REFEREMCE

AlllQb tlObl?

NBSIR 74-479

Analysis of Cost-Sharing Programs

for Pollution Abatement of

Municipal Wastewater

Harold E. Marshall and Rosalie T. Ruegg

Building Economics Section

Institute tor Applied Teclinology

National Bureau of Standards

Washington, D. C. 20234

September, 1974

Final Report

Prepared for

Office of Research and Monitoring

U.S. Environmental Protection Agency — -Washington, D. C. 20460

100

.U56

#74-479

1974

NBSIR 74-479

ANALYSIS OF COST-SHARING PROGRAMS

FOR POLLUTION ABATEMENT OF

MUNICIPAL WASTEINATER

Harold E. Marshall and Rosalie T. Ruegg

Building Economics Section

Institute for Applied Technology

National Bureau of Standards

Washington, D. C. 20234

September, 1974

Final Report

Prepared for Office of Research and Monitoring

U.S. Environmental Protection Agency

Washington, D. C. 20460

U. S. DEPARTMENT OF COMMERCE, Frederick B. Dent, Seaetary

NATIONAL BUREAU OF STANDARDS, Richard W. Roberts. Director
CONTENTS

Page

Abstract iv

Figures v

Exhibits v

Tables vi

Acknowledgments vii

Sections

I Executive Summary 1

II Introduction 7

Purpose 7

Scope and Approach 8

General 9

Organization 15

III Description of Existing Cost-Sharing Programs and 19

Institutional Constraints

Construction Grant Program 19

Eligibility for Grants as Defined in 23

Legislation

Eligibility for Grants in Practice 26

Cost Sharing By Other Agencies 32

Institutional Constraints to Abatement 34

IV Theoretical Relationships 39

Selective Survey of the Literature 39

Derivation of Demand 43

ii
CONTENTS-continued

Page

Conditions for Efficiency A8

Techniques 49

Scale 55

Characteristics of Equity 64

V Efficiency Implications of Existing and Alternative 70

Cost Sharing Programs

Techniques 70

Scale 81

VI Effects of User Fees on Cost Shares 90

Legislated User Fees 91

Alternative Interpretations 93

Interest Charges In User Fees 102

User Fee Implications 104

VII Summary, Findings, and Suggestions for Further 112

Research

Summary 112

Findings 114

Suggestions for Further Research 121

Appendix 123

Bibliography 135

lii
ABSTRACT

This study evaluates existing cost-sharing programs for wastewater pollution

abatement as described in the Federal Water Pollution Control Act Amendments

of 1972, describes alternative cost-sharing programs that provide improvements in terms of national efficiency and equity criteria as defined herein,

and suggests related areas for further research. Emphasis is on how Federal

cost sharing biases communities in favor of certain kinds of techniques.

The approach is to describe the current cost-sharing programs for both plant

and nonplant techniques; to examine cost-sharing, legal, and other Institutional

biases against certain techniques; to analyze efficiency and equity effects

of alternative cost-sharing programs; and to describe the incentive effects

of cost sharing on nonfederal interests with respect to their choices among

abatement techniques. Findings of the study are that more efficient abatement will result if the same percentage cost share applies to all plant

and nonplant techniques of abatement; the same percentage also applies to

all categories of cost (e.g., capital, land, operation and maintenance) for

a given technique; the same percentage applies to large and small communities;

institutional constraints on the selection of nonplant techniques are removed;

and if the program provides for Federal cost sharing of every abatement

technique that is technically viable.

