pass them on to the client.

31.76/pu for surface waters and from information Note:

39.03/pu on the charge. but exempt, are

€

OPEAN COUNTRIES

Industrial and STP 1999: Discharges to No exceptions. discharges (STP operators only payoperators only discharges into systems sewerage database1 indicates that

effluent releases andeffluent releases r domestic sewage.

” (included Nondomestic

Collecting Effluents / rate Tax

ontreinigings–

edevance

eceives theeceives dischargers, direct

edevance

case of delegation surface waters and based on (water bills), Municipalities < 400

Agence de l’Eau Agence r r

Bureau Ve heffing Rijkswateren heffing

◊

into state

INDUSTRIAL EFFLUENT DISPOSAL IN SELECTED EUR

◊

edevance pour edevance

) introduced the concessionaire subject are sewers differ pollutants; industry and inhabitants.

1998.

Effluent charging

ater Pollution Charges ater Pollution

pollution in 1964. collects the to the charge. regions between agriculture. Distributive chargingDistributive or in Municipality, to is returned The revenue “ All discharges to Charges are Households STP. Effluent charges from scheme ( ofthe polluter in the form in the water bill) dischargers subsidies for pollutionsubsidies for the households. from (large industries) abatement.

W (pollution levy (pollution levy waters / pollution tax into local waters) apply Pollution (Office for 10% of the tariff for state waters; liable to are STP the discharges from to all direct and indirectto all direct Waters) State Taxes agricultural industry), dischargers (industry,dischargers effluents discharges, for average sent to questionnaires agriculture, households). agriculture, and leakage from discharges into officials states that Financing qualityminor landfills, waters regional merely charges are management of local and state waters (incl. STP).

rance

Country system authority tax base paying Actors Exceptions F

Netherlands

TABLE 7

Source: Hansen and other Source: EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 31 the consideration of ELV. Furthermore, negotiated SUBSIDIES IN THE WATER SECTOR agreements in terms of environmental policy play an important role The effluent charge applicable to discharges into Environmental subsidies constitute a vast field of state waters is a flat rate of €31.76 per pollution unit. study, encompassing a variety of possible schemes The rates for discharges into regional waters differ and measures. The following section, therefore, aims between water boards and are higher than for state at giving an introductory overview on some subsidy waters (€39.03 per pollution unit on average in 1999). schemes currently operating. The examples presented Individual charges are calculated on the basis of ac- are mostly drawn from European countries (EU mem- tual measurement as determined by self-monitoring ber states and accession countries). Box 6 additionally and compliance monitoring. For small discharges, introduces the case of New Zealand, where all agri- charges are based on standard rates (estimates). cultural subsidies were eliminated in 1984. The revenue includes effluent charges from households and from indirect and direct industrial Subsidies Related to Environmentally- emitters. In 1999, total revenue amounted to €900 Friendly Farming million. Effluent charges paid for discharges into state waters are administered and collected by the state Most countries operate financial transfer schemes water authority, while fees for discharges into local that, rather than regulate, offer incentives to farmers and regional waters are managed by the water boards. and other landholders to achieve a desired environ- Like in France, the earmarking of revenues is rather mental outcome. It has been questioned whether broad and the charging system provides funds for a these measures can be regarded as subsidies, as they variety of tasks, such as subsidies for investment in are often made in return for an environmental ben- sewerage services and water pollution control (finan- efit. However, as subsidies for environmentally cial function). friendly farming are part of the overall incentive struc-

TABLE 8

SUBSIDIES RELATED TO ENVIRONMENTALLY-FRIENDLY FARMING

Conditions related to payments Country for environmentally-friendly farming Effects / objectives

Czech Given to farmers that experience losses due to cultivation Republic limitations in protection zones for drinking water abstraction

UK Nitrate Sensitive Area scheme (NSA): payments range The NSA aims at reducing from €79 per hectare for restrictions on nitrogen fertilizers, the loss of soil nutrients to €843 for the conversion of arable land to native species from agricultural practices grassland The farm waste grant was A total of €5.1 million was paid in 1995/96; the Ministry of introduced to help farmers to Agriculture, Fishery and Food introduced farm waste grants comply with the EU Nitrate for the installation or improvement of farm waste facilities Directive (91/676/EC)

Ireland Rural Environmental Protection Scheme (REPS) Grants are provided to farmers who adopt nutrient management plans for the purpose of protecting water quality

Sweden a) 1989/1990: compensation payments for cultivation of a) In order to reduce the nitrogen-fixing crops (Gotaland and Svealand) use of pesticides by b)1989: a temporary compensation scheme for farmers introducing more efficient who convert all or a part of their acreage to organic active ingredients and by production lowering dose-rates 32 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

BOX 6 ture that influences water-relevant behavior of farmers, they are included in the analysis conducted here. CASE STUDY: NEW ZEALAND – As an example four different compensation schemes EFFECTS OF THE REMOVAL OF are presented in Table. AGRICULTURAL SUBSIDIES The Czech Republic operates a subsidy scheme under which financial transfers are made to farmers In 1984 and subsequent years, New Zealand removed for losses due to cultivation limitations in protected virtually all direct and indirect support to agriculture, zones where there is abstraction of drinking water. eliminating: In the United Kingdom, the Ministry of Agricul- ture, Fishery and Food operates a group of subsidy ● output price assistance for agricultural products; schemes that aim to protect and enhance the quality ● input subsidies for fertilizer and pesticides; of the rural environment. Among the most impor- ● subsidies for irrigation and drainage schemes; tant are the Nitrate Sensitive Area scheme (NSA), ● land development loans and subsidized credits; which aims to reduce the loss of soil nutrients from ● tax concessions; agricultural practices, and the implementation of the ● free government services to farmers; European Union Nitrate Directive. ● subsidies for soil conservation and flood control. The NSA compensates farmers who voluntarily While these measures were largely taken in the past change their farming practices in ways that signifi- for economic reasons, it was also considered neces- cantly reduce the leaching of nitrates. Payments € sary to remove distorting price signals, and to address within this scheme range from 79 per hectare for € environmental ‘bads’ before offering governmental restrictions on nitrogen fertilizers, to 843 for the assistance to farmers for the provision of environ- conversion of arable land to native species grassland € mental ‘goods.’ (1995/96). In 1995/96, a total of 5.1 million was paid to farmers. The resulting decline in income caused difficulties for The implementation of the European Union Ni- rural communities. Farmers reacted by cutting back trate Directive requires the designation of Nitrate on all discretionary expenditures (fertilizer use, non- Vulnerable Zones (NVZ), in which farmers are essential repairs and maintenance, new land develop- obliged to change their farming practices. In order to ment, new equipment). They also laid off labor and help farmers comply with the restrictions on the did more work themselves. Credit mediation and a spreading of livestock manure in NVZ, the Ministry write-off of about 20 percent of the total farm sec- of Agriculture, Fishery and Food reintroduced farm tor debt helped to limit the number of farms being waste grants for the installation or improvement of sold to about 5 percent. farm waste facilities (Kraemer and Buck, 1997). The elimination of government support had a num- The Department of Agriculture, Food and For- ber of environmental implications: estry in Ireland operates a Rural Environment Protection Scheme (REPS), under which—among ● In some cases the financial stress of farmers led to other purposes—grants are provided to farmers who short-term exploitation of the resource base; adopt nutrient management plans for the purpose of ● The development of marginal lands virtually ceased; protecting water quality (Egan, 1996). ● Livestock numbers declined; From 1988 onwards, Sweden initiated a variety ● The use of fertilizers and other agricultural chemi- of compensation schemes for farmers in order to cals decreased; supplement existing regulations regarding limitations ● Forestry plantings continued to increase; of the use of pesticides, fertilizer, and manure. In 1989 ● The previously constant increase in demand for and 1990, for example, compensation payments for irrigation water stabilized. cultivation of nitrogen-fixing crops was granted in Gotaland and Svealand. In order to reduce the use of Overall, the New Zealand experience implies that pesticides by introducing more efficient active ingre- the removal of subsidies may be a necessary, but not dients and by lowering dose-rates, farmers were a sufficient, condition to redress the environmental encouraged by this compensation to test improved impact of agriculture. The remaining externalities still field crop sprayers. Furthermore, a temporary com- have to be targeted through domestic environmen- pensation scheme was introduced in 1989 for farmers tal policies. who converted all or part of their acreage to organic Source: Shepherd, 1996. production (Bergvall, 1996). EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 33

New Zealand reports that there are currently no mulated substantial experience with water-based government subsidies for farmers to improve envi- tradable permits, namely Chile, the United States ronmental performance (see Box 8). Instead, it is and Australia (in the United States and Australia, considered necessary to remove distorting price sig- tradable permit schemes exist in more than one nals that lead to environmental ‘bads’ before state). introducing measures to assist farmers for the provi- While the European Union has adopted a provision of environmental ‘goods’ (Shepherd, 1996). sion to allow for water trading (Kramer and Banholzer, 1999), it has not yet been applied any- Other Water Subsidies where so that the postulated process of policy learning cannot be observed. Therefore, the following section While compensation payments for environmentally will present two case studies on the systems oper- friendly farming constitute a common subsidization ated in Chile and Australia and their experiences will scheme, most countries grant additional subsidies to be discussed. The intention of this section is to give set incentives within the framework of water man- the reader a brief introduction to the field. For a more agement. detailed discussion and review of existing tradable In Norway and a number of other European permit schemes, the interested reader is referred to countries, there are some subsidies for the building Kraemer, Interwies and Kampa (2002) or Kraemer of new and the upgrading of existing water plants and Banholzer (1999). (Sjoholt, 1996). In Denmark, municipal and private water works generally seek to cover the full amount Chile of capital and operational costs via water tariffs and charges. As of 1993, the average price for water was Chile moved to tradable water permits soon after its €0.414 per cubic meter. Generally, the water price transition in 1973 to a market oriented society. The per cubic meter is the same for all consumers and introduction of tradable property rights to water can remains constant regardless of consumption. How- be termed a “natural extension” of the initiated re- ever, there are some examples of quantity discounts forms that stressed open trade, the power of markets for industrial users. In regard to the tax on water ab- and economic liberalization, as it aimed at strength- straction that has recently been introduced as part of ening property rights, a more efficient water use and the “green tax reform”, industrial water users can introduced market principles (Holden and Thobani, deduct this tax on water consumption on their VAT 1996). proceeds (Wallach, 1996; Andersen, 1996). Assumed While the Chilean water market has been in that the additional costs imposed upon consumers operation since 1976 following the privatization of by the tax on water consumption still do not cover previously state-owned land and water resources, all of the environmental costs involved, this tax ex- the passing of the Chilean Water Code in 1981 made ception, in principle, could be regarded as a subsidy. the system more effective. According to the law’s However, although methodologically consistent, the provisions, the state grants existing water users inclusion of exceptions from environmental taxation property rights to both surface and ground water schemes in the concept of subsidy seems problem- without charge. New or unallocated rights are then atic, as the noninclusion of environmental costs into auctioned off. Water rights are completely separate water prices is the norm in OECD member countries from land rights and their property status is based and full recovery of economic costs of water services on the property laws of the civil code and, except is still the exception.25 for a few restrictions, they can be transferred or sold to anyone for any purpose at freely negotiated prices. Accordingly, water usage and the allocation of rights are independent of pre-determined priorities and TRADABLE PERMITS IN WATER RESOURCE market forces alone determine the allocation of PROTECTION AND MANAGEMENT water and its use.

Despite the growing importance of water resource allocation issues in many countries, little emphasis 25 If environmental costs are not taken into account in water has so far been placed on the economically efficient prices, this constitutes de facto an indirect subsidy, as costs allocation of water. Only three countries have accu- are incurred but not recovered. 34 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

The acquisition of water rights requires notifica- An important factor in the development and dif- tion in a public register and the presumptive use of fusion of the use of tradable permits for water the acquired right either as consumptive or non-con- resource allocation and water pollution control has sumptive, permanent or temporary must be recorded. been the co-operation over the river Murray and its Different regulations apply for the different uses tributaries through the River Murray Commission (Holden and Thobani, 1996): (later the Murray-Darling Basin Commission) established originally by the River Murray Waters ● Permanent consumptive use: rights are defined in Agreement. volumetric terms. In cases where the demand for water exceeds the available quantity so that not Policy Recommendations all permit holders can be fully satisfied, water is distributed proportionately. Kraemer, Interwies and Kampa (2002) enumerate ● Temporary consumptive rights: these rights are several points to be considered for the effective ini- only considered after all permanent consump- tiation and operation of a tradable permit scheme. tive rights have been met. ● Non-consumptive rights: are granted in cases ● First of all, the definition of property rights and where the water is returned to its source at a a transparent initial allocation mechanism are specified location and time (for example for hy- vital to the success of any trading scheme. dropower stations). ● Secondly, in most cases, the schemes of water tradable permits need to consider the regional physical While non-consumptive rights account for the scale for the development of a market, and bear largest water use, the number of consumptive per- in mind the specific framework of each region. mit holders is about twice as high. ● Thirdly, successful trading regimes tend to be built on pre-existing institutions and are inte- Australia grated into traditional regulatory regimes. This often includes the combination of tradable per- The Australian States of New South Wales, South mits with other economic instruments (for Australia, Victoria and Queensland have established example, taxes and charges) in order to form legislative provisions for transferable water use instrument mixes for more effective water man- rights. However, there is still no example in Austra- agement. lia of a free market for trades in water rights, and a ● Finally, the success and effectiveness of water number of restrictions are imposed by water man- trading markets depend on the frequency of agement authorities. There are restrictions on the trades and the number of market participants. spatial transfer of water use, volume controls, and environmental considerations such as the preservation of river flow, control of salinity, and protection of wetlands and river ecosystems. Water authorities LIABILITY AND RISK ALLOCATION facilitate trades rather than participate in the water market, although they usually are empowered to veto trades if the conditions are unacceptable. Most au- In the absence of a set of environmental liability laws thorities monitor trades and keep registers of buyers applicable to the water sector, so that damage to the and sellers. aquatic environment is borne by society in general, The New South Wales Environment Protection all other efforts to effectively establish the polluter- Authority (NSW EPA) has introduced a pilot sys- pays-principle are undermined. Environmental tem for salinity control in the Hunter Valley, and a liability laws, which act as a believable threat that number of Australian states are considering trad- anyone who causes environmental damage must pay able discharge rights. Tradable rights have also been for its repair, provide enormous incentives for pre- introduced for the Murray-Darling Basin, providing vention and avoidance. for salinity trades between New South Wales, The case of Sweden is described in Box 7. Its leg- Victoria and South Australia (inter-state trading). islative framework underwent major structural New South Wales is adopting a supplementary changes over the last years as a reaction to a perceived scheme, but this scheme is limited in scope and po- lack of adequate tools for reacting to infringements tential impact. of environmental laws. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 35

BOX 7 Since the early 1990s, there has been extensive discussion in the European Union about a commu- ENVIRONMENTAL LIABILITY LAW nity-wide applicable environmental liability regime. In IN SWEDEN 1993, the European Council concluded the “Conven- tion on Civil Liability for Damage Resulting from Swedish environmental legislation has undergone Activities Dangerous to the Environment” (Lugano major structural changes over the last years. On Janu- Convention),26 which aimed at making possible the ary 1, 1999 the new Environmental Code (EnvC) came adequate reparation for damage resulting from activi- into force, which replaces and extends 15 former acts ties that are a hazard to the environment. It is based and implements all relevant EC legislation. The code on strict liability and recognizes the role of environ- aims to “promote sustainable development, so that mental NGOs as important actors. It has, however, not present and future generations will be guaranteed a entered into force so far (as of 29 August 200327 ), as safe and healthy environment” (Swedish Environmental the condition (three ratifications) has not been fulfilled. 28 Protection Agency, 2000). Also in 1993, the European Commission drafted With the EnvC, a new approach is being followed, a Green Paper on responsibility for environmental namely to determine future actions to avoid damage harm, which elicited the comments of several mem- and promote sustainable development on the basis ber states, environmental protection organizations and of the effects an action has instead of its nature. associations of industries. The White Paper on Envi- ronmental Liability published in February 2000 (Eu- Along with the establishment of the new EnvC came ropean Commission, 2000c) examined how the a change in procedural rules. Five regional environ- polluter-pays principle, one of the key environmental mental courts have been instituted with two basic principles in the EC Treaty, can best be implemented, functions: First, they are entitled to grant permits for and how a Community regime on environmental li- potentially harmful activities, and second they deter- ability should be designed. It concluded that drawing mine whether an environmental damage (property up a directive would be the best way to set up a com- damage, personal injury and economic loss) has been munity regime for environmental liability. caused by environmental pollution. The granting of As a result of the discussion following the publi- permits must be in accordance with an Environmen- cation of the White Paper, the European Commission tal Quality Standard (EQS) set by the government produced a proposal for a Directive on Environmen- that outlines the highest permitted concentration of tal Liability in January 2002 (European Commission, a substance in water within a fixed geographical area. 2002a). The aim of the proposal is to adopt a com- Environmental interest groups with more than 2,000 prehensive European regime for the prevention and members that existed for at least three years have mitigation of environmental damage, and to ensure the right to appeal against permit or exemption deci- that the affected areas are cleaned up, which is not sions taken by the court. always guaranteed under the differing national laws The most important principle enacted through the (CES, 2002). The main provisions of the proposed EnvC is the precautionary principle, a natural exten- directive are reviewed in Box 8. sion of the polluter-pays-principle: everyone must take necessary precautions to prevent and reduce damage to human health and the environment. FINANCIAL ARRANGEMENTS Failure to comply with the requirements as set by the IN WATER USER ASSOCIATIONS EnvC is subject to penalties ranging from fines to two years of imprisonment. Operators, whose actions caused disturbances to the environment and resulted The German ‘Water Association Act’ allows for the in personal or financial losses, are under duty to pay formation of so-called water user associations. They compensation. Furthermore, the law requires envi- are self-financing institutions for the construction and ronmental repair: Those who currently carry out an operation which causes pollution on land or water 26 are liable for the repair of any environmental damage Source: http://conventions.coe.int/. 27 caused by the operation. This also applies retroactively Source: http://conventions.coe.int/Treaty/EN CadreListeTraites.htm. to those who have carried out a polluting operation 28 29 Source: http://www.internat.naturvardsverket.se. after 30 June 1969. 29 Source: http://www.law500.com. 36 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

