Ellen Hanak, Brian Gray, Jay Lund, David Mitchell, Caitrin Chappelle, Emma Freeman, Dean Misczynski, James Nachbaur

In late January, Gov. Jerry Brown released the California Water Action Plan, which outlines 10 strategic priorities for putting the state on a more sustainable water management path. The plan – intended to guide state water policy for the next five years – places the current drought emergency in a broader context, acknowledging the need for a comprehensive approach to improving water supply reliability, restoring damaged ecosystems, and making our water infrastructure more resilient to droughts, floods and other hazards.

Action #10 of the plan focuses on funding, something needed for every other area to succeed. It calls on the state to develop a comprehensive funding strategy, and it flags as priorities the removal of legal barriers to local and regional funding of water projects and the introduction of new fees on water users and polluters. These recommendations are consistent with the findings of our new Public Policy Institute of California report, Paying for Water in California, which examines key funding gaps and ways to fill them (Hanak et al. 2014a).

Since the release of the water plan, the water-and-money talk in Sacramento has mainly centered on a single source: state general obligation bonds — borrowing that is reimbursed from the state’s general fund. Water spending in the Brown administration’s 2014-15 fiscal year budget comes primarily from the remainder of bond funds approved in the 2000s. Meanwhile, the Legislature has been focused on what to include in a new water bond for the November 2014 ballot.

Our study found that while state bonds have helped fill key gaps over the past decade, they cannot do the job alone. It is time to broaden the conversation, considering not only which areas are most in need of bond dollars, but also which other sources of funds and reforms are needed to keep California’s water system financially afloat.

Here we examine the funding challenges and implications for state action for each Water Action Plan priority area. But first, here are some highlights from our study for context:

Paying for Water study

California spends more than $30 billion annually on the water system. Most of that money (85 percent) comes from local sources, with state and federal governments covering the rest (11 percent and 4 percent, respectively). Urban water and wastewater utilities generally get passing financial grades; they can muster the funds to provide safe and reliable services from customers’ monthly bills.

In contrast, we found five types of fiscal orphans: safe drinking water in small, rural communities (funding gap of $30 million to $160 million a year); flood protection ($800 million to $1 billion); management of stormwater and other polluted runoff ($500 million to $800 million), restoration of aquatic ecosystems ($400 million to $700 million); and support of more integrated water management ($200 million to $300 million). The combined annual funding gap is $2 billion to $3 billion.

The orphans have one thing in common: agencies charged with providing these services face tough legal hurdles to raising funds locally, mainly because of restrictions from Proposition 218. This constitutional amendment, approved by voters in 1996, introduced important transparency and accountability requirements, but it also undermined the fiscal health of our local water systems.

Prop. 218’s strict cost accounting rules – requiring that fees be proportional to the costs of services actually delivered to a property – seem reasonable at face value, but they actually are largely impossible to implement in a rational way.

They end up limiting the ability to implement modern water management strategies such as conservation-oriented pricing and tapping non-traditional supplies (for example, recycled wastewater and stormwater). They also make it harder to extend “lifeline” rates to low-income households and to assess fees to pay for activities with broader benefits such as ecosystem recovery.

Prop. 218 also requires voter approval of all flood and stormwater fees — a higher bar than for water and wastewater utilities — which only must give the public the opportunity to protest rate increases.

Over the past decade, state general obligation bonds have largely been used to help fill gaps in these five orphan areas. Although bonds have been available in historically unprecedented amounts, they have at best made $1 billion a year available for the water sector. So California is looking at a $1 billion to $2 billion annual funding gap, even if a new bond passes this November.

To fill this gap, and to prevent new ones from forming, our study recommends legislation to introduce new statewide fees on water use, hydropower generation and sources of water pollution such as pesticides, fertilizers and trash.

We also recommend that the Legislature issue guidance to the courts on the flexible interpretation of Prop. 218’s cost-accounting rules so as not to impede modern, integrated water management. In addition, we suggest constitutional reforms to remove the voter-approval requirements for increases in stormwater and flood management fees. This would make them consistent with the standards for increasing water and wastewater charges while preserving transparency and accountability requirements.

Now back to the governor’s water plan and how Californians might pay for it.