This report was submitted in fulfillment of Program Element PE 1BA030 and

Work Order Number EPA-IAG D4 H 374 by the National Bureau of Standards,

Building Economics Section

.

iv
FIGURES

No. Page

1 Combined and Separate Municipal Sewer Systems 14

2 Alternative Approaches to Reduction of 16

Wastewater Pollution

3 Indifference Curves and Budget Constraints 45

4 Demand for Pollution Abatement 45

5 Demand for Pollution Abatement, With and 47

Without Enforcement

6 Insufficient Demand for Pollution Abatement 48

7 Cost Share for Efficient Technique(s) 54

8 Cost Share for Efficient Scale 60

9 Average Cost and Efficient Scale of Pollution 62

Abatement

10 Efficient Scale with Regional Abatement 65

EXHIBITS

1 Alternative Techniques for Abating Wastewater 13

Pollution

2 Allowable and Unallowable Project Costs Under

the Construction Grant Program 28

v
TABLES

No. Page

1 Cost of Some Alternative Techniques for 11

Meeting the Dissolved Oxygen Objective

of 4 PPM in the Potomac Estuary

2 Eligibility for EPA Construction Grants of 30

Alternative Techniques, by Cost Cateogry

3 Grants by EPA and Other Federal Agencies as a 31

Share of Eligible and Total Project Costs as of

December 31, 1972

4 Maximum Federal Cost Shares for Sewer Facilities 33

Provided by HUD, FHA, and EDA

5 Impact on Local Project Cost of Different Cost- 71

Sharing Rules: An Illustration

6 Impact on Choice of Techniques of a Cost-Sharing 75

Rule Which Does Not Apply Equally to All

Categories of Cost

7 Determination of a Cost-Sharing Constraint to 79

Reduce Potential Bias in Selection of Abatement

Techniques

8 Federal and Nonfederal Expenditure Requirements 85

of Alternative Cost-Sharing Rules Viewed

Historically

9 Illustration of a Grantee's Costs for a 101

Hypothetical Abatement Project With and

Without Retention of User Fees

10 Application of Pollution Abatement Techniques 123

To Major Problems of Municipal Waste Treatment

Systems

11 Some Waste Treatment Plant Operations and 131

Processes Applicable to Treatment of Wastewater

vi
ACKNOWl.EDGMENTS

The authors wish to thank the project monitor. Dr. Marshall Rose, and

Dr. Roger Shull, both in the Implementation Research Division, for help

in defining the boxinds of this research effort. We also acknowledge the

many persons in the Environmental Protection Agency and in state agencies

who patiently explained to us many Issues concerning waste treatment and

discussed with us the potential impacts of alternative cost-sharing programs.

Finally, we are indebted to those persons in the National Bureau of Standards,

especially Dr. Vartkes Broussalian and Dr. Peter Colwell, who gave helpful

comments in the course of the in-house review process. The responsibility

for all errors and shortcomings in the paper, however, rests with the

authors.

vii

SECTION I

EXECUTIVE SUMMARY

The Environmental Protection Agency (EPA) administers the Construction

Grant Program for the abatement of wastewater pollution. The Federal

Water Pollution Control Act Amendments of 1972 (1972 Act) describe to some extent the eligibility requirements for a community to apply for

EPA grants and the percentage Federal cost shares that can be awarded

for community abatement projects.

The Construction Grant Program, as enacted by the 1972 Act and administered

by EPA, has been criticized for being inefficient in that it encourages

a misallocation of resources in wastewater pollution abatement. The

purpose of this study, undertaken at the request of EPA, is to evaluate the

existing and alternative cost-sharing programs primarily with respect to

efficiency and to some extent equity ( see Section IV for definitions of

efficiency and equity). Cost sharing affects efficiency through its

incentive effects on the choices by local communities for one kind or size of abatement program over another. Cost sharing affects equity in

abatement through its differential treatment of participating communities.

