From Sewer

Garden Badger

Water Sector Reform #2:
Regulatory Transparency & Fairness

Bringing together the best of both states

With a major federal investment in water infrastructure possibly on the horizon, the United States has a once-in-a-generation opportunity to leverage that money into transformational, institutional solutions for America’s water sector. This is the second in a series of five posts outlining five broad ideas to reform the management, governance, and regulation of U.S. drinking water, sewer, and stormwater systems. The first proposed reform was consolidation of water utilities.

The second proposed reform is an overhaul of the processes and institutions that regulate water system finance using regulatory models from New Jersey and Wisconsin. The goal of this reform is not to regulate water quality directly, but rather to change the incentives for the organizations that operate water systems.

The need for regulatory reforms follow from the ownership structure of the U.S. water sector.

Infrastructure ownership

Another important way in which water is different from energy and other utilities is ownership. The overwhelming majority of Americans get their electricity and/or gas from a private, investor-owned firm, with small minorities receiving service from government utilities. But water is a different story: about 88% of Americans get their drinking water service from a local government, with about 12% served by private firms.

Source: US Dept of Energy, US Dept of Transportation, US Environmental Protection Agency

Ownership is crucial because different institutions govern private and public systems, creating different incentives for infrastructure investment.

Public Utilities Commissions

Let’s start with the private sector. The profit motive, constrained by regulation, drives management of investor-owned utilities.

Private utilities of all kinds—water, energy, telecom, whatever—are operated by corporate managers in the interests of their shareholders. But utilities are natural monopolies, and so we can’t count on free markets to guide investment and pricing. Instead, prices are not set by the companies themselves, but rather by the state Public Utilities Commissions (PUCs). The PUCs require utilities to report publicly their asset management plans and financial records in order to justify their pricing. PUC-regulated systems must also report a variety of performance data, which commissioners scrutinize to ensure that utilities are maintaining adequate service.

PUCs allow private utilities to set prices based on the amount of capital they invest in the system: the more capital invested, the more revenue they earn. That can create an incentive for private utilities to over-invest in infrastructure because those investments allow them to raise rates—a problem known as the Averch-Johnson Effect. Much of what the PUCs do is scrutinize all those investments to ensure that they’re justified and that utilities aren’t gold-plating their systems. In other words, PUCs act to prevent over-investment in utility capital.

But remember, that’s only about 12% of the water sector.

Local governments

The overwhelming majority of water service is provided by local governments—usually cities, counties, towns, villages, authorities, and special districts. These systems are managed by local bureaucrats, with investment and pricing decisions made by local elected officials. For all the talk about federal funding, U.S. water infrastructure investment is mainly a function of local politics.

Local politics are unkind to water infrastructure because the price of water is much more visible than the quality of water. As in all things, people generally like high quality and low prices. Thing is, most contaminants in water are invisible. Unless my water is so bad that I can smell or taste it, unless there are frequent an ongoing outages and main breaks, I really have no idea how good my water system is. Unlike roads and bridges, water systems are literally buried.

But the price of water is easily observable. Voters may not know what contaminants are in the water, but they know for sure what they pay for it when they get the bill each month.

Now suppose I’m an elected official who wants to please my voters. If I make decisions that maintain or improve water quality, that’s good! Alas, my voters may not recognize the improvement. But quality improvement might cause prices to increase, which is bad because higher prices are immediately visible to voters.

No mayor wants to roll into the office & find these folks waiting

But blame avoidance isn’t good for infrastructure investment. That’s a big part of why all those facilities built back in the 1970s and 80s are crumbling today. Back when the CWA and SDWA sent hundreds of billions of dollars to local governments, the idea was never for the US government to own and operate water systems. The goal was for ​Uncle Sam to help get those systems up and running in compliance with the new environmental laws. Local governments were then supposed to take over responsibility for those systems. In too many cases political forces have led local officials to run those systems to failure. Local politicians don’t neglect water infrastructure because they’re stupid​; they do it because they’re responsive to voters.

Jersey to the Rescue?