BOX 8

THE PROPOSAL FOR AN EU DIRECTIVE ON ENVIRONMENTAL LIABILITY The proposed liability regime applies to environmental or restorative measures. Competent authorities are des- damage and to any imminent threat of such damage. ignated by each member state. If the operator is unable The system is based on public law and thus excludes to pay for all or part of the necessary measures or can- civil liability and traditional damage (such as personal not be found (“orphan damages”), the member states injury and damage to property). The reason is that natural have to ensure that the measures are taken, and may assets are in most cases not privately owned, and that set up alternative financing mechanisms (such as finan- the loss of natural assets normally affects society as a cial guarantees, securities or collective funds). whole (European Commission, 2002b). The directive Environmental public interest groups, alongside with le- would have a limited scope of application linked to Eu- gal and natural persons likely to be adversely affected ropean environmental legislation. Environmental damage by environmental damage, are entitled to require action should be defined “by reference to the relevant provi- to be taken by the public authorities or to challenge sions of Community environmental law” (European their decision before courts (access to judicial review). Commission, 2002a). Environmental damage thus includes damage caused to the aquatic environment Liability is prospective and not retroactive, which means (according to the Water Framework Directive), that pollution that occurred within a member state prior biodiversity (regulated by Community legislation on na- to the adoption date of the EU-liability regime will be ture conservation), protected areas (under national/ dealt with under the member state’s legislative provisions. regional legislation) and soil contamination, which causes Exemptions: The proposal does not cover environ- harm to human health. The proposed regime would not mental damage resulting from an armed conflict, a natural apply to diffuse or nonspecific source damages such as disaster, emissions allowed to the operator by permit, forest damage caused by acid rain. authorization or laws or regulation (permit-defense), or The proposed regime imposes mostly strict liability (with activities which were not considered harmful according several defenses), which implies that liability is based on to the state of scientific knowledge at the time the activ- causation irrespective of fault. The decisive factor is ity took place (European Commission, 2002d). whether damage has occurred, not whether it has been In the comments on a working paper preceding the pro- caused by incorrect or negligent behavior. posal, some regret has been expressed by the member The actors potentially liable under the Directive for the states that civil liability and traditional damage are not costs of preventing or restoring environmental damage covered any longer, and there is concern about poten- are the operators of risky or potentially risky activities tial financial consequences to public authorities in relation that are listed in Annex I of the proposal (e.g., chemical to “orphan damages” that is when the polluter cannot industry). Activities not included in the list can also be pay for restoring the damage (European Commission, liable if they cause damage to biodiversity, but only if the 2002a). Discussions are still going on regarding the is- operators are found to be negligent (fault-based liability). sues of permit defense and whether financial security should be mandatory or optional. Public authorities are charged with enforcing the regime. It is their responsibility to ensure that operators under- The proposal is currently undergoing a legislative pro- take or finance measures to restore or prevent cedure at the end of which the European Parliament environmental damage. This entails the need to conduct and the Council of Ministers will jointly adopt the new investigations, to assess damage or the danger of dam- Directive. It is thus likely to enter into force within the age and to determine the most appropriate preventive coming two or three years.

Sources: European Commission, 2002a, b, c and d; EEB, 1998.

finance of water infrastructure. Their scope of op- The operation of these water associations is fi- eration includes the allocation of services among nanced purely through the members’ fees. Members users, sewerage, the promotion of co-operation be- control the association according to democratic prin- tween agriculture and water management and other ciples with voting rights weighed according to the water management functions. economic importance of water use or water pollu- EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 37

tion. For members who do not directly abstract or BOX 9 discharge water, voting rights can be based on the benefits derived from the associations activities or RIVER BASIN USER ASSOCIATIONS the economic burden the association imposes on the IN LOWER SAXONY member (Kraemer and others, 1998a). Association statutes can provide for an association committee One of the 115 River Basin User Associations in Lower (Verbandsausschuss), consisting of elected members Saxony is the Unterhaltungsverband ‘Hunte’ named af- acting on behalf of all members, to assume functions ter the main watercourse in the Hunte precipitation of the general assembly. area. It was first established in 1965 based upon the A water association can be established by the Lower Saxony Water Act. Pursuant to Paragraph 100 unanimous decision of all interested parties and sub- of the amended Water Act of 1990, the association sequent approval by the supervisory authority, or by constitutes a Water Management Association in ac- majority decision of interested parties and approval cordance with the Water Associations Act. including the enforced participation of additional The River Hunte rises near the Mittellandkanal and is members. The approval for the construction of a a tributary of the River Weser. From its source it runs water association may be denied if the proposed northwards and then joins the Weser at Elsfleth north association’s objectives are already or could better be of Bremen. Responsibility for the Hunte river basin fulfilled by another corporation. All those who ben- is shared between four associations, with the efit or can expect to benefit from the association, are ‘Unterhaltungsverband Hunte’ being in charge of the involved in the establishment of an association. In upper catchment area. The total length of this second cases where nonmembers benefit from the associa- order water system is 794 km draining an area of tion, they can be required to make a financial 99,330 hectares covering approximately 4 rural dis- contribution. Furthermore, associations have the tricts (Landkreise). Competency for supervising the right to use all land needed for their operations and association’s work and activity lies with the rural dis- can even expropriate property. However, anyone trict authority of Diepholz. suffering a direct economic loss because of an Real-estate ownership in the catchment area is a nec- association’s activities is entitled to a compensation. essary requirement for becoming a member. To date, Water associations can themselves become mem- the Hunte association has approximately 17,250 indi- bers of, cooperate with, or transfer part of their vidual members. Additionally, two neighboring water responsibilities to other associations, thus creating management associations serving the downstream networks of associations. Upon the fulfillment of cer- reaches of the Hunte watershed also hold a mem- tain circumstances, associations can be dissolved, bership. This linkage provides a platform for close co- either by decision of its members and the approval operation with regard to watercourse maintenance of the supervising authority, or by order from the and management along the Hunte river basin. authority (Kraemer and others, 1998a). To date, River The association’s main duty according to its statute— Basin User Associations are exclusively and required by state law—is to properly maintain found in the German states of Lower Saxony, watercourses so as to support the natural drainage Brandenburg, Saxony-Anhalt, Schleswig-Holstein, regime. Accordingly, keeping the functional status of and Mecklenburg-Western Pommerania. Provisions all managed catchment waters is a central issue. Field- for their establishment are made by the respective work activities of the association range from the mow- state Water Management Act, which clearly pre- ing of slopes or river bed maintenance to river bank scribes maintenance of inland waters as a public duty. stabilization and clearing of drainage ditches. In addi- Activities of such associations, however, only tion, the association operates several dams/water re- include management and maintenance of second or- taining works, locks, and bucket elevators in the der watercourses as defined by the water acts. The catchment area. Co-ordination of all necessary activi- first order river maintenance and management re- ties is achieved through a maintenance and manage- mains in the owner’s hands, which in most cases is ment plan listing the material and staff required. The the federal state or the Länder. plan is drawn up on an annual basis. Assessment of The case of the River Basin User Association the work of the association takes place annually in the Hunte in Lower Saxony is presented in Box 9. form of an inspection tour by members of the super- The Water Associations West German Canals vising authority (Verbandsschau). (Wasserverband Westdeutsche Kanäle - WWK) constitutes a further example of institutional arrangements Source: Kraemer and others, 1998a. 38 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT for inter-basin management (or ‘inter-sub-basin ments in water management is varied and exten- management’) allowing the integration and develop- sive. While some instruments are used in all or the ment of shipping canals, power station cooling, water majority of European countries (sewerage charges, supply, and ecological needs in densely populated and water prices), others find no application at all (trad- heavily industrialized areas (see Box 10). able permits). In most cases, economic instruments have more than one function and they are often intended to provide incentives for a more environmentally-friendly behavior. Revenues generated CONCLUDING REMARKS ON are often earmarked and reemployed for further ECONOMIC INSTRUMENTS IN water management activities, or used as an addi- WATER MANAGEMENT IN THE EU tional source of finance for the general government budget. This second option allows for a reduction in other taxes and may shift the tax burden from As the presented case studies have demonstrated, economic “goods” (labor) to economic “bads” the European experience with economic instru- (pollution).

BOX 10

THE WASSERVERBAND WESTDEUTSCHE KANÄLE To maintain shipping on the Dortmund-Ems-Canal so that up to 4.5 m3 per second of canal water can be linking the industry in the Ruhr area to the port of pumped into the Lippe to increase its flow in the in- Emden (completed in 1899), the Rhine-Herne-Canal terest of water supply and river ecology. providing a link to the Rhine (1914), and later on the The canal and Lippe water regime can now be Wesel-Datteln-Canal serving the northern part of the operated in two modes. The first is the abstraction of Ruhr Area (1931, see map) the Datteln-Hamm-Ca- Lippe water to feed the canals and provide water for nal in the East (1914) was used to bring Lippe river abstraction; the second is to reverse flow and pump water of good quality from Hamm into the canal sys- canal water, Ruhr water, and in extremis Rhine water, tem to replace the water used in the operation of up into the Lippe (see map). During the extremely locks. The availability of good water in the canals lead dry accounting period from November 1990 to to an increase in demand as industrial users were October 1991, a total of 199 million m3 was taken attracted. In effect, Lippe water was transported from the Lippe when flow was sufficient, and 33.3 through the canals to water users – power stations, million m3 were added to the river when the flow was mining pits and industry – but also agriculture and low (WWK, 1993). Water for industry amounted to drinking water production (groundwater recharge). 79.0 million m3 and a further 83.2 million m3 were 3 A minimum flow of 7.5 m per second was left in the provided for non-consumptive use (cooling). Lippe. In order to raise the capital investment required, the In 1968, the Federal Republic of Germany as the owner Land instigated the establishment of the Water Asso- of the canals and the Land North Rhine-Westphalia ciations West German Canals, with the Lippeverband, signed an Agreement concerning the Improvement of 37 water users (abstraction only) and 7 public water the Lippe Flow, the Feeding of Water to the West suppliers being members; another 20 small users are German Shipping Canals and Water Supply. Compared not members. The Water Association West German to the previous arrangements, the agreement brought Canals also operates and manages the infrastructure. two important changes. One was the increase in pump- The annual turnover or budget of the association is ing capacity at the canal locks to cover the operational around DM 5 million. Since 1982, water quality in the water need and to pump water from the Ruhr at canals is monitored even though this is not strictly Duisburg (and from the Rhine if need be) for the ben- within the remit of the association. Changes to be efit of water users along the canal system. The other agreed in association’s statutes over the next few years change was that the minimum flow of the Lippe was may provide a basis for measures to improve the eco- increased to 10 m3 per second and changes were made logical quality of the Lippe. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 39

THE EUROPEAN WATER THE ECONOMIC INSTRUMENTS FRAMEWORK DIRECTIVE IN THE WFD AND THEIR RATIONALE

The European Water Framework Directive (WFD)30 For a first overview, the economic requirements in- is one of the first environmental policy Directives of tegrated into the WFD can be grouped into three the European Community that explicitly draws on broad categories: economic instruments for achieving its objectives. Economic approaches integrated into the Directive ● The economic analysis of water uses (regulated foremost include the polluter-pays and the cost-re- by Article 5 and Annex 3 of the Directive); covery principles. ● The justification of exceptions and the declara- While economic principles are to play an impor- tion of heavily modified water bodies; tant role, Article 1 of the Directive also makes it clear ● Water pricing that ensures an adequate cost re- that the WFD is not intended as a one-dimensional covery for water services. “economization” of European water management by stating that “water is not a commercial product like Different time horizons apply for these three any other but rather a heritage which must be pro- categories. The economic analysis of water uses in- tected, defended and treated as such.” volves setting up of an inventory of water uses, a The purpose of the WFD (Article 1) is to estab- process that has to be completed by 2004. The jus- lish a framework for the protection of inland surface tification of exceptions and the declaration of heavily waters, transitional waters, coastal waters and modified water bodies have to be included in the groundwater. Its key objective is to establish “good river basin management plan for 2009, while a sys- water status” for all waters by 2015. tem of water prices that fulfils the principle of The main provisions of the Directive include the cost-recovery for water services has to be operational promotion of sustainable water use; the reduction of by 2010. groundwater pollution; and the mitigation of the ef- As indicated by the time horizons, the economic fects of floods and droughts. analysis is the first task to be tackled by member states of the European Union. First, the analysis must provide sufficient information to determine whether water services meet the condition of cost recovery. THE WATECO GUIDANCE DOCUMENT Second, it should enable a decision on which combination of measures allows to restore the good status most cost-efficiently. The economic analysis will be The European Union countries, Norway and the Eu- reviewed until 2013 and from then on regularly ev- ropean Commission agreed on a common strategy ery 6 years. approach for the implementation of the WFD. Ac- According to the WATECO document (WATECO, cordingly, several European Working Groups of 2002), water services include abstraction, impound- experts and stakeholders have been created to pre- ment, storage, treatment and distribution of surface pare “guidance” documents on the main issues of the water or groundwater; and waste water collection and Directive for ensuring concerted actions and parallel treatment facilities, which subsequently discharge into developments across Member States. One of the surface water. groups, the WATECO group (WG 2.6) dealt with the The definition has deliberately been constructed economic analysis of water uses and produced the very broadly and makes no distinction between pri- WATECO guidance document. The paper is of a le- vate and public provision. gally non-binding character but directs the efforts Three different types of costs of water services undertaken in the different Member States (WATECO, have been identified by the WATECO working group, 2002). namely operating, environmental and resource costs. Operating costs include maintenance and capital costs as well as internalized environmental costs, for ex- 30 Directive 2000/60/EC of October 23, 2000 establishing a ample water abstraction charges. Environmental costs framework for Community action in field of water policy. The full text of the Directive can be downloaded in English, relate to damages to the environment caused by the French, Spanish and Portuguese from the following webpage: provision of water services. As only those costs that http://europa.eu.int/eur-lex/en/search. are associated with the provision of water services 40 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT are to be considered, the definition excludes damage CHALLENGES TO THE IMPLEMENTATION caused by diffuse pollution. Finally, resource costs are OF ECONOMIC INSTRUMENTS scarcity or opportunity costs that result from excess demand for water. Institutional and administrative challenges The economic analysis can answer two questions with respect to these three cost categories. First, One of the greatest impediments to the introduction whether the costs are met by user payments or by of economic instruments in the Region is deficien- subsidies, and second, whether all cost types are paid cies in the administrative and institutional settings. by the users of a specific service or only the direct The biggest challenge in this respect is that the deliv- operating costs. ery of water services is still predominantly managed The condition of cost-recovery for water services through a sectoral organization which is typically ill- is anchored in Article 9 of the WFD and constitutes funded, overextended and therefore inadequate for the second task on the agenda for member states of the provision of quality services. the European Union. Until 2010, they have to en- The creation of adequate institutional capacities sure that users pay their share of the costs of the including the legal framework under which water use provision of water services. The information gained and management take place is urgently needed. At- through the economic analysis is to form the basis tempts to modify water laws have been made in for the necessary calculations. several Latin-American countries, but progress in this respect is generally slow. In many instances, water resource management legislation includes provisions, which may no longer be relevant and may actually RELEVANCE FOR LATIN constrain new management initiatives. AMERICAN AND CARIBBEAN A second major challenge to innovations in wa- COUNTRIES ter management is the fact that most Latin-American countries still lack effective monitoring and enforcement procedures and struggle with a confusion of roles The preceding chapter provides additional evidence among different administrative bodies that result in of the advantages in using economic instruments in overlapping mandates among related sectoral agen- the water management sector. The following sec- cies. With lines of responsibility and accountability tions try to build a bridge between the European being unclear, the prerequisites for the implementa- experiences with economic instruments and their tion of sophisticated charging systems are not met. In capacity to provide a solution to the challenges posed consequence, actual management (water pollution to water management in Latin America and the Car- control, operation and maintenance of some water- ibbean. works) is in many cases still very poor (Dourojeanni, First, the major challenges faced by the water 2001). The lack of integrated river basin management sector in the region will be presented and then the constitutes thus a key challenge for the region. obstacles will be discussed that presently impede the A third factor to be considered is that although introduction of economic instruments. The chal- attempts have been made over the last years to in- lenges that countries in the region face can broadly crease the degree of integration between the be grouped into five categories: environmental and other governmental sectors, inter-linkage remains weak both, on an inter-sectoral ● Institutional and administrative challenges as well as between federal and regional levels. As Box ● Human resource constraints 11 outlines, fiscal federalism may intensify the prob- ● Financial challenges lem of impairment of objectives and coordination ● Lack of data unless certain prerequisites are met. ● Social challenges. Furthermore, water management is often still carried out in a top-bottom manner with little par- As a next step, different approaches practiced in ticipation of locals and key stakeholders, reducing the the region to address these challenges and to imple- system’s transparency, the perception of problems, and ment economic instruments will be presented. On their inter-linkages. With exchange being limited to a the basis of these examples, a list of relevant factors small group of actors, the optimal allocation between that have proven to be important for a successful competing uses and the determination of a proper implementation will be developed. economic valuation is difficult to achieve. EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 41