The existing cost-sharing program as described in the 1972 Act and implemented

by Agency regulations is discussed. Theoretical relationships between

cost sharing and its incentive effects on conununity decisions regarding the

size of abatement projects and the kind of techniques used therein are identified. Case examples illustrate the biasing t;ffects on communities of

current rules that apply different cost-sharing percentages to different

techniques and to different cost categories. Local communities have

Incentives to pick techniques which cost them the least money, but under
existing rules, these are not necessarily the least-cost techniques to

the nation. Equity In the sense of fairness to parties participating In

abatement seems violated In that cost sharing Is not directly related to

or varied with benefits received. Finally, legal and other Institutional

constraints appear to play a significant role In affecting what techniques,

plant or nonplant, are chosen by communities seeking assistance In pollution

abatement. Specific findings of the study are summarized below:

(1) Application of the same- percentage cost share to all plant and nonplant

techniques for the purpose of abating wastewater pollution will encourage

nonfederal interests to simultaneously select the combination of techniques

which is least costly to the nation as well as to themselves.

Applying the same share (regardless of what that share is) across all

techniques will eliminate the potential cost-sharing bias for some techniques

over others (e.g., for plant over nonplant techniques) that exists under

the current rules. (See Sections IV and V.)

Granting of cost-sharing eligibility to all technically viable alternatives

would encourage consideration of new technologies. Where only part of a multiple-purpose project is abatement, sharing only those costs that could

properly be allocated to abatement per se would encourage the efficient

scale of abatement. Thus a lower Federal cost share would apply to

techniques that provide other benefits in addition to abatement, than to

techniques which provide abatement only, and the cost share would decrease

as the cost of providing those other benefits Increases relative to the

cost of abatement,

(2) Application of the same percentage cost share to all categories of

project costs (i.e., to capital; to land for both site and process; for

operation and maintenance; and to planning) will encourage community

selection of the nationally least-cost technique (s) of providing abatement.

Because operation and maintenance costs are not currently shared at all by

the Federal government, while capital costs are shared, grant recipients

are biased towards capital-intensive techniques even though all techniques

may be eligible for the same percentage share of capital cost, (See

SectloasIV and V.)

2
Where only one category of cost (e.g., capital) can be shared, two alternative approaches for encouraging local selection of the least-cost

technlque(s) might be considered In lieu of the same percentage for all

categories. The first approach is to vary the share of the single cost

category to be subsidized so that the local share as a percentage of

total project costs (i.e., the effective cost share) will be uniform

across all techniques. A second approach, still providing a Federal share

for one category only, would Impose a constraint on the percentage of

total costs that the Federal agency could bear. The cost-sharing bias

would be reduced to a degree dependent on how low the constraint is, and

in some cases would be completely eliminated.

(3) Nationally efficient scales of abatement would be encouraged by reducing

the effective Federal cost share.

The legislation governing the Construction Grant Program does not specify

nationally efficient scales of abatement (i.e., the maximization of national

net benefits) as an objective of the program (see Section III). If,

however, this were an objective, the Association Rule (see Section IV)

could accomplish it by encouraging grant recipients to choose a scale of

abatement that is nationally as well as locally efficient. For most

projects, existing Federal cost shares probably exceed those that would be

obtained from applying the Association Rule (see Section V). Lower Federal

shares would tend to encourage more efficient scales of abatement, but

could nevertheless be set large enough to provide some incentive for

communities to expand their abatement activities. Since adequate information

regarding the incidence of abatement benefits is not available, further

research is needed before specific percentage cost shares can be selected.

(4) Varying cost shares in proportion to community size, other things being

equal, may lead to inefficient scales of abatement.

Over some range of abatement levels, the average cost of abatement is likely

to fall as a result of economies of scale. Assuming that this range of

decreasing average cost extends to large scales of abatement, big cities

with large demands for abatement would be expected to have lower average

costs than small cities with less demand for abatement.

3
One way of encouraging small cities to demand higher levels of abatement

and thereby profit from economies of scale is to raise the percentage

cost share for small cities above that of big cities. However, the

efficient scale of abatement for a small city may be much less than that

scale at which average costs are minimized (see Section IV), Thus,

applying preferential Federal cost shares to small cities to encourage

them to take advantage of economies of scale may result in oversized

projects from the standpoint of maximizing net benefits from abatement.