In 2017 New Jersey passed the Water Quality Accountability Act (WQAA), which requires all water utilities—both government and investor-owned—to develop asset management plans, report on infrastructure conditions, and reinvest adequately in their systems. Rule-making to implement the new law is still under way, but what the WQAA requires of all water systems is similar to what PUCs already require of investor-owned utilities: transparency about infrastructure conditions, evidence that they are managing assets responsibly, and evidence of system performance.

Making all that system information transparent can make water’s quality as visible at its price. We can make water infrastructure a credit-claiming opportunity for local officials, not just a blame-avoidance game. Mayors seeking reelection should point at their cities’ water system performance with pride, not merely seek to duck responsibility for rate increases.

Meanwhile, in Madison…

A thousand miles away, Wisconsin employs a unique regulatory system that’s a perfect complement to New Jersey’s new law. All fifty states and the District of Columbia have Public Utilities Commissions, but Wisconsin is the only state where all systems—public and private—are subject to PUC financial regulation. That is, Wisconsin local governments must get approval of their rates from the PUC (or the Public Services Commission, as they call it there).

expected a cheesier logo

As with other utilities commissions, the traditional role of the Wisconsin PSC with respect to rates is to guard against over-pricing by private monopolies. But in the case of local government utilities, the PSC’s authority could include New Jersey-style asset management requirements and a guard against underpricing due to inadequate reinvestment. At the same time, the PSC provides something of a shield for local leaders. As a 2012 Alliance for Water Efficiency report observed:

“The Wisconsin Public Service Commission regulates both public and private water systems, and assumes the responsibility for approving all changes to water rate-making in the state. Thus, the political ‘heat’ is off at the local level and water systems can more easily approach the PSC for needed changes to their revenue structures.”

In theory, if a utility isn’t adequately investing in maintenance and upgrades, the Wisconsin PSC might actually be able to compel rate increases. (I’m not sure that’s ever actually happened).

Regulatory overhaul

Together, the Garden State’s new WQAA and the Badger State’s PSC authority over local governments would be a potent regulatory combination. So my second proposed reform is to require comprehensive asset management and performance reporting for all water utilities (as in New Jersey), and to extend PUC pricing regulation to government utilities (as in Wisconsin). The idea is broadly consistent with Australia’s model for urban water price regulation. As with my other proposed reforms, achieving such a significant overhaul to the nation’s regulatory institutions will require federal leverage.

The great promise of the regulatory regimes pioneered in New Jersey and Wisconsin is that transparency and fairness can make buried infrastructure more visible, and so shift the political incentives for sound management of water systems.

Grow to Shrink, Shrink to Grow

​Better Together

Water Sector Reform #1: Consolidation

With a major federal investment in water infrastructure possibly on the horizon, the United States has a once-in-a-generation opportunity to leverage that money into reforms to transform America’s water sector. This is the first in a series of posts outlining five broad proposed reforms.

The first is consolidation and regionalization of water utilities. This is the single most important, badly-needed reform. Without this reform, any major federal investment will be a temporary fix, and the rest of my proposed reforms probably won’t work without it. To understand why, start with a simple observation:

There are WAY too many water systems

One of the things that really surprises newcomers to the American water sector is just how many water systems there are. The energy sector provides a useful comparison. In the United States today there are about 3,200 electrical utilities and about 1,400 gas utilities. There are about 50,000 community water systems.

These systems are highly skewed in size. It turns out that 40,000 of those 50,000 are very small, serving populations fewer than 3,300. These small systems serve less than 10% of the population, but they are 80% of the total systems. A little more than half of the US population gets its water from the largest thousand utilities.

It’s difficult to overstate the effects of this extreme fragmentation. Virtually every aspect of America’s water sector is worse because there are so many tiny systems that lack the capacity to operate effectively.