BOX 11

FISCAL FEDERALISM For a centralized state, it might be difficult to adapt poli- policy in a counter-cyclical sense becomes more difficult cies to the individual needs of different regions in the within a decentralized structure. At times, sub-national country, especially if the surrounding conditions vary governments may pursue expansionary fiscal policy at considerably. The local level can be better equipped for the time when the national government follows a con- understanding regional needs and interests due to the tradictory policy. This argument applies in particular if more immediate exchange with the citizens concerned local governments face soft budget constraints and can by the policy. count on being bailed out by the state (Afonso, 2001). However, several problems often go along with fiscal fed- Tanzi (2000) points to the fact that the existence of a eralism. In the case of Brazil, Afonso (2001) reports that decentralized fiscal structure has often been a major tax competition among states or regions through differ- impediment to needed tax reforms. The assignment of ent incentives for enterprises has contributed to the mis- taxes is difficult in a federal system, due to administra- allocation of capital. Furthermore, differing sale taxes or tive considerations related for example to economies personal income taxes may have influenced spending of scale in tax administration, access to information, tax patterns and the allocation of labor between states. He competition and others. In the case of Argentina, a turn- concludes that decentralization may in some cases be over tax is levied at the provincial level. The central gov- market constraining rather than market enhancing as it ernment has tried to eliminate this tax which creates leads to a fragmentation of the domestic market. great distortions in the economy and to replace it with Decentralization can lead to a confusion about roles more efficient revenue sources for many years (Tanzi, and responsibilities when two or three different levels 2000). However, as the tax generates substantial rev- step in to pursue similar objectives. Precise and final enue at the provincial level, the federal structure has decisions would be required on which functions and made it difficult to reach a consensus for reform, espe- taxes are under the responsibility of the national or the cially as changes affect the provinces differently. sub-national level, which is in many cases not possible. A further challenge related to fiscal decentralization is Stringent macroeconomic coordination can be difficult the issue of transparency. Local governments often can- within a decentralized structure characterized by a high not provide good data on a timely basis, which compli- degree of autonomy, as sub-national governments might cates the conduct of fiscal policy and the analysis and be less willing to comply with policies to sustain macro- evaluation of public sector operations. economic stability, but act purely in their own instead of Finally, one of the main functions of a national govern- the nation’s interest. In light of this argument, it can be ment is to redistribute income from richer to poorer difficult to reconcile greater fiscal decentralization with regions. When regional disparity is high and income lev- national economic policy objectives. els vary greatly among regions, so that one region has to Co-ordination is of vital importance for ensuring a co- subsidize another on a significant scale, it becomes diffi- herent and effective interaction among all relevant ac- cult to pursue an effective policy of income redistribu- tors and administrative levels. The coordination of fiscal tion within a federal system.

Human resource constraints A more general problem is that public awareness on the nature of the problems and on the current Water resource management is often hindered by a situation is low so that the imperative need for im- lack of adequate staffing at all levels. The sector faces provement does not reach an adequate level of a persistent difficulty of keeping qualified workers recognition. and cannot rely on expertise available in the private sector. Integrated river basin management along with Financial challenges stakeholder participation has the capacity to offer a remedy to this shortcoming by bringing together dif- The environmental sector in the Region faces seri- ferent experts and through the facilitation of ous budgetary problems, as the necessary investments discussions and knowledge transfers (Huber, on the infrastructural and operational level are very Ruitenbreek and Seroa da Motta, 1998). capital intensive, especially with costs of additional 42 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT water provision being continually on the rise (World will affect the living conditions of the poor in three Bank, 1998). Economic instruments can help in gen- ways: Firstly via better health and increased potential erating the required resources for reforms and labor productivity, secondly through considerable cash restructuring. At the moment, water is often supplied savings (water from trucks is much more expensive), at below-cost prices, which increases the challenge and thirdly through reduced time use in bringing the for water companies to increase connection rates and water to the household (San Martin, 2002). finance maintenance and infrastructural upgrading. Market-based instruments have in principle the Charging for water services can provide operators capacity to mitigate the discrimination against low with sufficient funds for carrying out their operations income groups in terms of access by generating fi- and maintenance activities and furthermore serve as nancial means for extending connections to these user a proper signal to water users on the opportunity cost groups. However, in order to achieve a socially com- of their water use (San Martin, 2002). However, most patible outcome, possible negative consequences of instruments require certain capacities before they can water service charges for the poor must be balanced be put to work. For the implementation of “correct by a complementary effective redistributive scheme. pricing” for example, accurate consumption metering and efficient and correct billing mechanisms must be in place (San Martin, 2002). Budgetary constraints can thus act as a serious constraint to the introduc- EXISTING EXPERIENCE WITH tion of measures that in the short run require ECONOMIC INSTRUMENTS IN THE REGION infrastructural investments and only in the medium and long run generate financial revenues. Subsidies

Lack of data The economic instruments most commonly applied in LAC countries are subsidies and tax exemptions Water resource management is often hindered by a (UNEP, 1999). For example, credit and tax incen- lack of adequate and reliable hydrological, meteoro- tives are offered for environment-related investments logical and water quality data as well as information e.g. in Brazil, Mexico and Colombia to cover abate- on socio-economic indicators of water use efficiency ment investments or clean technology adoption in (IDB, 1998a). The persistent lack of assessment the industrial sector (Huber, Ruitenbreek and Seroa and monitoring of the quantity and quality of the da Motta, 1998). They may, however, not develop existing resource is a major shortcoming for its ap- their potential in terms of environmental effects if propriate utilization and an impediment to proper the enforcement of standards is limited so that there management. is little incentive for firms to demand financial sup- Due to a lack of reliable inventories, databases port for measures to meet these standards. Also, and information on water uses and users, major companies may not put the money received to its in- deficiencies exist with respect to supervision and pol- tended use if their investments are not adequately lution control, as well as with regard to the monitored. This illustrates the necessity of an ad- measurement of contamination. Until adequate mea- equate institutional and legal framework for the surement systems have been put into place, charging implementation of economic instruments. for pollution is not feasible (Dourojeanni, 2001). The lack of systematic and qualified monitoring Charges for water supply and sewerage poses serious challenges to the enforcement of environmental legislation and the implementation of Regarding water pricing, including charges for sew- economic instruments. age collection and treatment, the coverage of users is limited and pricing policies often do not achieve cost- Social challenges recovery objectives. Therefore their environmental effectiveness may be minimal (UNEP, 1999). In or- Safe access to clean water and a proper disposal of der to convey economic signals about decreasing waste water constitute an important contribution to water availability through water prices and to pro- public health by reducing the spread of water-borne mote a more rational use of the resources, Peru and diseases. Especially among low income groups, the Central American countries are making advances to rate of piped water coverage has to be increased. Ex- assess the value of their water resources (UNEP, tending coverage rates for water supply and sanitation 1999). EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 43

In two Brazilian states, Sao Paulo and Rio de According to Huber, Ruitenbreek and Seroa da Janeiro, sewage tariffs are levied by sanitation com- Motta (1998), pollution charges may create perverse panies on industrial users. The charges are based on incentives in some Latin American countries, that is, the content of organic matter and suspended solids. they may have a negative environmental effect de- In the greater Sao Paulo Region, considerable rev- spite being intended to improve the environmental enue has been raised through the charge, although situation. Pollution charges based on the concentra- only partial coverage has been achieved (only 95 big tion of substances rather than on volumes or total firms have been included by the sanitation company) loads will induce polluters to dilute effluents and thus because of monitoring difficulties. It is reported that increase water consumption instead of making them pollution abatement measures have been induced by reduce the pollution load. A careful design is there- the pollution-based tariff system (Huber, Ruitenbreek fore important for triggering the intended user and Seroa da Motta, 1998). response.

Effluent Charges Tradable permits

Effluent charges have been in place in Mexico and Chile is the only country in the Region that has ex- Colombia since 1991 and 1974, respectively, and are tensive experience with tradable water permits. Chile under discussion in Jamaica and Brazil (Huber, has a long tradition in water property rights, which Ruitenbreek and Seroa da Motta, 1998; San Martin, is believed to be the basis for the political acceptance 2002. See also annex one). In Mexico the pollution and enforceability of the system. As pointed out in charges are tied to wastewater rights: an amount is that section, the assurance and acceptance of water paid for the right for each cubic meter of discharge, property rights is, next to an effective administrative collected from those who exceed determined stan- and legal system, seen as a prerequisite for a func- dards for organic matter and suspended solids. tioning trading system. It is suggested in the literature The charge level varies with both water quality and that other countries planning to implement a similar total discharges. A simplified approach based on vol- system take this into account and carefully review ume alone is used for discharges below 3000 cubic the Chilean example (Asad and others, 1999). meters. The success of the charge has so far been lim- Legal redress and advocacy ited. The system requires monitoring resources that are beyond the current financial capacity of the CNA Successful liability legislation requires adequate en- (National Water Commission). The amount of rev- forcement. Since in many Latin American and enue raised has been substantially reduced by Caribbean countries courts are heavily backlogged, insufficient enforcement. Thus the charges actually liability might be complemented or replaced by con- collected represent only a minor percentage of the sumer advocacy through voluntary measures or potential revenue. Additionally, a lack of public par- public pressure (Huber, Ruitenbreek and Seroa da ticipation and of proper analyses of potential impacts Motta, 1998). of the charge lead to a fierce opposition by polluters. In Trinidad and Tobago, for instance, the corpo- Nevertheless, Mexico’s pollution charge is one of the rate PetroTrin established a voluntary policy of full first instruments in the region that is based on the compensation for environmental damages after a se- polluter-pays principle. It is designed to induce be- ries of uncontained well blowouts in the 1980s that havioral change through incentive setting. caused a significant public outcry as no assistance The Colombian charges for effluent discharges was received by the population. This voluntary policy and water use, although in place since 1974, have provided the company with an incentive to improve only been applied in few cases and have been subject blowout prevention devices on wells. to similar problems to those in Mexico. In 1993, new In Colombia, consumer action is enhanced by legislation changed the former cost-recovery design innovative economic instruments: Anyone pursuing of the charge to a scheme based on criteria of full environmental liability judicial action is entitled to environmental costs. However, this new system will receive a payment that amounts to 10-15 percent of pose even greater challenges to implementation and the total compensation. Since its introduction in may entail high administrative costs, so the new 1992, this financial incentive has been reported to charges may not be implemented according to the have increased the number of actions taken to court exact terms of the law (Asad and others, 1999). significantly. 44 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

The Brazilian water management reform Law that was passed in 1997 fosters the integration of economic instruments and promotes an integrated As a example of recent developments in the water approach to the planning and management of water management sector of Latin America, the case of Bra- resources. zil will be presented. The new Federal Water Resource

BOX 12

WATER MANAGEMENT IN BRAZIL Background Committees need to be established only in the pres- Water management in Brazil has suffered from many of ence of actual or potential conflict over water. The the problems common in Latin American countries, one establishment of these Committees should serve as a of which is lack of institutional capacity. Historically the means to achieve the goal that decision-making take place system was characterized by sectoral management with at the river basin level with effective participation by strong influence of the hydropower sector, which was stakeholders. By the representation of government, us- kept under the control of government owned compa- ers and society, this system creates the necessary nies. During planning of projects (e.g. construction of conditions for integrated water management. It is the big dams) externalities caused to the environment or responsibility of the River Basin Committees to the economy were not considered. After the democra- ● promote discussion of water-related issues; tization process in Brazil in 1986, discussion about ● coordinate the work of the entities involved; institutional reorganization of the country followed in ● arbitrate conflicts; order to address problems such as the lack of integra- ● approve the Water Resources Plan, and monitor its tion among water sectors (irrigation, hydroelectricity, execution; water supply), the uncontrolled urbanization processes, ● suggest the fees to be charged. and the occurrence of droughts in the Northeast. The associated executive branches of the River Basin The 1997 Water Law Committees are the Water Agencies. A single Agency In January 1997 the Federal Water Resources Law was may serve as the executive office for one or more River adopted, which introduced new approaches to water Basin Committees. They are responsible for the techni- management. The concepts promoted by the Law in- cal work required to support the work of the River clude: Basin Committees, such as conducting studies to evaluate water availability, assessing new projects, and ensuring ● planning and management of water uses at river ba- adequate allocation of withdrawal rights (Porto and sin scale; decentralization of the management Porto, 2002). The Agencies are also responsible for da- process; tabase management. They maintain registers of water ● stakeholder participation; resources, as well as a roster of the users of water re- ● controlled and coordinated issuance of water per- sources. Additionally they collect fees for water use and mits for intakes or for dilution of effluents; assess proposals for projects to be financed (Dourojeanni, ● development of Water Resources Plans; 2001). ● status of water as an economic good that should be charged for appropriately in order to (i) achieve ra- Water pricing reform tional allocation (ii) create the financial resources The institutional reform initiated by the new Water Law necessary for the improvement of the river basin; was accompanied by water pricing reforms. A system of ● the use of water required to meet people’s basic bulk water pricing was introduced, which allows for needs shall have priority before other uses. charges to be levied on the collection of water from Institutional reform natural sources, or alternatively, on issuing the water The Law provides for the creation of River Basin Com- permit. This levy is thus comparable to water abstrac- mittees (“water parliaments”) which are composed of tion charges in European countries (see section \n \h 0). members of bulk water users, government officials (of Its goal is to balance water demand and supply by send- Federal, State and Municipal level) and NGOs. River Basin (Continued on next page) EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 45