Achieving efficient levels of abatement is not necessarily incompatible

with taking advantage of economies of scale, however. For example, it

might be advantageous to individual cities as well as the nation for cities

to join in the construction of regional treatment plants that would lower

the average cost of abatement to all while at the same time providing the

efficient level of abatement,

(5) Returning all industrial user fees collected against the Federal grant

to EPA for redistribution through the Construction Grant Program will

eliminate the problems described below, without reducing the amount of

funds available to municipalities.

Existing Federal user fee practice allows grantees to retain part of the user fees collected from industry to repay industry's share of the Federal

grant. Retention of these user fees by the grantee increases the Federal

subsidy and reduces the effective cost share to the grantee. The more

industrialized the community, the larger this additional subsidy and the

lower the effective cost share of the grantee. This practice has the

following effects: (a) the tendency towards construction of larger-thanefficient scales of abatement is increased because the grantee's effective

share of cost is thereby reduced; (b) the bias towards capital-intensive

and eligible land-intensive projects Is increased, because the grantee's

effective cost share is inversely related to the amount of capital and

eligible land costs that are attributable to industry; (c) a larger Federal

subsidy Is provided to Industrialized communities than to residential

communities, because the amount of retained user fees is dependent on the

construction cost of facilities provided to industry. (See Section VI,)

4
(6) Including an Interest charge In user fees collected from industry

against the Federal grant would help ansure that industry paid its full

share of costs. Under existing arrangements, industrial users tend to

be substantially undercharged for their part of the costs of facilities

because they pay no interest on their part to reflect the time value of

money. Hence, the user fee revenue is much less than it would be if

industry repaid the full cost of treating its wastewater, (See Section VI,)

(7) Legal and other institutional constraints exist which bias against

the selection of efficient abatement techniques.

The following steps might be considered for eliminating these biases:

(a) educational and promotional efforts to encourage planners to consider

nonplant techniques; (b) encouragement by grant officials of applicants

to consider fully abatement alternatives during the Initial project

planning stages; (c) establishment of architects' /engineers' fees based

upon operation and maintenance costs, as well as capital costs, to avoid

bias towards capital-intensive techniques; (d) encouragement of regional

management of wastewater abatement to reduce the inefficiencies resulting

from the narrow view taken by small jurisdictions; and (e) the same treatment of all abatement techniques in the law, the regulations, and the

program, (See Section III,)

In summary, this study has identified action that would Increase the local

share of abatement costs; reduce the cost-sharing bias toward capitalintensive and eligible land-intensive projects; reduce the cost-sharing

bias for some plant over nonplant techniques; Increase the Federal and

local expenditures on nonplant techniques relative to plant techniques;

increase the community demand for nonplant techniques; increase the degree

of abatement per national dollar spent, and in general result in more efficient and equitable projects.

Additional areas of research were identified that might be of value to

EPA in meeting its objectives of encouraging efficient abatement and of

treating cost-sharing parties equitably. One type of research needed is

an investigation of how institutional requirements affect communities'

selections of techniques of abatement. A second research problem is the

5
determination of the optimal points In time for reducing and/or eliminating

pollution abatement grants. A third potential area is the analysis of the

link between levels of local performance in abatement and rewards or grants

based on good performance, A loan program for capital that reduces the

amount to be paid back as performance improves should be studied. A fourth

area of research should be the determination of community objective

functions in pollution abatement to see if communities are really concerned

with collection and disposal. A fifth area of research would be to

Investigate the responsiveness to varying cost shares of community demand

for nonplant techniques. Additional perspective that is needed to analyze

the potential biases against nonplant techniques might be obtained through

these areas of research.