Paying for the Water Action Plan

• Action #1: Make conservation a California way of life

Fiscal status: The fiscal health of water conservation is fairly strong. Water-use efficiency tends to be one of the most cost-effective ways to free up water supplies in urban areas. Local utilities can use revenues from their customers’ water bills to pay for rebate programs that encourage the adoption of low-flow plumbing fixtures and low-water landscapes.

Water pricing can also encourage conservation, giving customers the incentive to pay for these investments directly to lower their bills. Prop. 218 introduces some uncertainties, however, about water agencies’ authority to use tiered water rates to encourage conservation (rates that charge higher per-gallon prices for higher levels of use, as for summer landscape watering).

State fiscal priorities: The state doesn’t need to use scarce bond funding for this area. To survive court challenges, water utilities must to do a better job of explaining their rate structures. The Legislature could help by clarifying that conservation-oriented rates are important for improving overall water supply reliability within a service area.

• Action #2: Increase regional self‐reliance and integrated water management

Fiscal status: Integrated water management seeks to encourage local agencies to participate in broader regional programs addressing water supply, water quality, floods and ecosystems jointly. This approach has been a major state priority for a decade.

Although integrated programs should ultimately be able to pay for themselves, they often need incentive funds to jumpstart collaborations, especially when fiscally weak partners such as stormwater agencies cannot pay their share. Integrated management is a fiscal orphan because it has largely been propped up with bond funds. Stormwater – which the water plan flags as a key opportunity for augmenting water supplies – faces the greatest fiscal challenges under current law.

State fiscal priorities: Although continued state bond funding is appropriate, an even better solution would be for the Legislature to introduce a small statewide fee on water use to support regional integration. The money could go directly to the state’s 12 principal hydrologic regions and be distributed by new regional water commissions — modeled after the California Water Commission, which is tasked with distributing bond funds for storage projects.

The state could also improve the way it allocates funds. For instance, it should enable local agencies to use the transportation dollars they get from the state gas tax as local matching funds for “green streets” programs, which integrate stormwater gardens into street renovation projects. This option wasn’t available for grants from the current bonds, leading to missed opportunities. Constitutional reform of Prop. 218 could make a big difference for funding stormwater programs.

• Action 3: Achieve the co‐equal goals of water supply reliability and ecosystem health in the Sacramento-San Joaquin Delta

Fiscal status: Paying for Delta solutions will be costly. The Bay Delta Conservation Plan calls for roughly $16 billion for new tunnels under the Delta to improve water supply reliability, and as much as $7 billion in ecosystem investments (at least $150 million a year for the next 50 years).

The assumption has been that water users relying on Delta exports will pay for the tunnels, although many agricultural water users will find this unaffordable unless urban water customers pay a larger share of the costs. The main public funding challenges are for ecosystem recovery, Delta governance institutions and the Delta science program (essential for supporting ecosystem recovery and scheduled to run out of funds by early 2015).

State fiscal priorities: The decline of the Delta’s ecosystem is a result of multiple sources of stress caused by decades of harmful water and land uses within the greater Delta watershed (National Research Council 2012; Mount et al. 2012).

Because most Californians rely on Delta water and land resources in some way – and so share a responsibility for this ecosystem decline – it is appropriate to use state taxpayer dollars to pay for Delta ecosystem programs.

Although general obligation bonds could be used for large ecosystem investments, the ongoing governance, science and management functions require a steadier funding source — perhaps a new small special tax, such as a small increment on the state sales tax.

Another good option for one-time investments such as habitat acquisition is to use “rainy day” funds from years such as this one, when state general fund revenues are higher than anticipated.

• Action 4: Protect and restore other important ecosystems

Fiscal status: Ecosystem protection elsewhere in California is also a fiscal orphan, lacking a reliable funding base. This category includes recovery efforts upstream of the Delta and in California’s other important watersheds. State agencies also face resource gaps for plan implementation and coordination.

State fiscal priorities: As with the Delta, general obligation bonds are an appropriate source for these investments. But it would be more fiscally prudent to meet ecosystem protection needs with new fees or special taxes on sources of polluted runoff — pesticides, fertilizers, road use and sources of trash — and on hydropower, to improve upper watersheds where power projects have caused damage.

The Legislature could also help by authorizing water utilities to use revenues from the upper tiers of their rate structures to pay for capturing and treating “urban slobber” – the chemical-laden runoff from overwatering landscapes. (Only two water agencies, both in Orange County, currently have this authority. Their surcharges on excess water use have helped clean up Newport Bay.)