BOX 12: (continued) capacities, both in terms of human resources and financial resources, need to be strengthened, and that ing an economic message to users that they might be competencies of authorities have to be clearly defined. constraining the use of others (Porto and Porto, 2002), Institutional capacity building can be simplified by a and to provide funding to create and sustain the River decentralized approach that involves small institu- Basin Committees. The 1997 Law guarantees water tions with limited spatial jurisdiction (Huber, users the right to retain control over the revenue gen- Ruitenbreek and Seroa da Motta, 1998). erated by stipulating that not more than 7.5% of Decentralized entities, such as the river basin financial resources collected in a basin can be trans- organizations proposed by Dourojeanni (2001), also ferred out of the basin. enable the active involvement of all local users and stakeholders in the management process. Participa- tion of all stakeholders, in turn, promotes an integration of the different water sectors, and thus, a coordinated management of the resource that takes Summary all demands and needs into account and balances economic interests and environmental protection From the examples outlined above, it becomes clear concerns. that experience with economic instruments in wa- It is a common view across the literature that ter management already exists in Latin American and users are willing to pay for their water use when they Caribbean countries, although some of the systems are guaranteed a safe and reliable water supply in re- are somewhat rudimentary, with little coverage or a turn (Asad and others, 1999; Huber, Ruitenbreek and pricing policy that neither covers the capital costs Seroa da Motta, 1998; Porto and Porto, 2002). A full nor incorporates environmental and social externali- cost recovery approach is increasingly recognized as ties. Still, systems are in place that can be built upon being essential for service expansion, as well as for and expanded. taking environmental costs into account. Such an approach may require the establishment of cross-subsidization schemes to assist low-income groups. Huber, Ruitenbreek and Seroa da Motta (1998) RELEVANT FACTORS FOR SUCCESSFUL also point out that non-regulatory mechanisms such IMPLEMENTATION OF ECONOMIC as public education programs should be made use INSTRUMENTS of, as they may improve compliance without adding to administrative costs. In order to improve water allocation and conser- From the information presented on the use of eco- vation and to establish effective environmental taxes, nomic instruments in the Region, as well as from it is necessary to have a system of monitoring and the reviewed literature, it is possible to extract a num- metering which allows for volume-based charges to ber of elements that have proven to be useful tools be levied and which raises consumers’ awareness or prerequisites for the successful implementation (Asad and others, 1999). of economic instruments in the Latin-American wa- It is consistently emphasized that earmarking ter management sector: revenues is likely to make the implementation of economic instruments such as water pricing more ● Capacity building successful in Latin-American countries. If charges col- ● Spatial organization (river basin management) lected were transferred to the central government and ● Decentralization and Integration incorporated into the general budget, users would ● Participation feel “taxed” which could spur their rejection of the ● Full cost pricing system (Porto and Porto, 2002). ● Cross-subsidization Another aspect that plays a potentially impor- ● Public education programs tant role for public acceptance of economic ● Earmarking of revenues instruments is their transparency: It has to be clear ● Transparency and as easily understandable as possible what is charged for and why. With respect to bulk water pric- It is generally recognized that in order to ad- ing in Brazil, Asad and others (1999) also requests dress the problem of weak enforcement, institutional that subsidies, where they are necessary for equity 46 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT reasons, be made transparent. He suggests that users process of the WFD exemplifies the promotion should receive water accounts that show the full cost of public participation, increased transparency of providing the bulk water, and the value and more extensive and reliable reporting. and source of the subsidy being applied. While miti- ● Based on the Latin-American case studies, ear- gating the impact of charges on low-income marking of revenues is recognized as an households, this measure would still create or main- important factor for the successful implementa- tain awareness of how much water resource tion of economic instruments (see Box 1). The management really costs. It would also help govern- European experience reinforces this conclusion: ments to assess the cost effectiveness of subsidy Many European countries use earmarking of rev- programs. enues, and it is assumed that the resistance to a charge is smaller if the responsible authorities retain control of funds collected and use them for environmental programming or investments DISCUSSION ON THE RELEVANCE OF in the water sector. The more transparent the use EU EXPERIENCE FOR LATIN AMERICAN of revenues collected is, the easier it is to raise AND CARIBBEAN COUNTRIES public support for a new scheme. ● While the EU experience in water pricing and with regard to subsidies is certainly relevant on As the discussion in this Chapter has shown, the use a technical and organizational basis, differences of economic instruments in water management is not in social settings must be considered. The social new to the Latin-American region. The generally rel- challenges water sectors in less developed Latin- evant factors, which can be derived from these cases, American regions face require water pricing indicate that the Regional experience with economic policies to be carefully blended with complemen- instruments is likely to be of particular interest when tary cross-subsidization or compensation addressing the specific problems of the Region. Fur- schemes. thermore, the list of relevant factors reveals a close ● Sewerage charges are common in all European resemblance with those issues stressed in the presen- Member States. While the same cautions apply tation of the European experience earlier on. here as to water pricing, increasing the coverage Therefore, while European approaches may not be of households connected to the sewerage system applicable to all cases and may need to be modified could be supported by carefully designed charg- to meet the specific circumstances in Latin Ameri- ing schemes that aim at recovering the costs. can and Caribbean countries, there are nevertheless Charges would provide operators and adminis- lessons to be learned. In the following, a non-exhaus- trations with the necessary funds for the required tive list of issues will be presented that can provide investments. Increasing the access of poorer instructive impulses: population groups to the sewer system is furthermore desirable from the point of view of health ● There is growing consensus that integrated wa- of the population. ter resources management (IWRM) is crucial in order to solve Latin America’s water-related prob- Finally, the European experience may be drawn lems (IDB, 1998a and b). Integrated management upon particularly with respect to economic instru- is a prerequisite for successfully implementing ments that so far have not or only in few cases been environmental taxes, as the design of an equi- applied within the Region (for example abstraction table and fair system (for example of supply taxes, pollution taxes). charges or abstraction taxes) requires that all uses be taken into account. The European experience, for instance from the implementation process of the Water Framework Directive (WFD) can serve OPTIONS FOR INTER–REGIONAL as an instructive example for a reorganization of COOPERATION procedural and organizational issues towards the integrated management of water resources. Ob- serving how the EU Member States proceed in A direct exchange between European and Latin order to fulfil the demands of the WFD can be American and Caribbean actors from all relevant instructive. Furthermore, the implementation stakeholder groups would be even more enlighten- EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 47 ing than a general comparison of the systems. Facili- CONCLUSIONS AND tating and strengthening the cooperation between RECOMMENDATIONS European and Regional actors and intensifying the exchange of experience and ideas would offer an opportunity for more direct case-specific support and Scientists and policy makers alike have increasingly advice by relevant actors in the field. acknowledged the benefits derived from instrumen- On a technical-scientific level, exchange is al- talizing market forces towards supporting the ready taking place in a more or less institutionalized achievement of environmental objectives. Economic way through workshops, conferences or dialogues, instruments have gained particular attention in re- leading to the import of expertise and a continuous cent years as an important tool in environmental exchange of information on relevant technical or sci- policy making, as they are capable of integrating en- entific advances and developments. vironmental concerns in economic decision making An important area where inter-regional coopera- processes. tion has so far been limited is the exchange of The main conclusion of the report is that there is experiences among regulators and officials on eco- a rich experience with economic instruments in Eu- nomic, environmental and health issues. In these ropean and other OECD countries that can be drawn areas, considerable gains of cooperation can be ex- upon in order to increase the efficiency of water man- pected through furthering the flow of information agement in Latin America and the Caribbean. among all relevant actors. However, economic instruments require substantive In general, steps should be taken to promote capi- administrative capacities before they can be success- tal investment and to encourage different forms of fully applied and administered, a capacity that in many private sector actions to help build capacities. Pri- cases will need to be put in place or strengthened be- vate European enterprises can fulfill an advisory fore these instruments become feasible in the Region. function, thereby importing their expertise in the field. As indicated above, integrated river basin management should be promoted in areas with a high GLOBAL EXPERIENCE intensity of water use. The examples of river basin organizations for instance in the mining areas in Eu- rope can serve as instructive cases (for example the This report illustrates how economic instruments in Water User Associations in Germany). the water sector can occur along the entire water cycle. Many of the relevant studies prepared by the Examples of economic instruments given are: (i) OECD in the field of water management have been Water abstraction taxes, (ii) water prices, (iii) prices strongly influenced by its European members and charges in sewerage collection and treatment, (iv) and therefore have a European focus, making them prices and charges in industrial effluent disposal, (v) not directly transferable to the Latin-American subsidies, (vi) tradable permits, and (vii) Environ- context. Yet, Mexico as a member country may mental liability laws. These instruments were argued function as the linking part between the OECD to be able to fulfill one or more functions such as and those Latin-American countries or regions incentive functions, fiscal functions, financial func- within these countries that have already reached relations and liability functions wherefore the choice and tively high industrialization levels. Although not design of the economic instrument should depend on universally applicable, many of the OECD’s recom- which functions the instrument is desired to address. mendations for Mexico offer valuable insights The German “Water Association Act” was pre- and allow for a conversion to other Latin-American sented as an example of a decentralized form of water countries. management that have successfully incorporated full- Finally, the existing lines of cooperation within cost recovery principles into its operations, primarily the EU–MERCOSUR framework should be used and achieved through pricing instruments. extended to direct cooperation with regard to envi- Furthermore, a recent political innovation in ronmental topics in general and water management European water management, the European Water issues in particular. Framework Directive, was presented. This is one of the first environmental policy Directives of the Eu- ropean Community that explicitly draws on economic instruments for achieving its objectives. 48 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

REGIONAL EXPERIENCE tive can also be instructive. Furthermore, this implementation process exemplifies the promotion of public participation, increased transparency and good Latin American and Caribbean countries have already reporting practices. some experiences with the use of economic instru- Based on the Latin-American case studies, ear- ments in water management. The report illustrated marking of revenues is recognized as an important this with examples of: (i) effluent charges from factor for the successful implementation of economic Mexico, Colombia, Jamaica and Brazil; (ii) credit and instruments. The European experience reinforces this tax incentives schemes for environment-related in- conclusion: Many European countries use earmark- vestments in Brazil, Mexico and Colombia; (iii) ing of revenues, and it is assumed that the resistance Sewage tariffs in Brazil; and (iv) tradable water per- to a charge is smaller if the responsible authorities mits in Chile. retain control of funds collected and use them for However, the effects of these policy innovations environmental programming or investments in the are often limited by problems such as inadequate water sector. The more transparent the use of rev- enforcement and insufficient coverage of users. In enues collected is, the easier it is to raise public many cases, impediments to the introduction of eco- support for a new scheme. nomic instruments such as major divergences from While the EU experience in water pricing and the outlined prerequisites, like severe deficiencies in with regard to subsidies is certainly relevant on a tech- the administrative and institutional setting, will have nical and organizational basis, differences in social to be addressed before the implementation of eco- settings must be considered. The social challenges nomic instruments becomes feasible. At times, the faced in the water sector of less developed Latin- instruments may also have to be designed so as to American regions require water pricing policies to take these challenges into account and to balance be carefully blended with complementary cross-sub- possible negative effects. sidization or compensation schemes. The main challenges in this regard faced by Latin Sewerage charges are common in all European American and Caribbean countries are: (i) Institu- Member States. While the same cautions apply here tional and administrative challenges; (ii) human as to water pricing, increasing the coverage of house- resource constraints; (iii) financial challenges; (iv) holds connected to the sewerage system could be lack of data; and (v) social challenges. supported by carefully designed charging schemes that aim at recovering the costs. Charges would provide operators and administrations with the necessary funds for the required investments. Increasing the LESSONS LEARNED access of poorer population groups to the sewer system is further desirable from the point of view of health of the population. While European approaches may not be applicable Integrated river basin management should be to all cases and may need to be modified to meet the promoted in areas with high intensity water use. The specific circumstances in Latin-American countries, examples of river basin organizations for instance in there are, nevertheless, lessons to be learned. There the mining areas in Europe, can serve as instructive is a growing consensus that integrated water resources cases (for example the Water User Associations in management is crucial in solving the Region’s water- Germany). related problems. Integrated management is a The European experience may be drawn on par- prerequisite for a successful implementation of envi- ticularly with respect to economic instruments that ronmental taxes, as the design of an equitable and so far have not or only in few cases been applied fair system (for example of supply charges or abstrac- within Latin America or the Caribbean (for example tion taxes) requires that all uses be taken into account. abstraction taxes, pollution taxes). European experience, such as the implementation Facilitating and strengthening the cooperation process of the Water Framework Directive, can serve between European and Regional actors and intensi- as an instructive example for a reorganization of pro- fying the exchange of experience and ideas would cedural and organizational issues aiming for offer an opportunity for more direct case-specific integrated management of water resources. Observ- support and advice by relevant actors in the field. ing how the EU Member States proceed in order to Considerable gains from cooperation can be expected fulfill the demands of the Water Framework Direc- through furthering the flow of information among EXTRA-REGIONAL EXPERIENCES AND THEIR APPLICABILITY IN LATIN AMERICA AND THE CARIBBEAN 49 regulators and officials on economic, environmental Toxic Release Inventory. 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Zulma Guzmán Castro.

This document reviews Colombia’s experience in environmental criteria came to be regarded, for the developing economic instruments for environmen- first time, as a necessary condition for economic tal management—specifically, in the area of water growth, and cost-effective tools for environmental pollution—with a view to providing recommenda- management were created. tions applicable throughout Latin America and in Prior to the 1991 Constitution, the task of envi- other parts of the world. The document consists of ronmental management and monitoring was three parts. The first describes the Colombian insti- distributed among various organizations, including tutional and legal context for these instruments, INDERENA, the regional autonomous corporations, presenting a detailed description of the particular in- the Ministry of Health and the Municipal Public Ser- strument in question (the environmental tax) and of vice Enterprises. This created overlapping functions the theoretical framework in which it was developed. and a lack of clarity regarding the scope of each The second section describes the various aspects of institution’s environmental mandate. the instrument’s functioning, implementation and re- In 1974, the National Renewable Natural Re- sults, as well as the difficulties it has encountered to sources and Environmental Protection Code date. The final section identifies the most significant (Executive Order 2811) created a formal framework positive and negative consequences of the instru- of principles and standards that institutionalized both ment– factors that should be taken into account in the right to a healthy environment and the regula- considering possible implementation in other coun- tions necessary to ensure it. Environmental taxes were tries, as well as in any modification of the instrument established by the Code, but were defined as a finan- in Colombia itself. cial instrument applicable only to profit-making users of the environment. This left large polluters, such as territorial entities, beyond the scope of the law. Decree 1594, of 1984, partially regulated issues NORMATIVE, INSTITUTIONAL related to the use of water and liquid wastes, cover- AND THEORETICAL FACTORS ing hundreds of pollutants and regulating the application of taxes. Institutional and legal framework The new Colombian Constitution of 1991 guar- for economic instruments in Colombia antees the right to a healthy environment for the entire population and for future generations, and as- The economic development process in Colombia has signs to the State responsibility for securing this right.2 jeopardized the country’s natural wealth.1 As a result of this situation, over a period of more than thirty 1 The primary indicator of Colombia’s natural wealth is the years, environmental regulations have been instituted fact that with only 0.8% of the planet’s land surface, the coun- and institutions have been established to oversee try has 10% of the planet’s biodiversity. environmental concerns. With the 1991 Constitution, 2 Title II. Collective and environmental rights. 58 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

Law 99, of 1993, put the principles of the Constitu- newing the resource. It is designed to function as a tion into operational form and restructured the public financial instrument and can only be applied by cer- agencies responsible for environmental management tain environmental agencies. and preservation and stewardship of renewable natural resources. To this end, it created SINA, which Tax incentives for environmental investment. These in- encompasses: the Ministry of the Environment (the centives were introduced in the 1997 tax reform (Law highest-ranking environmental policy body); thirty- 383). They are a significant variable affecting invest- three regional autonomous resource-management ment decisions by taxpayers, since they provide corporations responsible for sustainable development relative advantages for environmentally friendly (as for the entire country; four environmental agencies opposed to environmentally harmful) investments.7 in the large urban centers,3 responsible for environ- There are exemptions for investment in clean pro- mental management; five research institutes4 to duction; there are also subsidies for the protection of provide technical and scientific support; a special ad- ecosystems and for reforestation. ministrative unit for the National Nature Park System;5 and entities at the departmental, munici- Except for the environmental tax for specific re- pal6 and district levels. leases of substances into the environment, these taxes The law put in motion a strong institutional and are considered to be financial instruments, and are regulatory process involving environmental instru- intended to provide revenue for environmental agen- ments such as pollution taxes, or environmental taxes, cies, not as solutions to environmental problems.8 clean-production agreements, environmental li- Law 99, of 1993, modified the tax structure to censes, environmental exemptions, a sanctions make these taxes an economic instrument to be used regime, mechanisms for citizen participation, and en- by the State to charge for environmental services when vironmental investment funds, which have led to the the environment is used for waste disposal. The law creation of new markets in the environmental sector. provided that all users of renewable natural resources, Following is a description of the economic in- whether involved in profit-making activity or not, be struments provided for in Colombia’s legislation with subject to the tax. It also established a new environ- relevance for water management, although not all of mental tax system, along with a method of calculating them are currently included in the regulatory process. amounts to be charged. Under this legislation, the Ministry is responsible for setting a minimum tax at Environmental taxes. These were established by Ar- the national level. The regional autonomous corpo- ticle 42 of Law 99, of 1993, with specific provisions for later regulation to deal with water pollution. En- vironmental taxes may be levied for direct and indirect 3 Environmental Management Departments are mandated for use of the atmosphere, water and soil, for atmospheric cities with over one million inhabitants. These departments emissions, for release of land pollutants, or for re- are: DAMA (Bogotá), DAGMA (Cali – Cauca Valley), the Aburrá Valley Metropolitan Area (Medellín – Antioquia), and leases of pollutants into bodies of water as a result of DADIMA (Barranquilla–Atlantic district). human or service-related activities. The taxes apply 4 These are: the Alexander Von Humboldt Biological Resources to pollution that is within permissible limits and are Research Institute, the SINCHI Amazon Institute for Scien- currently in effect only for water pollution. Since tific Research, the Jose Benito Vives de Andreis Institute for 1997, 27 regional agencies have levied such taxes. Marine and Coastal Research (INVEMAR), the Hydrological, Meteorological and Environmental Studies Institute (IDEAM) Compensatory taxes. These were established by Ex- and the John Von Neumann Institute for Pacific Environmen- tal Research. ecutive Order 2811, of 1974, in articles that remain 5 This unit is a part of the Ministry of the Environment and is in effect. In addition, these taxes are provided for in responsible for managing areas that are part of the park sys- Article 42 of Law 99, of 1993. They were created to tem. provide for the cost of maintaining renewable natu- 6 Both Law 99, of 1993, and the National Development Plan ral resources and rationalizing their use. To date, they include the municipalities as part of the National Environ- have not been implemented. mental System. 7 Incentivos Tributarios A La Inversión Ambiental [Tax In- centives for Environmental Investment]. Ministry of the En- Water use tax. This was established by the 1974 Natu- vironment, Colombia. 1997. ral Resources Code, Law 99, of 1993 and Law 373, of 8 Estrategia De Financiación Ambiental Para Colombia [En- 1997. It charges users for different uses of water in vironmental Funding Strategy for Colombia], 1998–2007. order to pay for the expense of protecting and re- Ministry of the Environment, 1998. CASE STUDY: THE COLOMBIAN WATER TAX 59