Small systems, big problems

America’s water problems aren’t only in small systems, but there’s no question that small water systems are disproportionately plagued by poor water quality. Here’s the relationship between system size and violations of the Safe Drinking Water Act’s heath standards:

As you can see, violations are strongly related to system size. In small systems it’s not uncommon for utilities to have multiple violations, year in and year out. This graph is from my own analysis w/David Switzer, but study after study after study after study after study finds this same relationship. Here’s the same plot for sewer treatment plants and NPDES permit noncompliance the Clean Water Act, from a study I did with Mellie Haider and David Switzer:

High prices, too

Adding insult to injury, water is also more expensive in small systems. Small systems pay more for capital, they have fewer customers to share the fixed costs, and they’re more vulnerable to revenue fluctuations, which limits their flexibility in rate design. Here’s the relationship between the price of basic monthly water and sewer service for a family of four (about 6,000 gallons a month) measured in hours of labor at minimum wage.*

Water and sewer services are most expensive in small systems, and get cheaper as systems grow. So with both quality and price, there’s strong evidence that there are huge economies of scale to the water sector. These economies of scale are well-understood.

Regulatory economies of scale

But there’s another, less obvious and more pernicious problem with all these small systems: all that fragmentation creates practical problems for regulators. Every one of those 50,000 systems has to be managed, monitored, and regulated by the EPA, ​in conjunction with more than a hundred state, territorial, and tribal bureaucracies. 50,000 systems means 50,000 sites to visit, 50,000 files to keep current, and 50,000 records to report. State regulatory offices don’t have the information systems—let alone the legions of workers—to handle all that work.

A well-kept secret of the water sector is that small systems are held to much lower standards than larger systems. It’s not just that enforcement is lax with small systems; the agencies that regulate water actually have different enforcement guidelines for small systems, with less stringent standards.

The good intention that paved the way to this particular hell is the recognition that small systems often lack the organizational capacity to comply with the rules. Water regulations are unfunded mandates. Rather than continuously slamming small systems for their violations, regulators move the goalposts, or simply look the other way when violations occur. So the correlation we see between size and SDWA and CWA violations actually grossly understates the real relationship between scale and water quality. Intentionally lax enforcement consigns people served by small systems—often poorer, rural populations—to heightened health risks and poor environmental quality.

Shrink by Growing

These problems are widely recognized. Sure, there are some excellent small systems, and small system operators often achieve remarkable things with limited resources. But the data are clear, and the stakes are high. The ​common sense solution is to reduce the number of systems through consolidation: shrink the number of systems by growing utility organizations. 

Consolidation can happen when multiple systems merge, a bigger utility takes over a smaller one, or when an investor-owned firm buys up small systems. The right consolidation approach will vary from one place to another; we ought to be agnostic with respect to the institutional form. Physically integrated utility systems are best where possible, but small systems can be folded into larger organizations even when they’re physically separate. That is, multiple small systems can be operated by a single organization. Several government and investor-owned utilities already operate under this model.

Recognizing the perils of fragmentation and the promise of consolidation, some state governments, including California and Connecticut, have taken steps to encourage consolidation.

But it’s hard. Consolidation efforts often face fierce political resistance, either from communities who fear losing control or from staff who fear losing jobs. Sometimes it’s difficult to find larger utilities willing to take on the responsibility for a small, failing systems. Consolidation is controversial in the water sector; in certain circles “consolidation” is a dirty word. I’ve heard privately from multiple regulatory officials that they desperately want consolidation, but are afraid even to utter the word “consolidation” in public. Sometimes it’s just hard to navigate the legal and financial complexities of consolidation. Consolidation has been agonizingly slow in Connecticut; four years after passing a law to promote small system consolidation in California, little has happened.

Tastier carrots, bigger sticks

Shrinking the number of systems is the single best thing we can do to improve water infrastructure in America. So my first proposal is to reduce the number of water utilities by an order of magnitude—to something like 5,000-10,000 utilities—by 2030. As is often the case in public life, moral appeal and clear empirical evidence have been insufficient to overcome the political barriers to consolidation. That’s where federal leverage can make a difference.

Federal funding for local water, sewer, and stormwater systems must be contingent on consolidation. Let’s spend money to fix failing systems, but only if the fixes put them on a path to self-sufficiency. Low-interest loan programs probably aren’t sufficient to induce consolidation; hundreds of billions in federal grants would be a whole lot more appealing. For small systems, federal grants must be awarded only with consolidation. For larger systems, federal grants should be awarded only to utilities that agree to takeover nearby or adjacent smaller systems. Consolidation can be technically, legally, and financially complicated, so federal funding should also provide technical assistance to support the process.