6
SECTION II

INTRODUCTION

PURPOSE

The Environmental Protection Agency (EPA) was directed by Section 317 of

the 1972 Amendments to the Federal Water Pollution Control Act,''^ hereafter

referred to as the 1972 Act, to continue to investigate and study the

feasibility of alternative financing methods for preventing, controlling,

and abating pollution. Implicit in this directive is a responsibility to

examine cost-sharing programs for nonplant* control and treatment of

sewage as well as for conventional plant treatment techniques. The purpose

of this study is to provide EPA with an evaluation of alternative costsharing programs both for plant and nonplant prevention, control, and

treatment, hereafter referred to as abatement.

The study will evaluate existing cost-sharing arrangements for their

national efficiency and equity effects and will recommend alternative

practical cost-sharing programs that will lead to more nationally

efficient projects and more equitable dealings with communities seeking

assistance In water pollution abatement. Cost-sharing rules will be

proposed that (1) will promote selection by local communities of the

nationally least-cost techniques for providing pollution abatement,

(2) will promote selection by local communities of the nationally efficient

scale of abatement, and (3) will treat each local community in the same manner with respect to certain defined conditions of fair treatment,

i.e., equity.

*Nonplant control and treatment here refer to all processes "outside

the fence" (see Figure 1)

7
SCOPE AND APPROACH

Because EPA's Construction Grant Program is the major program through

which cost-sharing rules set forth in the 1972 Act are implemented, It is

the focus of this study. The incentive effects of cost sharing under

the Construction Grant Program are emphasized. "Cost sharing" as used in

this report refers to the rules for sharing project costs between Federal

and nonfederal participants in a pollution abatement project. "Incentive

effects" refers to the way In which cost-sharing programs might encourage,

or bias, local communities to pick one kind or size of abatement program

over another.

The Incentive effects of cost sharing are examined from the standpoint of

two efficiency problems that might arise from a cost-sharing bias. One

problem Is that nonfederal interests may be Induced to choose a technique

for abating pollution that is not cost effective from the viewpoint of

society (i.e., the nation), although it may be least costly for nonfederal

interests. Another arises In terms of the scale of abatement to be

considered (regardless of the technique(s) chosen for a particular project.

Local communities will be Influenced by cost sharing In deciding how large

a project to build. If Federal grants are too large, local communities

will be encouraged to opt for projects that are overdeveloped In the

national sense, i.e., too many resources are allocated to abatement at

the expense of other types of investment projects. If Federal grants are

too low, local cbmmunities will be encouraged to opt for projects that sire

underdeveloped in the national sense, i.e., too few resources are allocated

to abatement relative to competing Investment projects.

In addition to the examination of biasing effects In the cost-sharing rules

per se , the report also examines user fee arrangements for their Impact

on effective* cost shares. By changing the effective cost shares, user

fees are found to influence the community government's choice of abatement

programs.

*The effective cost share is the actual percentage of total abatement

costs that a project participant must bear after taking into consideration

the cost-sharing rule and other factors which affect the ultimate cost

share

8
The two types of efficiency issues—the least-cost technique (s) and the

efficient scale—are examined In the theoretical discussion. However, the

emphasis Is placed on cost-sharing Incentives as they relate to encouraging

the selection of the nationally least-cost technique (s) , as this appears

to be the more prevalent problem and the one for which corrective measures

could be Implemented most easily In practice.

In Its focus on cost sharing, the study does not review other economic

tools which could be used to encourage polluters to control their wastes

in a particular manner. For example, selective payments to waste dischargers

for waste reduction, low-interest loans for pollution control equipment, and

grants for research and development are forms of subsidies which would

encourage desired behavior. Likewise, penalties in the form of effluent

charges, fines, excise taxes on polluting products, charges for discharge

permits, and required insurance coverage would discourage undesirable

behavior.