TABLE 1

ORGANIC WASTE BY METROPOLITAN AREA IN TONS OF BOD/DAY

Metropolitan Areas Domestic Industrial % Domestic % Industrial Total

BOGOTA – SOACHA 259,9 82,4 28,25 8,96 342,3

MEDELLIN – VALLE ABURRA 145,9 89,2 15,86 9,69 235,1

CALI – JUMBO 64 121,0 6,96 13,15 185,0

BARRANQUILLA 38,5 20,0 4,18 2,17 58,5

MANIZALES – V/MARIA 17,4 18,3 1,89 3,08 35,7

BAHIA CARTAGENA 29,6 9,0 3,22 0,98 38,6 Source: National Planning Department. “Diagnóstico y Control de la Contaminación Industrial” [Diagnosis and Control of Industrial Pollution]. Bogotá, July 1993.

rations may adjust this figure at the regional level, The agricultural sector, without sugar cane or following procedures and guidelines set forth in the coffee processing industries, generates the highest regulatory standards. volume of BOD, with approximately 4,000 tons daily, followed by the livestock sector, households, and in- Background for current environmental issues dustry. Industry generates 500 tons of total suspended solids (TSS) per day.9 For twenty-three years, Colombia has had a system In 1997, it was ascertained that only one of for creating and implementing environmental stan- the 6,000 sources of waste flowing into the Bogotá dards, mandates and monitoring mechanisms. River —from its headwaters to Giradot—was in com- However, fecal coliform levels in the country’s pliance with the standards set in 1987 by the rivers are some of the highest in the world, with environmental agency with authority over the region. 97% of sewage being released, untreated, into the Clean technologies have been designed for many rivers. of the country’s productive sectors, and most are low- Society incurs a number of costs as a result of cost technologies that, in some cases, even increase this situation, since clean water is necessary to the profit. However, existing standards do not create in- society’s well-being. Examples of these costs are: centives for changing from polluting practices to clean ones.10 ● Increasing costs of purifying drinking water, due to waste and sewage discharged into the rivers. Design of the environmental tax: legal aspects ● The reduction of fishing in the national rivers. ● The disappearance of tourists as a result of poor The concept behind the environmental tax is to gen- water quality in some locations. erate revenue from actual or potential public services ● Illnesses involving diarrhea, which are a major provided to taxpayers, with the revenue going only consequence of water pollution. to the service areas involved.

Releases of household sewage into surface water have risen to 1,200 tons of BOD/day in urban and 9 Aguas Limpias Para Colombia Al Menor Costo, Implemen- rural areas, while industry contributes 520 tons of tación de las Tasas Retributivas por Contaminación Hídrica BOD/day. [Clean Water for Colombia at the Lowest Cost; Implementa- Of this total, the metropolitan areas that gener- tion of Environmental Taxes for Water Pollution], Ministry of the Environment. 1998 ate the most organic waste are Bogotá-Soacha, with 10 For example, PROPEL, an international NGO, developed 342.4 tons of BOD/day, Medellín -Valle de Aburrá, production methods adapted to Colombian tanneries. The with 235.1 tons, and Cali-Yumbo with 185 tons. The methods reduce pollution by as much as 70%, and signifi- following table provides a breakdown. cantly reduce the leather lost in processing. 60 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

Article 42 of Law 99, of 1993, establishes the quantitative variables defined to measure the environmental and compensatory taxes to be levied damage incurred by the activity and coefficients for direct or indirect use of resources, or as compen- that weights it as part of the set of factors and sation for the expense of maintaining and renewing variables taken into consideration. resources. This modification strengthens the tax as ● The calculation of those coefficients shall take an economic instrument. into account the pollutants involved, the diver- sity of regions, availability of resources and its ● “Direct or indirect use of the atmosphere, water capacity for assimilation, the opportunity cost of or soil to dispose of agricultural, mining or in- the resource, and the socioeconomic conditions dustrial wastes or residues, sewage or waste water of the population affected. of any type, smoke, vapor, or harmful substances that result from human activity or from activi- In Decree 901, of 1997, the Ministry of the Envi- ties resulting from human activities, or economic ronment provided regulations under Article 42 to or service activities (whether or not profit-mak- define the system and method to be used for levying ing) shall be subject to payment of environmental the tax. The decree sets forth a system designed to taxes to compensate for the harm caused by the levy amounts for particular releases of TSS and BOD 11 activities involved.” into surface water. The amounts levied must be set for each water basin or section thereof. Article 42 of Law 99, of 1993, also establishes a It must be borne in mind that the concentra- system and a method whereby the Ministry of the tions of TSS and BOD allowed at the national level Environment sets the amount of the tax. The system are set in Decree 1594 of 1984, which establishes and method is based on the following rules: that for household and industrial discharges, 80% of TSS and BOD must be removed. Hence, according to ● The Ministry of the Environment shall make an this standard, the permissible release is 20% of the annual determination of the method for calcu- total amount of these substances, and the environ- lating depreciation, taking into account the social mental tax is applicable only to this percentage. and environmental costs of the damage, as well Concentrations beyond permitted limits are not sub- as the cost of returning the affected resource to ject to the tax. its prior state. The amount levied shall take into account full depreciation of the affected resource. ● Calculation of depreciation shall take into ac- 12 11 count an economic assessment of the social and Article 42, Law 99, of 1993. Ministry of the Environment, 13 Colombia. environmental damage caused by the activities 12 Damage to human health, landscape, public tranquility, involved. public and private goods, and other goods of economic value. ● The amount of tax to be levied should be deter- 13 Damage to the normal functioning of ecosystems or the mined by a mathematical formula that includes renewability of resources and their components

TABLE 2

ADJUSTMENTS TO MINIMUM ENVIRONMENTAL TAXES FOR SPECIFIC RELEASES 1997–2002

Period BOD (US$/KG.) TSST (US$/KG.) Adjustment

April 1, 1997 – May 5, 1998 0,017 0,007 May 5 – December 31, 1998 0,020 0,009 17.68% January 1 – December 31, 1999 0,024 0,010 16.70% January 1 – December 31, 2000 0,026 0,011 9.23% January 1 – December 31, 2001 0,028 0,012 8.75% January 1 – December 31, 2002 0,030 0,013 7.65%

Source: Ministry of the Environment, 2002. CASE STUDY: THE COLOMBIAN WATER TAX 61

According to the decree, the minimum amount CHART 1 levied per unit of pollutant for each parameter is to be set by subsequent rulings to be issued annually, watershed adjusting the amount of the tax in accordance with inflation. To date, the amounts set by the Ministry are as follows. These minimum rates were based on studies by the Ministry of the Environment establishing the maximum cost of restoring the resources, based on technologies currently applicable in Colombia. Each parameter subject to taxation was considered Municipality (sewerage) separately, and the resultant increases were spaced over ten 6-month periods as a way of smoothing the Industrial source impact of the change. The following formula was Agricultural source used: Specific releases

Amount leviedi = minimum tax *regional multiplieri

Decree 901 establishes this incremental mechanism, which is to be used for setting rates in each If the pollution exceeds the target, the tax is in- watershed or section thereof, through a consultative creased by a “regional multiplier” of 0.5, which will process involving all the parties involved, including increase the tax in the following six-month period those responsible within the regional community. for all parties in the watershed. This multiplier was These parties define and agree on a target for reduc- set by the decree, and its purpose is to induce pollut- tion of total pollution released into the watershed for ing parties to attain the tax level that involves the succeeding five years. Reduction is specified in reducing all releases to the target level in the least terms of total kilograms of pollutants released in each costly manner, and to induce polluting parties to six-month period. implement technological innovations. The gradual Once the target is set for a watershed or section adjustment in the amount of the tax is an ongoing thereof, the regional environmental authority begins incentive to reduce pollution to the equilibrium level. to levy the tax, based on the minimum set by the “The a priori determination of an environmen- Ministry. The revenue generated goes to the regional tal target is basic to the cost-effective functioning of environmental authority. any economic instrument, since it reflects the pref- The environmental authority is responsible for erences of the society in relation to environmental identifying the parties responsible for specific releases quality. Thus, it is important for the target to be into the water for each section of the watershed, or agreed on by all sectors involved with water as a re- for the watershed as a whole as illustrated in the chart. source, including both those who produce damage Parties releasing pollutants are required to report through pollution and those who suffer the conse- releases to the authority, which, in turn, is required quences. In this way, the costs and benefits of the to make direct, statistically significant measurements decision—economic, as well as environmental and that make it possible to efficiently determine the social—become a part of the decision regarding the amounts to be levied. Thus, each authority must es- regional target. The target also sets a benchmark for tablish a monitoring program to make semi-annual measuring the effectiveness and performance of the measurements of releases into the watershed and instrument.”14 compare them with agreed reduction targets. The environmental tax functions on the principle that “the polluter pays.” It was designed as a Pigovian If the target is met:

Regional multiplieri = regional multiplieri-1 14 Aguas Limpias Para Colombia Al Menor Costo, Imple- mentación de las Tasas Retributivas por Contaminación If the target is not met: Hídrica [Clean Water for Colombia at the Lowest Cost; Im- plementation of Environmental Taxes for Water Pollution],

Regional multiplieri = regional multiplieri-1 + 0.5 Ministry of the Environment. 1998 62 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

CHART 2

MEETS THE TARGET IN THE FIRST SEMESTER DOES NOT MEET THE TARGET UNTIL THE FIFTH SEMESTER

Amount of the Tax Amount of the Tax 400 400

350 350

300 300

250 250

200 200

150 150

100 100

50 50

0 0 0 123456... 0 123456... Six-month periods during the 5-year plan Six-month periods during the 5-year plan

Source: Based on a presentation by OAE. Ministry of the Environment, 1998.

charge levied on the polluter, based on the pollution ● At the end of the five years period, the target may generated, and is an application of a concept devised be reevaluated and changed by the members of and developed by William Baumol and Wallace the regional watershed community who are di- Oates.15 The Ministry selected this model because of rectly involved or affected. If the target proves to its applicability to a situation in which there is little have been too ambitious, and the economic costs information on environmental damage and on the excessive, the target should be made less restric- cost of reducing pollution. tive. On the other hand, if the economic costs have been minimal but the environmental im- Operational aspects of the environmental tax pact great, then the parties may agree on a more demanding target. The process of target setting must involve all available information, qualitative and quantitative, taking The system has the virtue of allowing the com- into consideration the social, economic and environ- munity that is subject to the regulations to be actively mental costs of damage caused by pollution, as involved with the environmental authority. Further- perceived by the society affected in each region and more, the amount of the tax is based on measured with respect to each resource. Thus, the agreement pollution rather than subjective criteria. Thus, the must take into account the abatement costs to pol- system produces the minimum tax rate needed to luters, in order to arrive at a target acceptable by the reach the agreed decontamination target in each re- entire regional society. gion, with society bearing the minimum possible cost The tax is to be implemented gradually over five- necessary to reach the level of environmental quality year periods, as follows: desired. By determining watershed-specific targets with ● An abatement target is agreed on for the selected input from the local community, using improved in- body of water. formation, and with economic rationalization as an ● The environmental authority gathers information on progress toward the goal on a semi-annual 15 basis. William Baumol, “On Taxation and the Control of Exter- ● The environmental authority raises the tax semi- nalities,” American Economic Review; William Baumol and Wallace Oates, “The Use of Standards and Prices for Envi- annually by applying a regionally determined ronmental Protection,” The Swedish Journal of Economics; multiplier if the goal is not met. Baumol & Oates, “Efficiency Without Optimality: the Charges ● Upon achieving the regional environmental goal, and Standards Approach,” Chapter 11, The Theory of Envi- the rate remains stable for a five years period. ronmental Policy, Cambridge Press. CASE STUDY: THE COLOMBIAN WATER TAX 63 integral part of the process, the environmental tax supplementary tool, known as Regional Investment can be more efficient in meeting targets. However, Funds, was released at the end of 1998. The funds economic, social and environmental conditions are intended to clarify the allocation of revenue, as change over time, e.g., with respect to evolving clean well as leveraging other funding sources in order to technologies and changing environmental commu- carry out cost-effective investments in water decon- nity priorities. Thus, every five years the community tamination. reevaluates perceived costs and benefits, adjusting The program has moved forward slowly, and with targets as it deems appropriate. significant problems. Of the existing 37 environmental authorities, 27 made progress in setting targets and implementing the instrument, while only 13 have billed users in their jurisdictions for the use of the IMPLEMENTATION OF THE INSTRUMENTS resource, and only 10 have begun forming the regional funds to handle revenue from the tax. The table Problems and overall issues below shows the stage of implementation of the taxes and regional funds by the various regional authori- Following the issuance of Decree 901 in April of 1997, ties, as of June 2001. the Ministry of the Environment put in place various Though the billing and collection process has tools for support and implementation. These included advanced, it has been a complicated task for some of an Implementation Manual written by experts in vari- the regional authorities, since there is a complete ous relevant areas, and a cooperative program with absence of guidelines for converting the collection environmental authorities, designed to ensure that of the tax to a system in which households are billed the tax coincided with regional needs and realities. for the public services involved. Moreover, most of At the end of 1997, only three of the regional the environmental authorities were created by Law environmental corporations had implemented the 99, of 1993, and therefore lack credibility and politi- decree. In response to this situation, the Horizontal cal power, as well as the administrative infrastructure Cooperation Program was created, aimed at exploit- and experience needed to carry out the necessary ing the institutional strengths of those regional activities efficiently. authorities that had made the most progress in imple- This is evident from the fact that billing has not menting the tax (CVC, CORNARE and CARDER) and necessarily led to collection of the funds, as seen in assisting other authorities in setting reduction tar- the table below that indicates that only 33% of gets in their jurisdictions, through an assistance and amounts billed have actually been collected. support system. The most significant delays are due to the lack of During implementation, the Ministry found that political resolve needed to implement the tax system the structure for channeling the revenue from the tax and, in some parts of the country—where pollution was a major limitation in the process. It therefore problems are minimal, e.g., the eastern plains and designed a tool to provide transparency in how the the Amazon region—a lack of need for the system. revenue is used. Information about the design of this The environmental authorities that have made the greatest progress in implementation have had positive results, reducing pollution by an average of 10% to 51%.16 TABLE 3 To date, Colombia’s environmental tax has proven effective in reducing pollution in the productive sec- Total number of regional tor. However, it has not had the same success in environmental authorities 37 respect to household pollution or pollution associ- Regional environmental authorities ated with municipalities. The technological with advanced implementation processes 27 Authorities that have invoiced 13 16 CORNARE has reported 31% BOD reduction and 47% TSS Authorities that have not begun reduction; CDMB has found 10% BOD reduction and 69% implementation 10 TSS reduction; and CVC has reported more than 46% BOD reduction and 36% TSS reduction. These data were calcu- Authorities with regional funds 10 lated by the authors based on the latest data reported to the Source: OAE. Ministry of the Environment, 2001. Ministry of the Environment. 64 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

TABLE 4

Total billed by regional environmental Total collected by regional environmental authorities (Colombian Pesos) authorities (Colombian Pesos)

