Irrigation Externalities: Pricing and Charges

Externalities associated with irrigation water supply and use are complex and the links between these sources of environmental change and their effects are not always well understood or measured.

Many factors influence the extent to which a charge or tax on water use would actually change water use, including the volume of water available to irrigators, the extent to which trade can occur, the size of the tax, the price responsiveness for irrigation water, and the existing mechanisms to address externalities.

• Where there is water trade and where restrictions on water allocations result in scarcity rents, a charge will only reduce water use (and consequent environmental costs) if it exceeds the scarcity rents. If water use does not change, there will be no short run improvement in economic efficiency from such a charge, although it might encourage long run efficiency improvements.
• Scarcity rents will vary within and between irrigation seasons, as well as between irrigation districts.

When assessing new policies to manage environmental externalities, care should be taken to define adequately the externality, and not simply identify instances of environmental change. Governments should carefully consider the potential benefits and costs in assessing such new policies.

An externality tax can make the costs of negative externalities transparent and provide incentives to some relevant economic agents. A tax equal to the marginal external costs at each level of output can improve efficiency and in the longer term may provide an incentive to undertake abatement activities.

A tax on water use may increase economic efficiency where external costs are related only to the level of water use. But such a tax is an unsuitable instrument if the government’s policy objective is to reduce environmental damage to a predetermined level or to raise a target level of revenue to address the externalities.

Challenges in considering and implementing an externality tax include whether such a tax is appropriate for a particular externality, variations in efficiency benefits, interaction with other externalities, difficulties in determining the rate, use of the revenue and legal feasibility.