Expanding water agency mandates to include watershed health also can make it easier to raise local and regional special taxes, as voters appear to favor local ballot measures that include a variety of water programs. Constitutional reform to Proposition 13 to reduce the voting threshold on local special taxes from two-thirds to 50 percent (as required for local general taxes) would also help.

• Action 5: Manage and prepare for dry periods

Fiscal status: State agency resources for tracking water use have been strained by the current drought, and fisheries agencies have struggled to fund special measures to protect ecosystems (Mount et al. 2014). It has also become clear that state agencies need more resources for drought preparedness.

At the local level, many water utilities may run fiscal deficits this year because their revenues will fall as customers make extraordinary conservation efforts. Relations with the rate-paying public become strained when utilities impose rate increases after people have saved water.

State fiscal priorities: Emergency drought legislation has provided some additional resources to state agencies for drought management, but longer-term cash infusions are needed to support modernization of data and monitoring systems and to prepare better for future droughts.

This money should come from regular general fund appropriations, not unstable bond funds. To support ecosystem recovery from droughts, the state also should consider charging other water users for water made available when environmental flow standards are relaxed (Lund et al. 2014).

The state should also encourage local water agencies to establish drought-pricing policies in advance — for example, setting higher per-gallon rates for droughts — so agencies can implement drought rates earlier to proactively promote conservation and protect their bottom lines. Local agencies also need to maintain adequate “rainless day” reserves.

• Action 6: Expand water storage capacity and improve groundwater management

Fiscal status: The current drought has intensified calls for two major actions in this area: stronger local groundwater management – making more effective use of California’s aquifers for dry-year water storage – and bond funding for new surface and groundwater storage projects.

Groundwater basin management and storage development should primarily be funded by water users because they are the principal beneficiaries. But most local agencies now face limits on their ability to charge for groundwater pumping and basin replenishment, which are necessary for sustainable groundwater management (Hanak et al. 2014b).

New surface storage is expensive; recent projects have been funded by urban water users in Southern California (Diamond Valley) and the Bay Area (Los Vaqueros). Like most bond proposals, the water plan calls for public cost-sharing of new storage projects to cover potential broader public benefits, such as support for aquatic ecosystems.

State fiscal priorities: A legislative package to support groundwater reform will need to expand local agency authority to charge for groundwater pumping to fund aquifer recharge. The state also should provide some financial support to help jumpstart new groundwater management efforts through integrated management funds (as in action item #2).

The state should be cautious in using public dollars to fund new storage projects. Given the high costs – especially for surface storage projects – stakeholders have incentives to overemphasize the “public” benefits of these projects.

• Action 7: Provide safe water for all communities

Fiscal status: We estimate that 80,000 to 160,000 Californians live in small, economically disadvantaged rural communities that have contaminated drinking water wells. This is an urgent public health issue and a matter of social justice in a state as wealthy as California. These communities face high unit costs and limited ratepayer capacity, so they will need outside help.

State fiscal priorities: Fortunately, this issue is now on the radar of policymakers. Some of the gap could be addressed through better organization of existing funding programs, since these communities often lack capacity to qualify for and employ available funds.

The Legislature also could facilitate physical and administrative consolidation by indemnifying utilities that agree to annex small systems from potential liabilities for pre-existing problems. A small statewide surcharge on water use could serve as a statewide “lifeline” rate to help fund these programs. A small surcharge on nitrogen fertilizers and manure – principal sources of nitrate contamination – could help address nitrate pollution of drinking water in several important agricultural basins.

• Action 8: Increase flood protection

Fiscal status: Even though state bonds have temporarily increased flood protection funding since the late 2000s, California is investing less than half the amount it should annually in this area. The federal government has been unable to meet funding promises for flood works. Some local agencies have raised the “local match” through voter-approved fees and assessments, but those funds pale in comparison with the estimated need, and state bond funds are running out.

State fiscal priorities: Most bond proposals under consideration omit funds for flood protection, but this fiscal orphan will require more state funding in the future. This is especially true following the California Court of Appeal’s Paterno decision, which held that the state may be liable for flooding caused by levee failures in the Central Valley.

Increased local funding also is needed; yet, this is a difficult task under Prop. 218’s voter approval requirements. Following the Delta Plan, the Water Action Plan proposes the formation of a regional levee assessment district for the flood-prone Delta. It also calls on the state to prioritize its spending on Delta levees.