$ 66,767,729,461 $ 22,518,267,884 Source: External consulting carried out for the Ministry of the Environment, 2002. constraints involved in controlling the latter type of Despite this situation, the environmental authori- pollution, the high cost of implementing municipal ties have billed water and sewage utilities, though waste water treatment systems,17 the low number of they have not collected. They have taken legal action such systems currently in existence,18 and the lack to enforce the environmental legislation, as in the case of control that public utilities have over the use of of regional authority DADIMA, which was forced to their infrastructure have limited the effectiveness of seize the Barranquilla Water, Sewerage and Street the instrument. Cleaning Company (also known as Triple A). The The tax has been effective in promoting indus- company then agreed to pay its approximately 2.5 trial clean-up, due to the elasticity of the pollution billion peso debt over a period of one year, in addi- tax. However, because of legislative problems in trans- tion to monthly payments for household sewage ferring collections and inelasticity, the results with discharged since October 2001. municipal systems have not been as positive. Mu- Similar cases have occurred elsewhere. Medellín nicipalities that have implemented the tax are Public Utilities (Empresas Públicas de Medellín) is incurring growing debts to the environmental au- one example. This utility only began paying for dis- thorities, a situation that, in the long run, could create charges as of 2000, but the underlying problem – one a serious budget problem for the authorities. of gaps in the law – was not solved. Thus, the more Municipal entities are the source of the country’s the tax is implemented, the worse becomes the prob- largest liquid waste discharges, accounting for 70% lem of collections, a situation that starts involving of such discharges. In the great majority of cases, they other sectors. have no clean-up or treatment systems. Failure to pay In this connection, the National Industrial As- the environmental tax for their discharges – despite sociation (ANDI) has expressed concern about the the fact that Decree 901 makes them subject to the inequality of implementation, since municipalities tax or responsible for the discharge – is an aggravat- are neither reducing their discharges nor paying the ing factor in the situation. tax, while the industrial sector, which is complying The country’s inability to solve the problem of with regulations and investing in clean-up, is hav- transferring collection of the tax to household users ing to pay successive increases in the regional of sewage systems is the result of certain peculiari- multiplier. These increases are due to a failure to ties of Colombian politics and law. reach target levels—a result, specifically, of the fact The Asociación de Empresas de Servicios Públicos that municipalities, which are responsible for 70% Domiciliarios y Actividades Complementarias, of the discharges, are not undertaking any mitiga- (ANDESCO) has been categorically opposed to imple- tion measures. menting the instrument, especially as it applies to In addition, the failure to impose the tax in all of entities providing sewerage services, and since the the country’s regions creates inequities and competi- initial implementation of the tax, its members have tive disadvantages for firms situated within the decided to refuse to pay it, in addition to initiating jurisdiction of those environmental authorities that several lawsuits against the tax. Their primary argu- are actually collecting the tax. These firms must ei- ment is based on regulatory problems relating to ther pay fees or reduce their discharges, while firms public utilities. Though Law 142, of 1994, allows not subject to the regulations are free of these addi- them to include environmental taxes in their average operating costs, and thus to transfer those costs to users, the utilities claim a lack of regulatory clarity, 17 Investment needed by this sector in Colombia is estimated and hence refuse to pay the tax until such time as the at US$2.175 billion. Drinking Water Regulatory Commission issues a clari- 18 Ninety-five percent of municipalities in Colombia release fying ruling. waste water without any treatment. CASE STUDY: THE COLOMBIAN WATER TAX 65

tional costs. The problem has been addressed by the CHART 3 Comptroller General of the Republic, which has NPV OF INVESTMENT IN TREATMENT VS stressed the failure of environmental authorities to COLLECTING THE TAX enforce the law, both with respect to collecting the 2.500 tax and in the sense of enforcing the absolute discharge limits imposed by Decree 1594, of 1984. 2.000 Much of the debate is focused on the lack of credibility of government institutions, which are 1.500 considered corrupt, inefficient and bureaucratic. Those subject to the tax oppose channeling these rev- 1.000 enues into the nation’s general budget for subsequent allocation. They believe that such a procedure will 500 not ensure that the funds will be used to solve specific regional environmental problems. With this in 0

mind, some of the regional authorities, under guid- Chía Cota Sopo Tenjo Ubaté Suesca

ance from the Ministry, have made agreements with Sesquile Zipaquirá municipalities for the management of regional invest- Anapoima NPV investment VPN collection ment funds to ensure the design of abatement measures that provide for cost-effective treatment Source: Office of Economic Analysis, Ministry of the Environment, systems. April 1997. The institutional process involved in handling the revenues, however, are highly complex involving the Ministry of the Environment, the Ministry of The chart below shows the results of studies car- Economic Development, the Ministry of Health, the ried out by the Ministry of the Environment, Commission for the Regulation of Drinking Water indicating that, for most municipalities in Colom- and Basic Sanitation, the National Planning Depart- bia, there are more cost-effective solutions than ment, and the Superintendency of Household payment of the tax.20 Utilities. Moreover, the taxes are seen as an addi- Additional studies by Fedesarrollo, Universidad tional cost which, when transferred to users, will have del Valle and Universidad Javeriana, in the cities of harmful effects on the lower socioeconomic strata, Cali, Bogotá and Cartagena, concluded that the sys- which is already in dire economic straits. This seg- tem of environmental taxes did not significantly ment of the population has already suffered, over impact the utilities’ economic or financial viability. the last two years, from the economic impact caused Most of the country’s sectors, however, disagree, by the withdrawal of subsidies experienced by utili- since actual implementation has been quite different ties. from the projections. The assumptions and estimates Before implementing Decree 901, of 1997, the of the Ministry have proven inaccurate, due to the Ministry of the Environment analyzed the impact of fact that diverse problems have arisen, and that those the tax on household users of sewage services. It con- assumptions did not necessarily take into account cluded that the monthly cost borne by a family would be only 0.2% of the monthly minimum wage (approximately 600 pesos in 2002 terms). The utilities, 19 however, predict average increases of 20% in billings Figures by the Empresa de Acueducto y Alcantarillado de 19 Bogotá, EAAB. 2000. for water and sewage services. 20 Simulation of present net value of investments and operat- The Ministry projected payments by municipali- ing costs for basic treatment plants in the cases of 9 munici- ties and utilities in each region, based on population palities in Cundinamarca, based on the tax applicable during or number of users, the amount of pollution being the useful life of the project (20 years). The payment in- discharged into the environment, and the reductions creases semi-annually by a regional multiplier of 0.5 until targeted for the respective regions. The analysis was year five, at which time the reduction target is assumed to based on two alternatives from which municipalities have been reached. From that point on, through the remaining 15 years, revenues remain constant. The amounts do not could choose: (a) paying an environmental tax to include collections from industry. Colombia’s average popu- environmental authorities on an ongoing basis; or lation growth (2%) was taken into account, and a social dis- (b) investing in pollution-solving measures that are count rate of 12% was used. OAE, Ministry of the less costly than paying the tax. Environment, April 1997. 66 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT the effective existence of cost-effective technological mentation of the tax with ongoing assistance from solutions. Without going into the details of this is- staff of the Ministry’s Office of Economic Analysis. sue, it should be pointed out that the tax, as planned, Unlike most of the country’s autonomous did not take into account the fact that implementing entities, CORNARE had a significant amount of cost-effective technologies to reduce pollution dis- information on the state and quality of the most charges would require designing and building important water resources in its jurisdiction, and solutions, and that in most cases this takes at least knew the entities responsible for the major dis- two years, during which time the regional multiplier charges in its watersheds. Using this information, is subject to increase. as well as statements by the entities themselves, as provided for in the regulatory scheme, baselines were established for each of eight watersheds, Positive aspects and successful cases based on discharges measured according to the parameters defined in the regulations. Discharge A group of experts from the Environmental Policy levels for the various parameters were specified Division of the World Bank, made the following ob- for specific discharge points within the water- servations in its evaluation of the environmental tax sheds. at an event hosted by the Ministry of the Environ- CORNARE had data on the location of pollut- ment in Bogotá in 2000.21 ers, classified by economic sector and subsector. This made the process of agreeing on regional clean-up “Our group has been directly involved in the targets clearer and the results more precise. More- design and implementation of environmental over, there had already been meaningful dialogue with taxes with officials from China, the Philip- unions within these subsectors, leading to agreements pines, Indonesia, France, Canada and Brazil on cleaner production.22 This was highly significant, during the last seven years, and we have had since these groups represented over 90% of identi- the opportunity to see where, in practice, there fied water pollution sources in the region’s productive are problems related to the implementation of sector. taxes. After having evaluated the Colombian In the case of municipalities and utilities serving tax, our conclusion, comparing this with the households, the statements received showed these experience in other countries, is that the Co- entities contributing approximately 70% of the vol- lombian mechanism represents the state of the ume of BOD and TSS. art in the design and implementation of taxes. The governing board of CORNARE approved the It is a system based on cost-effectiveness and first six months of charges, covering April 1st to Sep- on minimizing costs. It is a mechanism no- tember 30th, 1997, and implementation has had table for its simplicity and transparency, and significant positive results in a number of the eight for the fact that is objective and gradual. It target watersheds. For instance, after two years of also stands out for the way in which it actu- implementation in the Río Claro – Cocorná Sur wa- ally incorporates the regional community in tershed, TSS pollution had fallen 84.95%, and BOD5 the setting of clean-up goals that reflect local pollution had dropped 40.42%. This watershed in- preferences. It is based on a fairly practical cludes cement plants and oil industry sites. The Río system and method, and empirical evidence Negro watershed, one of the most polluted in Co- indicates that the mechanism can be imple- lombia, showed reductions of 33.81% in TSS and of mented with existing institutional resources 33.56% in BOD5.23 to reduce pollution in a very cost-effective The table below shows reductions, by watershed manner.” and by category.

This conclusion appears in the case analysis made by the CORNARE regional authority, in Green- 21 ing Industry, a book published by the World Bank in Seminar. Colombian Ministry of The Environment and the 2000. World Bank. Bogota, Colombia, 2000 22 Industrial entities associated with CEO (Corporación When the regulatory decree establishing the Empresarial del Oriente), flower growers (Asocolflores environmental tax was first issued, the regional Antioquia), pork producers (ACP and others), agave farmers environmental authority of Antioquia (CORNARE) (Asdefique and others), and beekeepers (Fenavi and others). was 15 years old. CORNARE pioneered the imple- 23 Hincapié et al. 2000. CASE STUDY: THE COLOMBIAN WATER TAX 67

TABLE 5

DISCHARGES BY SECTOR CORNARE JURISDICTION 1996–2001

Domestic Industrial Agribusiness Total BOD TSS BOD TSS BOD TSS BOD TSS Periodo Kg/semester Kg/semester Kg/semester Kg/semester Kg/semester Kg/semester Kg/semester Kg/semester

1996–1 3.207.392 3.056.154 1.305.810 1.193.659 5.231 15.929 4.518.433 4.265.743

1996–2 3.207.392 3.056.154 1.305.810 1.193.659 5.231 15.929 4.518.433 4.265.743

1997–1 3.315.668 3.159.585 1.305.810 1.193.659 5.231 15.929 4.626.710 4.369.174

1997–2 3.264.212 3.084.237 722.232 802.617 30.085 27.685 4.016.529 3.914.539

1998–1 2.055.271 1.898.749 635.668 336.456 19.988 29.899 2.710.927 2.265.104

1998–2 1.844.458 1.735.820 656.682 223.846 27.236 26.818 2.528.376 1.986.484

1999–1 1.885.275 1.741.866 511.982 181.767 17.330 21.228 2.414.587 1.944.861

1999–2 1.921.268 1.723.254 785.294 188.673 13.591 18.434 2.720.152 1.930.361

2000–1 1.909.852 1.722.465 687.526 162.805 12.760 17.924 2.610.138 1.903.195

2000–2 2.011.534 1.821.916 466.440 118.754 11.336 15.310 2.489.310 1.955.980

2001–1 1.698.055 1.610.147 582.356 97.904 9.182 13.614 2.289.594 1.721.665

2001–2 1.245.910 1.163.713 382.394 125.171 8.004 12.618 1.636.309 1.301.503

Source: Authors’ figures, based on data from the Ministry of the Environment, 2002.

The following chart shows the changes in the CORNARE has also been successful in the area amount of discharges over time, before and after the of collections, having collected 57% of the total billed. implementation of the water tax. This is far higher than in other parts of the country. Indeed, all of the industrial entities that signed cleaner-production agreements with CORNARE24 CHART 4 have made their environmental tax payments in a DISCHARGES, CORNARE JURISDICTION PRIOR TO AND AFTER THE TAX timely fashion. 5.000.000 One key point in CORNARE’s success is the trans- 4.500.000 parency with which the collected funds have been 4.000.000 managed. From the start, CORNARE determined that 3.500.000 50% of the money would be used to co-finance 3.000.000 projects designed to deal with municipal pollution, 2.500.000 30% for investment in industrial reengineering and 2.000.000 Start of Leaving of taxes cleaner production, 10% for environmental science

Kg/six month period 1.500.000 and technology research, environmental education, 1.000.000 and dissemination of information about the environ- 500.000 mental tax, and an impressively low 10% for operating 0 expenses. A regional clean-up fund was created to handle the revenue, following guidelines provided by 1996–1 1996–2 1997–1 1997–2 1998–1 1998–2 1999–1 1999–2 2000–1 2000–2 2001–1 2002–2 Year the Ministry of the Environment for the purpose. BOD (Kg/semester) TSS (Kg/semester)

Source: Authors’ figures, based on data from the Ministry of the 24 Members of CEO (Corporación Empresarial del Oriente Environment, 2002. Antioqueño). 68 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

TABLE 6 Total billings Payments 1992–2001 ($/semester) Outstanding Collections % Collected

Household collections 2.935.587.307 1.221.806.022 1.713.781.285 58% Industrial collections 944.108.990 451.643.589 492.465.401 52% Agribusiness collections 26.590.765 12.404.094 14.186.672 53%

Total 3.906.287.063 1.685.853.705 2.220.433.358 57%

Source: Authors’ figures, based on data from the Ministry of the Environment. 2002

ECLAC25 has also been involved in analyses of CHART 5 consequences of the tax, conducting an assessment DISCHARGES BEFORE AND AFTER of the impact of the tax on Colombia’s industrial sec- THE ENVIRONMENTAL TAX tor after four years of implementation. The study dealt 9.000.000 with environmental effectiveness and economic effi- 8.000.000 ciency in the jurisdictions of environmental 7.000.000 authorities CVC, CORNARE and DADIMA, examin- 6.000.000 ing the two following scenarios: 5.000.000 a) Regulated entities have met standards on dis- 4.000.000 charges, investing in costly treatment plants, as 3.000.000 in the cases of CVC and CORNARE; 2.000.000

b) Regulated entities have low levels of compliance kg discharged per six-month period 1.000.000 with standards, not investing in treatment plants, 0 as in the case of DADIMA. CVC CORNARE DADIMA Baseline BOD BOD 2nd semester 2000 The study concluded that in both cases the tax Baseline TSS TSS 2nd semester 2000 produced significant reductions, in addition to those Source: ECLAC 2001 already produced by existing treatment plants, and more rapidly than in previous years, as shown in Chart 5. studied, approximately 90% reductions were In addition, ECLAC evaluated the cost of com- achieved within a year of implementation, pliance for regulated enterprises, examining two even where production was increasing. Such individual companies, Monómeros Colombo results had not been achieved previously, despite a Venezolanos S.A. and Canteras Yarumal, as well as policy that imposed fines and even shut down com- a third company, Cultivadores de Caña de Colom- panies. bia (ASOCAÑA), in the sugarcane subsector. The ECLAC concludes that the tax is a more cost- results showed that in addition to a reduction in effective instrument for environmental authorities pollution compared to the previous system, com- than the previous system of fines and shutdowns, panies had incentives to create cleaner production since although the total cost of the new system is processes, thus leading, in some cases, to a rise in productivity. Though the sugar industry already had treatment 25 ECLAC: Aplicación del principio contaminador-pagador plants for its wastes, additional reductions of 24% en América Latina: evaluación de la efectividad ambiental y (BOD) and 65% (TSS) followed implementation of eficiencia económica de la tasa por contaminación hídrica en the tax. In the cases of the individual companies el sector industrial colombiano, 2001 CASE STUDY: THE COLOMBIAN WATER TAX 69 comparable to the cost of the old regime, the admin- agement and reduces taxation on activity that is ben- istrative cost per kilogram of reduction in BOD is eficial for society. lower under the new system (79% lower in the case Thus, in theory, taxing pollution creates an in- of CORNARE). centive for environmentally favorable behavior, According to the ECLAC study, the tax, as a promotes proper valuation of natural resources, and source of funds for the environmental authorities, promotes their efficient allocation and use. As a re- gives these entities budget stability independent of sult, the environment is treated in a manner that the central government, guaranteeing that there will ensures efficient economic allocation of resources in- be money for new projects, and ensuring continuity ternalizing any environmental damage derived from for programs that administer, supervise and monitor production. water resources. For example, an accurate valuation of pollution To summarize, the most significant benefits of implies that the marginal costs of reducing pollu- the environmental tax system, according to the vari- tion (or, viewed from another perspective, the ous studies and analyses of its application in marginal benefits of polluting) are equal to the mar- Colombia, are: ginal costs of damage to the natural resources involved, in the optimal scenario. Environmental ● Updating of inventories of users that generate goods and services, however, are not tradable, and direct or indirect discharges into bodies of the information needed to determine the marginal water. cost of harm done is generally unavailable. Hence, ● Developing updated information on the state of economic instruments are used – ones that, despite water resources, in regard to organic pollution a lack of important information, do permit polluters and suspended solids. to determine the most appropriate form of reaching ● Identification of users and their discharges, us- an established target, or of making their marginal ing statement forms for users. cost for decontamination equal to the level of the ● Use of information that had been on file but had tax that has been set on the amount and type of pol- not been used. lution in question. The use of economic instruments in environmen- In addition documents in which companies and tal policy is not new. Nevertheless, there is a large municipalities describe the discharges they generate gap between the theory on which they are based and are now taken into consideration. This information the actual implementation of the instruments. Ac- is of value to management, and can be a factor in cording to the OECD,26 though these instruments are inducing regulatory entities to fulfill their environ- the type most commonly used, they have been prob- mental responsibilities. Other notable effects are: lematic in practice and have not created the incentive levels needed to attain environmental goals, prima- ● In certain regions, closer and better relations have rily because the level of the tax has been set too low been established between environmental authori- – conceiving of them primarily as financial instru- ties and those responsible for discharges. ments or sources of revenue. ● The obligation to pay the tax has made users more The situation in Colombia is different. The in- aware of environmental issues. strument here was designed primarily as an economic ● In some regions of the country, industrial pollu- incentive to reduce releases of polluting agents into tion has been reduced. bodies of water. While this is its principal strength, it suffers from other problems. These relate primarily to implementation rather than design, except for the exponential nature of the regional multiplier. CONCLUSIONS Thus, the environmental tax is, in theory, an ideal instrument for pollution control, but in practice its applicability has been problematic. This is not nec- It is widely recognized that it is more economically essarily the fault of the instrument itself, but rather, efficient for society to tax “negative” activities (such can be attributed to the country’s institutions and to as pollution) than “positive” ones (such as work or difficulties in the Colombian economy. savings). Hence, there is a three-way benefit in taxing pollution: it diminishes harm to the environment, generates additional revenue for environmental man- 26 Organization for Economic Cooperation and Development. 70 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