A key corollary to that federal largess is a leveling of the regulatory playing field. There must be one rule book: all water and sewer systems must be held to the same standards. No more loosening the rules for small systems because they lack the organizational capacity to comply with environmental regulations. If systems lack the capacity to comply with the rules, then regulators should be empowered to force consolidation for systems that fail perennially.

Next time I’ll turn to the second major proposal: a change in regulatory transparency aimed at changing the local politics of water infrastructure.

*You can see a bunch more analysis of affordability here.

Golden Opportunity

What the Cuyahoga River Fire says about the past, and maybe the future

Cleveland, 1969

Fifty years ago this week the Cuyahoga River caught fire in downtown Cleveland.

Observers of U.S. water policy and environmentalism more generally have been celebrating the fire’s golden anniversary all year, because three years after the Cuyahoga River burned, Congress passed the Clean Water Act. The Safe Drinking Water Act followed two years later. The Cuyahoga River Fire is a textbook example of what political scientists call focusing events: high-profile occurrences that suddenly put previously obscure issues onto the public policy agenda.

The 1969 fire is rightly iconic today, but many forget that it was the twelfth time that the river burned. Why did the 1969 fire catch the public imagination? The truth is that nobody knows. But it did, and it changed the way Americans think about water pollution. The fire presaged a series of laws that fundamentally changed the regulation of water pollution in the United States, invested hundreds of billions in infrastructure, catalyzed new technology, and built a generation of professionals dedicated to protection of the nation’s waters.

A new focus

A year ago I called the Flint Water Crisis the Cuyahoga River Fire of our generation. Flint has changed the way that Americans everywhere think about water infrastructure. As with the 1969 Cuyahoga River Fire, Flint wasn’t the first, wasn’t the worst, and wasn’t the biggest drinking water disaster in recent U.S. history, but it’s the one that caught the public imagination.

The Flint story wasn’t just about water chemistry and failing infrastructure—it was also about bureaucratic organizations and partisan politics. And it was about poverty and race: Flint showed America that water infrastructure is an environmental justice issue. That’s expanded the political coalition focused on water infrastructure. There’s a growing consensus that existing infrastructure funding arrangements are failing.

I’ve worked on water system management, regulation, and finance for more than 20 years and have never seen this kind of public attention to the issue. As recently as two years ago I dismissed the idea of a trillion-dollar federal program for water infrastructure as politically unviable. But something has shifted. Last month Congressional leaders and the president began sketching out a $2 trillion infrastructure package—with potentially hundreds of billions for water, sewer, and stormwater systems.

Those talks have broken down, but the fact that they were even happening suggest that we may be an election away from a major federal investment in infrastructure. Whether it’s next year or two years from now, it looks like Washington may soon be raining infrastructure money. That’s music to the ears of lots of activists who cry out that an injection of federal money is needed to fix America’s water systems.

Recovery & reform

Today people paddle their kayaks on the Cleveland riverfront and safely eat the fish they catch there. If the problems weren’t too big then, they surely aren’t too big today.

River paddling in Cleveland has gained popularity with the decline in fires and toxic waste (Jim Ridge, Share the River)

To be honest, I was a little relieved when negotiations between the White House and Congress faltered last month, because the breakdown gives us a chance to pause, take a deep breath, and think systemically. Today, the principal barriers to progress in the water sector are not environmental or technological—they are political, social, and economic. Accordingly, a big federal funding package can and should be used as leverage to reform the institutions that govern water in the United States.

Recently I was asked to speak about water infrastructure at the University of Rhode Island’s Metcalf Institute. With the Cuyahoga River Fire’s golden anniversary on my mind, I proposed five broad reforms to the U.S. water sector that ought to accompany any big federal program. They are:

  1. Consolidation / Regionalization
  2. Regulatory Equality & Transparency
  3. Technological Investment
  4. Human Capital
  5. Water Equity

Later this week I’ll start a series of posts elaborating on these to help get a deeper conversation going. Since this is a blog, I’m going to breeze by a great deal of detail and keep things at a 30,000-foot level. But each proposal is rooted in empirical research, each part is ambitious, but also technically and politically feasible. Over the next 2-3 years we have a once-in-a-generation opportunity to rebuild and reform water governance. Let’s make the most of it.