These are both appropriate ways to begin addressing an immense and underfunded public safety, land protection and water management challenge. Constitutional reforms to Prop. 218 to treat flood protection as water and wastewater would significantly help in this area.

• Action 9: Improve operational and regulatory efficiency

Fiscal status: The water plan’s calls for more efficiency focus on the operations of the large state and federal water projects and environmental regulatory actions in the Delta. In both cases, reforms could lower costs and improve water system performance.

State fiscal priorities: The out-of-pocket costs of implementing these measures are likely to be small, but this is an area where funding for a few positions and programs can make a big difference.

To improve operational efficiencies, California should consider consolidating the state and federal water projects and placing them within a new public utility (Little Hoover Commission 2010; Hanak et al. 2011).

To improve regulatory efficiencies within the Delta, one alternative is to create a Delta ecosystem regulatory coordinator within the governor’s office to help streamline review processes (Hanak et al. 2013, Gray et al. 2013). Such changes would initially entail some costs, but they would save money for water users and other regulated entities. It therefore would be appropriate to fund them with water-use surcharges or regulatory fees.

Time for action

The current drought provides California with a unique opportunity for innovation in water management and funding. The governor’s Water Action Plan provides a framework for exploring new and innovative ways to fund water activities. Bonds can help, but they are not enough. More reliable state and local funding sources are the foundation needed for a strong and sustainable water system that supports a healthy Californian economy, society and environment.

Ellen Hanak, Dean Misczynski, Caitrin Chappelle and Emma Freeman are with the Public Policy Institute of California. Jay Lund is with the UC Davis Center for Watershed Sciences. Brian Gray is with the UC Hastings College of Law. David Mitchell is a principal with M. Cubed. James Nachbaur is an American Association for the Advancement of Science  fellow in Washington, DC.

Further reading

Governor Edmund G. Brown Jr. 2014. California Water Action Plan.

Gray, B., B. Thompson, E. Hanak, J. Lund, J. Mount. 2013. Integrated Management of Delta Stressors: Institutional and Legal Options. Public Policy Institute of California

Hanak, E., J. Lund, A. Dinar, B. Gray, R. Howitt, J. Mount, P. Moyle, B. Thompson. 2011. Managing California’s Water: From Conflict to Reconciliation. Public Policy Institute of California

Hanak, E., J. Lund, J. Durand, W. Fleenor, B. Gray, J. Medellín-Azuara, J. Mount, P. Moyle, C. Phillips, B. Thompson. 2013. Stress Relief: Prescriptions for a Healthier Delta Ecosystem. Public Policy Institute of California

Hanak, E., B. Gray, J. Lund, D. Mitchell, C. Chappelle, A. Fahlund, K. Jessoe, J. Medellín-Azuara, D. Misczynski, J. Nachbaur, R. Suddeth. 2014a. Paying for Water in California. Public Policy Institute of California

Hanak, E., E. Freeman, C. Chappelle, B. Gray, J. Lund, D. Misczynski, J. Medellín-Azuara, D. Mitchell, J. Mount, J. Nachbaur, R. Suddeth, B. Thompson. 2014b. Funding Sustainable Groundwater Management in California. CaliforniaWaterBlog.com. April 3, 2014

Little Hoover Commission 2010. Managing for Change: Modernizing California’s Water Governance. Sacramento, Calif.

Lund, J., E. Hanak, B. Thompson, B. Gray, J. Mount and K. Jessoe. 2014. Why Give Away Fish Flows for Free During a Drought?, CaliforniaWaterBlog.com, Feb. 11, 2014.

Mount, J., W. Bennett, J. Durand, W. Fleenor, E. Hanak, J. Lund, P. Moyle. 2012. Aquatic Ecosystem Stressors in the Sacramento-San Joaquin Delta. Public Policy Institute of California.

Mount, J., E. Hanak, B. Cain, C. Chappelle, R. Frank, B. Gray, R. Howitt, K. Jessoe, J. Lund, J. Medellín-Azuara, P. Moyle, L. Szeptycki, B. Thompson. 2014. Drought’s No. 1 Lesson: Modernize Water Management. CaliforniaWaterBlog.com, April 9, 2014

National Research Council. 2012. Sustainable Water and Environmental Management in the California Bay-Delta. Washington, DC: National Academies Press