This situation has been aggravated by the fact appears in the statements provided by entities that a number of variables were not taken into ac- responsible for discharges; and count in initiating the tax—variables whose 11. Perhaps most important of all, the exponential importance was, in some cases, difficult to foresee. increase of the regional multiplier and, conse- For example: quently, of the tax, due to failure to meet targets—a situation that has led to widespread 1. The time needed to design, build and implement resistance to the tax. technological solutions to mitigate the releases of pollutants; For these reasons, experiences that have been per- 2. The low level of municipal resources available to ceived as successful are those involving environmen- build the treatment plants needed in a timely tal authorities already engaged in managing fashion; discharges by economic agents in their jurisdictions 3. Delays in bringing complete sanitation services prior to the advent of the economic instrument— to many municipalities, making it impossible to entities with basic information on discharges into solve the problem of waste releases into bodies their bodies of water. Thus, they have been free of of water—even with the construction of treat- most of the problems that have occurred in the rest ment plants (which would be under-utilized of the country, and have managed to obtain compli- because of the incomplete coverage of the sew- ance with the targets, thus preventing sharp increases age collection system); in the regional multiplier. 4. Lack, in many cities, of sewage collection sys- The increase in the regional multiplier should tems and systems for separating rainwater, be controlled so as to make it proportional to the creating the same problem as indicated in the degree to which the target has been met during the above point, in addition to the problem of pay- immediately preceding period, creating a real con- ing environmental tax on discharges that can vergence between the amount of the tax and the value neither be controlled nor mitigated; that makes it possible to achieve optimal clean-up. 5. The elimination of subsidies to utilities, which

entails significant economic impact, leading to Amount of the taxi =

social opposition to the tax; minimum taxi * regional multiplieri 6. The vagueness of regulations governing utilities’ transferring the tax to users, which has caused If target is met: resistance by sanitation companies, which believe

that they may be forced to pay the charges out of Regional multiplieri = regional multiplieri-1 their own pockets; 7. Lack of knowledge about environmental issues, If target is not met: especially in terms of the basic concepts of the

instrument as designed. This has caused chaos Regional multiplieri = Regional multiplieri-1 + when the time comes to negotiate clean-up tar- (0.5 - (0.5 * percentage gets, sometimes leading to targets that are entirely compliance with target) unrealistic; 8. The low level of experience and technical ca- Studies analyzing benefits of the environmental pacity of the environmental authorities, tax program have pointed to solutions to the prob- reflected in the fact that they have been unable lems of information and management essential to to explain to the regulated parties the rationale successful implementation, e.g., (a) updating of infor the tax, and the fact that they have not had formation on discharges and their causes; (b) closer the credibility and capacities needed to negoti- relations between environmental authorities and ate agreements; regulated entities; and (c) growing awareness of natu- 9. Environmental authorities’ lack of information ral resources among users, with reduction of on releases of pollutants into bodies of water— industrial discharges being the only concrete result information necessary for billing and collection of implementation. of the tax; The intention behind the instrument was valid, 10. The problems that environmental authorities and the design of the instrument was a response have had in carrying out the auditing and moni- not only to existing legislation, but also to the prin- toring needed to confirm information that ciples of “equi-marginality” and economic efficiency, CASE STUDY: THE COLOMBIAN WATER TAX 71 attempting to reach the socially optimal equilibrium CAR. Surface Water Master Plan. in a gradual manner. However, a number of legisla- Freeman, A. Myrick III: “Water Pollution Policy.” In: tive, informational and social factors were not taken Public Policies for environmental Protection, into account—elements that are essential to the Paul Portney, ed. Resources for the Future, success of the instrument and that must be consid- Washington, DC. 1990. ered in future applications of future instruments of Field evaluation report by the MMA’s Office of Eco- this type, such as the water use tax now being for- nomic Analysis, by invitation of the French mulated. Institute of the Environment and the technical cooperation program of the French Embassy, January 1998. Law 99 of 1993. Congress. Republic of Colombia. BIBLIOGRAPHY Ministry of the Environment 1998. El que Contamina Paga: Aguas Limpias para Colombia al Menor Costo. Implementación de las Tasas Retributivas Barrera et al. 1996. Valoración Económica de los Costos por Contaminación Hídrica. Economic Analy- en Salud Causados por la Contaminación Hídrica. sis Support Office. Universidad de los Andes. Department of Eco- Ministry of the Environment 1998. La Experiencia nomics – Specialization in Social Evaluation of Colombiana en las Tasas por Uso del Agua. Office Projects. Bogotá, June 1996. of Economic Analysis. Baumol, William & Wallace Oates, “Efficiency With- Ministry of the Environment 1993. Estudio para la out Optimality: the Charges and Standards Estrategia de Saneamiento del Río Bogotá. Approach,” Chapter 11, The Theory of Environ- OECD, Managing the Environment: The Role of Eco- mental Policy, Cambridge Press. nomic Instruments. Paris, 1994. Baumol, William & Wallace Oates, “The Use of Stan- Sabogal, L and Solano. Aproximación a la normatividad dards and Prices for Environmental Protection.” vigente y a la valoración de costos ambientales The Swedish Journal of Economics. mediante la relación costo-beneficio, en la cuenca Baumol, William “On Taxation and the Control of alta del Río Bogotá. Universidad Incca of Co- Externalities.” American Economic Review. lombia. 1995.

Synthesis of Regional Experiences: From Theoretical to Practical Issues

Ronaldo Seroa da Motta, Jose Gustavo Feres, Céline Nauges, Alban Thomas, Antonio Saade and Lilian Saade

The economic literature commonly identifies eco- France, Mexico and Brazil. These country reviews are nomic instruments (EIs) as a “better” way to achieve summaries based on investigations undertaken by environmental goals than specified quantity and tech- local experts. Each country evaluation is organized nological standards known as command-and-control along the same guidelines covering topics of relevance mechanisms (CAC). However, the choice of an ap- for the application of a policy instrument, namely: propriate economic instrument is complex, which is recognized by the ongoing controversies regarding (i) policy analysis phase: the policy setting in which the efficiency of previous experiences. the water EI was introduced as a mean of achiev- Seroa da Motta, Huber and Ruitenbeek (1999) ing policy goals. have presented a comprehensive survey of the ex- (ii) instrument design phase: the theoretical, institu- periences with EI in Latin America and Caribbean. tional and legal basis on which the EI was This survey concludes that there is a wide range of conceived . application of EIs in the region that closely follows (iii) instrument implementation phase: successes the OECD pattern concerning revenue-raising aims. and failures of the EI application and its review The survey shows that water charges is the instru- process. ment with most regional applicability. It also shows persisting problems in design and implementation, such as: COUNTRY CASES i. Weak targeting and performance monitoring of environmental goals; France ii. Lack of sound pricing criteria; iii. Poor performance on revenue collection. The 1964 Water Act profoundly modified the French water management system and its apparent success The French river basin system has been used as has been paradigmatic for water policies elsewhere, a paradigm for Latin America experiences. This is particularly in Latin America. mostly due to the fact that the French system was The French approach was based on two general created by governmental decision and implemented principles: Decentralization and planning. First, de- in a reasonable time with immediate results. How- centralization reflected the idea that the organization ever, praising of this experience has obscured the of water management should correspond to the physi- identification of its main difficulties and constraints cal unity of water bodies to be managed in order to that, once recognized, could be of great value for address more effectively potential sources of conflicts. followers. In this approach the externality problems and con- Based on the prior diagnostic, this brief review flicts linked to water pollution and other uses were will present the cases of water charge experiences in integrated, in difference to the centralized approach 74 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT that addressed use with one set of unified perfor- A federal law that is revised every year sets the mance standards. Secondly, planning was intended price criteria of water pollution charges in Mexico, to provide consistent decisions at the river basin level, and regulation is thereby not decentralized. The pol- and to introduce a medium-term perspective on wa- lution charges perform the role of a non-compliance ter management. charge since polluters only pay for units above the The decentralization principle was put into prac- discharge standard. However, the implementation of tice by the creation of Water Agencies and River Basin the water charges has not been very successful since Committees in each of the six French river basins. national coverage of the country’s vast water system The former were intended to perform executive func- has required monitoring resources and enforcement tions, and the River Basin Committees would act as capability beyond the institutional capacity of the consultative bodies. CNA. In addition, the CNA has been more concerned The application of the Water Act began with the with infrastructure development than pursuing en- adoption of two new instruments: five-year manage- vironmental targets. Another problem is the reduced ment plans and water charges. The implementation scope for private and public participation due to lack of water charges was gradual and it worked very well of information made available, which has created to generate revenues for water-related investments, polluters’ opposition on competitiveness and distribu- with much of the revenue transferred back towards tive grounds. water charge payers. However, no major role for price As a consequence of these institutional barriers, incentives has been found to induce changed water revenue generation has been very low and no changes use patterns at the applied water charge levels. More- in water use pattern have occurred. A law reform over, the special treatment to agricultural users proposal entitled Ley de Cuencas y Aguas Nacionales through exemptions has led to the sacrifice of no- (Basin and National Water Law) and at least two other ticeable environmental gains. reform proposals of the current Law are being analyzed by the Congress (February, 2003). Although Mexico they are still in the discussion phase, it is worth men- tioning that they all aim to give more autonomy to Mexico is one of the countries in Latin America that the river basin institutions. While the autonomy has adopted water charges in the last two decades. proposed might not go as far as it could, the goal of The water use charge applied to the use of federal every proposal is to strengthen the institutional ca- water bodies has been in place since 1986 and the pacity of the decentral institutions. wastewater charge since 1991. The most recent regulation is the 1992 National Water Law that is the Brazil backbone of the federal water system. In 1989, a central agency—the National Water The Brazilian experience is quite different from the Commission (Spanish initials CNA)—was created to Mexican. Following the approval of the Federal Wa- be in charge of the use of federal water resources. ter Law (Law 9433 of 1997), Brazil has recently The CNA is the sole authority for federal water man- implemented a wide-ranging water sector reform, in- agement and is responsible for the promotion and cluding the introduction of environmental water execution of federal infrastructure and the necessary charges. The Brazilian legal framework for water re- services for the preservation of water quality. The sources management is based on the constitutional CNA is attached to the Ministry of Environment and distinction between federal and state waters. Federal Natural Resources (SEMARNAT). The Federal wa- waters are those that flow across state boundaries or ter management system encompasses 13 along the boundaries between two or more states or administrative regions defined by the CNA, follow- a foreign country. State waters are those situated ening hydrographic criteria. Each region comprises one tirely within the territory of a single state. or more basins, thus basins and not states are the The new water management system also adopted basis for the organization of the Mexican water man- the French principles of management by water basin agement system. In total the system includes 26 Basin committees and agencies, in which water charges are Councils. Following the French principles, the ob- associated with River Basin Management Plans that jective of the Councils is to promote participation in identify environmental targets to be accomplished the management processes of the basins. However, with a set of water-related investments and financed the Councils have not been fully implemented and with water charge revenues. However, pricing crite- their capacities not completely developed. ria for the setting of charges have no general structure SYNTHESIS OF REGIONAL EXPERIENCES: FROM THEORETICAL TO PRACTICAL ISSUES 75 and committees have more autonomy in this matter approach. This new approach, however, has been than in France. primarily concerned with (1) the need to plan and The creation of river basin committees is also less decentralize water management in order to accom- centralized. The formation of a committee depends modate multiple conflicting uses and the assimilative on an initiative from the users, the fulfillment of some and support capacities of the country’s water systems, managerial requirements and the approval from the and (2) the need to raise revenue. National Water Council. This means that the river The reference experience for many countries in basin’s national grid will be gradually extended. The the region is that of the 1964 French Water Act that National Water Council is the competent authority resulted in the new legal and institutional frameworks to deal with inter-basin and inter-state disputes and for water management, though most come in a na- it also supervises and assists river basin committees tional variant. In Mexico, the current setup is similar in other issues. to the French approach, though user charges were The first implementation of water charges in fed- already in place in the eighties, however, without eral rivers is due to begin in March 2003 in the Paraíba proper institutional and policy frameworks. It was do Sul River Basin, where a single low charge will be only with the creation of the National Water Com- levied on users for only a small number of pollut- mission (CNA) in 1989 and later with the 1992 ants. In this initial phase, the aim is to collect enough National Water Law that the implementation was en- revenue to entitle the basin to compete for federal larged to pollution matters and decentralization funds oriented toward water clean-up projects. conceived as a tool for planning. At state levels, almost all states have their own water policy based on the principles adopted in the Water charges are introduced as a complement to CAC: national framework. Ceará has already water use Despite the fact that in theory, the primary goal of charges and São Paulo is also near to implementing water charges has been to assign an economic value its charge system very similar to the one adopted for for water, in practice the examined cases has shown the Paraíba do Sul River Basin. that charges were in place mainly to enforce CAC So far Brazil has followed revenue-raising aims instruments, such as discharge permits and standards. as in France. But changes in water use patterns have That is, no CAC instruments were replaced to give not resulted from the price incentives developed room for a pure economic instruments approach. For through participatory processes institutionalized in example, in Mexico, emission standards were sim- the river basin committees. plified and set according to grace periods in order to facilitate the application of charges. Moreover, the new water policy frameworks created new CAC instruments such as the River Basin CONCLUSIONS and National Water Management Plans where water charges would work to achieve the plan’s targets. In fact, these plans ended up being the main instruments Based on the reviews, our conclusions can be sum- in this new policy framework since they combine a marized as follows: variety of considerations including water availability and priority supply, environmental targets, invest- Policy Phase ment plans and distribution of water charge revenues. This point is crucial in analyzing implementation is- Water charges have been introduced within a broader sues, since it shifts the role of water charges to policy framework: The introduction of water charges revenue-raising aims from their ability to induce at- has occurred within a new policy context. Charges tainment of environmental goals through behavioral have been considered as instruments to achieve policy changes. goals rather than being goals themselves. All three countries analyzed have been dealing with water Decentralization is carried out with river basin institu- policy since the early 19th century. However, increas- tions: Decentralization is planned in two ways: (i) ing water scarcity and environmental problems due water management goals and targets differentiated by to rapid industrialization, urbanization and irrigation river basins and (ii) conflicts among users dealt with have forced policy changes in water resource man- through a participatory process. Institutional bases agement. In all three cases, water charges have been for that are the River Basin Committees that define introduced as instruments for this new water policy management targets to be executed by their Water 76 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

Agencies. This is the basis of the French system in ence in the Paraíba do Sul River Basin has set charge which river basin committees take managerial deci- levels according to the financing needs required to sions on several water measures, particularly on leverage federal funds for river clean-up programs. charge levels. In Mexico, the CNA has recently explicitly commit- In the case of Mexico this decentralization pro- ted to use revenue funds for water-related cess is less accentuated since the federal water agency investments. In all cases, agriculture is either ex- – CNA – is in charge of accommodating a basin’s de- empted or paying very low charges. mands and needs, and river basin authorities have been relegated in practice to a secondary role. Brazil Implementation Phase has gone further in decentralizing and shifting management power to basin authorities. In that country Unsolved sectoral conflicts reduce system efficacy the creation of river basin authorities is not compul- since they are the main barriers for the full applica- sory and water charges’ pricing criteria are defined at tion of charges. In France, the charge system was basin level. Consequently, river basin committees gain gradually implemented by increasing the set of pol- more autonomy in this matter than in France and, in lutants and sectors included over time. The French particular, than in Mexico. system started by charging for pollutants that are more easily monitored (industrial and residential organic Design Phase matters and suspended solids, for example) and from sectors with less political resistance and higher abil- Water charges are designed as a financing mechanism: ity to pay (industrial and residential users). It must Following the approach in the French system, the be noted that ability to pay is used here in the sense pricing criteria for water charges take into account of water intensity costs in total operational costs, so assimilative and support capacities of river basins. the agriculture sector in France was only recently To accommodate economic and social conflicts they subjected to user charge, and is still free of pollution also differentiate by users on sectoral and equity charges. grounds. However, all cases confirm that water Mexico, in turn, has failed to fully implement its charges in practice are financing mechanisms charge system mostly due to political resistance that for investment solutions for water management, was not solved prior to the implementation phase. including pollution control investments. This rev- CNA was not able to attract enough federal budget- enue-raising feature is very clear in the Brazilian ary resources to improve its monitoring and case, where investment plans, as in the French enforcement capacities to collect payments from state- system, are designed in accordance with water owned sanitation companies and also from several charge levels to achieve water management targets. industrial sectors that received waiver schemes dur- In the case of Mexico, the goals are clearly delin- ing recession periods. All this contributes to eated since there is an emphasis on using the water undermine the system and reduce revenue allocation charges (for discharges above the levels set by stan- to improve institutional capacity. Mexico, in fact, has dards) and exemptions to enforce CAC instruments been trapped in this vicious circle despite several and targets. modifications in the water charge regulation. This can be partly explained by the fact that regulation Revenue transfer and exemptions play a major instru- enforcement in developing countries generally is of- mental role: Apart from administrative costs, the ten poor. But it is also reasonable to assert that a major share of water charge revenues goes to infra- greater autonomy of river basin authorities could have structure investments and direct transfers for users mitigated the weak monitoring and enforcement ca- to finance their pollution abatement actions. Such pabilities by accommodating conflicts. The recent transfers are thought of as the cornerstone for po- movement to a more river basin oriented approach litical acceptance and users’ commitment to the in this country may change this pattern. charge system. Charge exemptions and rebates are Brazil, has adopted a more cautious approach of also widely used to protect economic activities or gradual implementation, recognizing that the are justified on equity grounds. All this has been country’s territorial and hydrological dimensions pointed out in the French case, as revenue transfer would not allow for the immediate creation of an al has, in fact, increased over time, and the attempts of encompassing complex structure of river basin man- the federal government to use fund revenues in the agement. The new water policy shifts the initiative to general budget have failed. In Brazil the first experi- create a river basin committee to the stakeholders and SYNTHESIS OF REGIONAL EXPERIENCES: FROM THEORETICAL TO PRACTICAL ISSUES 77 thereby also the application of water charges. This will RECOMMENDATIONS most likely lead to a slow implementation initially, but it is expected that successful experiences will create incentives for the supply of qualified human Based on the analysis presented above, we make the resources and the transference of institutional capa- following recommendations: bility that will eventually speed up the whole process of mounting river basin committees over the country. ● A policy framework must be in place before Nevertheless, the present lack of a national grid of charges are designed, and charges must be in ac- river basin committees, poses serious problems related cordance with policy goals. If revenue-raising to inter-basin externalities when connected basins are goals are the only politically viable options, that not all organized in river basin committees, as already should be explicitly acknowledged and the rein- apparent from the first major experience of the Paraíba forcement of CAC instruments for achieving do Sul River Basin Committee. environmental goals has to be planned. ● Autonomy of river basin authorities must be tai- Participatory process may preclude price incentives: The lored according to the dimension and complexity need for a participatory process to accommodate us- of the hydrological system to maximize institu- ers’ conflicts and to increase acceptance does not in tional capacity by facilitating political acceptance, itself make available the potential benefits of a water reducing information gaps and administrative charge system. The French case has shown that agri- costs. cultural users can use sectoral subsidies to ● River basin committees are important to launch compensate for the increasing burden of water the system but they can promote favor seeking charges, thereby reducing their incentives for changes and do not solve the economic and environmen- in water use patterns. It is also known that low charge tal conflicts that prevent charges from being levels can create incentives for operation of abate- implemented to support environmental targets. ment facilities once they are in place, but it does ● Water management framework must be inte- induce abatement investments that are highly depen- grated to other policy frameworks to increase dent on charge transfer. That is, participation may monitoring and enforcement capacities. This is solve revenue-related conflicts but it does not neces- the case for environmental agencies as well as sarily create a charge system that will significantly sectoral agencies in order to accommodate policy change water use patterns. In the Brazilian experi- aims. Since this integration requires federal level ence of the Paraíba do Sul River Basin the charge level negotiations this is a task for a federal water setting was initially calibrated to have the minimum agency and cannot be delegated to river basin economic impact level on users’ costs with no atten- authorities. tion to environmental consequences and water use ● Even with emphasis on revenue generation, en- levels. vironmental consequences of charge application should be explicitly discussed to allow for gradual Environmental and water management frameworks incorporation of environmental criteria in the have to work together: Although monitoring of wa- charge system. Continuous environmental evalu- ter use is usually under the responsibility of water ation of the river basin should be undertaken agencies and so within the water management incorporating economic models that identify framework, water pollution control is exercised by water use changes related to charge impacts. environmental regulators. As said before, in France ● An explicit criterion for desirable charge levels and in Mexico, where water charge systems are al- should be elaborated based on economic and eq- ready in place, efforts have been made to conciliate uity factors, and all users should be covered by the water pollution’s CAC instruments with the the charge system from the beginning to water charge systems. However, in both cases joint strengthen commitment and enforcement. work in terms of monitoring and information shar- ● Cost-benefit analytical tools should be developed ing needs to be improved. It is also known that the for projects to be financed with charge revenues lack of a continuous evaluation process to analyze to maximize the social value of the investment the effects of the charge system on use levels and actions. on environment quality has delayed improvements ● Public opinion should be brought into the de- in the system and in the allocation of the water bate by putting public attention on water charge revenues. management issues with data release and tech- 78 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

nical arguments to consolidate river basin man- Management in Latin America: From Theoretical agement and the role of water charges. to Practical Issue. The Case of Mexico. Unpub- lished. Report available from: [email protected] Seroa da Motta, Huber and Ruitenbeek 1999: “Mar- ket Based Instruments for Environmental BIBLIOGRAPHY Policymaking in Latin America and the Carib- bean: Lessons from Eleven Countries”. Environment and Development Economics. 4 (2). Feres, José Gustavo, Celine Nauges and Alban Tho- Seroa Da Motta, Ronaldo and José Gustavo Feres mas 2003. Water Charge Instruments for 2003: Water Charge Instruments for Environmen- Environmental Management in Latin America: tal Management in Latin America: From From Theoretical to Practical Issue. The Case of Theoretical to Practical Issues. The Case of Bra- France. Unpublished. Report available from: zil. Unpublished. Report available from author: [email protected] [email protected] Saade Hazin, Lillian and Antonio Saade Hazin 2003. Water Charge Instruments for Environmental Discussion Note on Economic Instruments for Water Management in Latin America and the Caribbean

Clifford Russell

The application of economic instruments in water price or regulatory instruments, and how such and solid waste management has been informed by solutions would have to change in a world that descriptions and analyses of a variety of approaches, is not even remotely static. But that literature including the prior examples from a number of Eu- also tells us there are other important charac- ropean countries (Kraemer, et al.), a longer study of teristics on which to judge the systems the French water management system (Feres, et al.), described, when thinking of them as candidates and two Latin American country case studies, Brazil for adoption in other countries represented in (Seroa da Motta and Feres) and Mexico (Saade Hazin this dialog. and Saade Hazin). Each study provides a wealth of detail, set against a background of instrument The actual economic instruments described can typologies and commentary on instruments based on be cataloged under 5 headings: the extensive economic literature examining their advantages and disadvantages. 1) One set has a general incentive purpose—as in To put this material in perspective, the following water abstraction charges aimed at encouraging observations may be helpful: reductions in total volumes extracted and waste disposal charges aimed at encouraging reductions There is something of a disconnection between in total discharges. These instruments, if set high the focus of the environmental economics lit- enough to have effects on behavior, can in prin- erature on instrument design, and the reality of ciple deliver specified reductions in aggregate instrument application reviewed by these stud- extraction or discharge at lower cost than command ies. The attention given in that literature to the and control approaches. (In practice the costs of ability, or lack thereof, of an instrument to de- monitoring and enforcement for various strategies liver the least-resource-cost solution to the must also be considered.) As the above paragraph problem of meeting regional or national ambi- notes, these charges have not been designed for ent environmental quality standards is not least cost achievement of ambient targets. reflected in the choice and design of the real 2) A second set is designed to raise revenue, which instruments. Other parts of the literature hint in turn is used either to subsidize water users or at why this might be, telling us how difficult it waste dischargers in their pursuit of more effi- is in practice to design least cost solutions to cient water use or to pay for collective facilities achieving ambient environmental targets using with the same goal. 80 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

3) A third set attempts to have it both ways and get known or discoverable through engineering studies. some incentive effect while producing revenue The same kind of information would be needed if for similar uses to those in (2). authorities wanted to raise a certain amount of total 4) In several situations, such as the provision of revenue with the least overall economic burden. But water to households and the sewering and treat- there is not the same need for detailed knowledge of ment of domestic wastewater, there are every party’s cost structure as there would be if eco- well-defined investment and operating costs that nomic efficiency (the full balancing of social marginal are supposed to be recovered from the charge costs and benefits of achieving different ambient en- levied on the units provided. vironmental conditions) were being pursued. In 5) Finally, one example (Mexico’s pollution charge practice a revenue raising charge can be structured scheme) is provided in which the economic in- simply by estimating revenue needed and parceling centive is, in effect, a fine for exceeding a dis- that need out over chargeable parties, perhaps evenly, charge standard, going to zero when the standard more likely not given political considerations. is met. The approach to economic instruments that stresses revenue collection and use of that revenue In table 1 a summary is provided of the types of for compensatory subsidies or the provision of col- instruments described in the dialog studies, using the lective public works may be seen to have a political above categories. advantage over the incentive charging schemes. Un- It is worth emphasizing how, by confining the der the latter, each party facing the charge must instruments used to these types, the choice of actual commit resources to making an adjustment to the per-unit charges is simplified. Any charge level high charge (as by reducing priced waste discharges to the enough to get the attention of the decision makers in level at which the price equals the marginal cost of firms, municipalities and households can provide a further reductions) and must pay the charge on each generalized incentive. Its effectiveness in changing remaining unit of discharges. By assuming that rev- behavior will depend on its relationship to the mar- enue is recycled through a subsidy or public works ginal costs for different decision makers of changing scheme with roughly the same environmental goal, behavior, which in most cases are either quite well the sources will be paying only the resource costs of

TABLE 1

CATALOGING ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT IDENTIFIED IN THE DIALOGUE STUDIESa

Applications Water Water Sewage Collection Direct Discharge Country Abstraction Delivery & Treatment (esp. industry) Austria (4) Denmark (1) (4) (1) France (4) (4) (2) Germany (3) (4) (4) (1) Netherlands (3) (2) Brazil (3)/(4)b (3) Mexico (1) (5)

Notes: The numerals refer to the catalog of types identified in the text: (1) Incentive, (2) Revenue raising, (3) Attempt to combine (1) and (2), (4) Cost recovery as for water works or sewers and sewage treatment plants, (5) “Fine” for exceeding a standard. a Not every element of the table could be filled in on the basis of the dialog studies. Blanks do not necessarily mean that there is no economic instrument applying to that use in that country. b The Brazilian case is very complex because of the autonomy enjoyed by the states in designing their own systems. DISCUSSION NOTE ON ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT IN LATIN AMERICA AND THE CARIBBEAN 81 achieving the goal plus a sort of markup reflecting dimension. For contrast, a charge system seeking the administrative costs of the agency through which least-cost attainment of an ambient target is similarly the revenue flows. characterized. There is, however, a broader implication for so- A reasonably close look at the table helps one to ciety at large, of emphasizing revenue collection and see why generalized incentive and revenue-raising redistribution (or, for that matter, the charge-equiva- charging schemes are popular with policy designers. lent-to-a-fine approach). These choices take away They tend to have modest information requirements, some part of the incentive to innovate that is present and the sacrifice of static efficiency in the pursuit of in incentive charge schemes. Not all the incentive is ambient targets is an ephemeral loss in the ever- lost, for the presence of a standard to be met or even changing real world. Otherwise they have somewhat a modest charge to be paid implies that there will be weaker versions of all the virtues ascribed to such a some reward to lowering the costs of responding charge system.28 It is important for real-world deci- through innovation. But that incentive will be lower sion makers that economists and other policy than the one produced by pricing every unit of dis- analysts give proper attention to instrument charac- charge. teristics that are important in situations where major In the long run, economic instruments aimed at changes are occurring in the types and quantities of revenue generation may create other problems. A pollution sources, information is scarce, technical closed system of charges, the revenue from which progress matters, and compliance with whatever in- supports an agency and its planning, construction, strument is put in place is hardly something that can operation and subsidization activities, creates an in- be assumed. centive to perpetuate all those activities even if the need for them declines over time (indeed, even if they become socially damaging rather than beneficial).27 Table 2 presents a summary of the advantages 27 Something very like this has arguably happened to high- and disadvantages of the several actual choices of way construction in the U.S. because of the earmarking of economic instruments relative to each other and to gasoline tax revenues for this purpose. 28 the alternative most often presented in the economic Note that there is no actual efficiency-seeking charging scheme in existence so far as I know. Several regions have literature. Seven dimensions, found in the literature been modeled and charges necessary to attain static efficiency as bases on which to judge instruments are applied, derived from the optimization process, so we know it can be and brief characterizations of the 5 instruments iden- done, but it is a daunting task even for highly developed tified in the dialog studies are provided for each agencies. 82 ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT

(Continued on next pag

equired.

environmental conditions.

Recalculation is r

Not applicable The goal

standard andstandard of marginal cost probability ofprobability functions and discovery regional

VARIOUS ECONOMIC INSTRUMENTS

-SEEKING CHARGING SCHEME

Instruments

AN EFFICIENCY

AND NEGATIVE ASPECTS OF AND NEGATIVE

Y OF POSITIVE

WITH CONTRAST

BRIEF SUMMAR

(1) (2) (3) (4) (5) (6) General Revenue (1) & (2) Cost “Fine” for Ambient-based Incentive Production Combined Recovery exceeding standard charge system

loading at lower cost) lower

about charged and subsidies depending on costs of facilities/ cost of meeting specific knowledge parties’ costs mix of goals operations

this is not and easily incentive erodes etc. changes meaningful annually.

erformance extraction or

Cost-effectiveness (though policy in Ambientin total can achieve Environmental in reduction P

of Change general, adjustable mix of goals. except as inflation as set of sources

Dimensions

1. Static Achieving luck by Only Not applicable Not applicable Not applicable

2. Needs Information Modest and general Cost of plans Combination known Well Something about Detailed and

3. Flexibility in Face is Since goal Chargesondepends Again, Not applicable Not applicable, Has to be updated

TABLE 2 DISCUSSION NOTE ON ECONOMIC INSTRUMENTS FOR WATER MANAGEMENT IN LATIN AMERICA AND THE CARIBBEAN 83

consideration

Column (1)

equency and precision that equency and precision

(continued)

VARIOUS ECONOMIC INSTRUMENTS

be avoided by be avoided

e actual discharges per unit time with enough fr

-SEEKING CHARGING SCHEME

d can be assured.

Instruments

AND NEGATIVE ASPECTS OF AND NEGATIVE

icing which has some efficiency properties but also much greater information requirements than rough average cost average than rough requirements icing which properties information has some efficiency greater but also much

uch or too little revenue.

AN EFFICIENCY

Y OF POSITIVE

harges and either too m harges

WITH CONTRAST

BRIEF SUMMAR

ould be charge

(1) (2) (3) (4) (5) (6) General Revenue (1) & (2) Cost “Fine” for Ambient-based Incentive Production Combined Recovery exceeding standard charge system

payment of proper charge or meeting of standar of proper payment

echnical Change equivalent standard than incentive itself standard equivalent to

eturn makes iteturn makes is for paymen

Production consideration

unpopular with meeting standard. sources

without obvious political sale than (2) harder see what the t since charge can Column (1) r

Dimensions

4. Revenue Secondary The whole point Part of the point The whole point Not important Secondary

5. for Incentives than an Greater Some but less Some Some but due to Some, Conceptually

6. Monitorability it is necessary all alternatives to be able to measur For

7. Political Feasibility Charge payment Likely easiest Easier than (1); Familiar and easy to Easier than (1), Similar to

TABLE 2

Notes: a It is possible, though difficult, to implement long-run marginal cost pr though difficult, a It is possible, Notes: pricing. LRMC pricing may also lead to fluctuating c pricing.