GENERAL

Financial requirements to meet pollution abatement goals expressed in the

1972 Act are immense. The 1972 Act authorized $18 billion to be spent in

2

fiscal years 1973 to 1975 under EPA's Construction Grant Program, (Of

the $18 billion authorized, $9 billion have been ordered by the President

3

to be spent; the remaining $9 billion have been impounded.) Costs of

waste treatment plants, pumping stations, and other facilities necessary

to meet clean water requirements through 1990 have been estimated at about

4

$60 billion by a recent survey, but It is thought that costs may run much

higher,^ In any case, extensive Federal financial support to local

jurisdictions is expected to continue through the Construction Grant Program,

Given the large expenditures, both required and authorized, the Importance

of an efficient allocation of resources to pollution abatement is apparent.

And, indeed, there are provisions in the 1972 Act which indicate legislative

concern for promoting efficiency in the abatement program.

Sec, 212 (2) (c) of the 1972 Act, for example, requires that grant applications be made for "the most cost-effective alternative , , , ,"

9
Nevertheless, the existing cost-sharing rules have been criticized for

inefficiently allocating resources to abatement.*

The central problem of existing rules examined here — that of biasing selection

against the most efficient abatement techniques — results from the variation

in Federal cost sharing among abatement techniques. Although the legislation

implies that Federal cost sharing for construction costs is now available for

a variety of techniques, historically there has been little Federal cost sharing

available for nonplant techniques. Moreover, some nonplant techniques continue to be ineligible for construction grants (see Section III). In addition,

for those techniques which are eligible, grants vary as percentageH of the

total costs (i.e., capital plus operation and maintenance (0 & M) plus land

costs) associated with the different techniques. Hence, the share of total

costs assumed by the Federal government may vary considerably depending upon

the abatement technique adopted by the municipality. Other things equal,

grant recipients will favor those techniques which cost them the least.

The Importance of considering a variety of techniques has been demonstrated

by studies of river basins** which have shown that nonplant techniques and

combinations of plant and nonplant techniques may offer Improvements in

efficiency over conventional plant approaches alone. Consider, for example.

Table 1, which shows the costs of alternative abatement techniques analyzed

for water quality improvement in the Potomac estuary. To meet the dissolved

oxygen performance objective of 4ppm, combinations of plant and nonplant

processes (shown under Item 2 of the table) are less costly than plant processes

alone (shown under items 3 and 4 of the table). But while there may appear to

be a number of viable alternatives from both a technical and cost standpoint, from

the standpoint of implementation under existing cost-sharing and institutional

conditions, there may be few alternatives.

With respect to the kinds of alternative abatement techniques which are

available, two general categories are delineated in this report: plant ,

*Some efficiency defects of existing rules have been documented in other

studies, among them, Richard Raymond, "The Impact of Federal Financing

Provisions in the Federal Water Pollution Control Act Amendments of 1972,"

Public Policy , Vol. XXII, Winter 1974, pp. 109-110, and Urban Systems

Research and Engineering Inc., Methods for Financing Water Pollution

Abatement from Point Sources , a research paper prepared for the Water

Quality Office of the Environmental Protection Agency, August, 1971, p. 39.

**See, for example, Robert K. Davis, The Range of Choice in Water

Management (Baltimore: The Johns Hopkins Press, 1968).

10
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11
those techniques concerned with waste treatment in a plant facility; and

nonplant , those techniques concerned with waste control, prevention,

reduction, or treatment outside the plant. Waste treatment in plant

facilities is the conventional approach to abatement of pollution of our rivers and streams from inflows of wastewater. However, the nonplant

techniques for treating wastewater, for preventing its generation, for

eliminating some of its detrimental characteristics, and for controlling

it, may be used in lieu of or in conjunction with plant treatment to

combat water pollution from wastewater. Examples of nonplant techniques

are wastewater-f low-reduction programs, active use of the sewage collection

system, in-stream aeration, community septic systems, and low-flow

augmentation. Exhibit 1 lists these and additional pollution abatement

techniques which are considered in this study. A description of each,

as well as an indication of the type of pollution problem to which they

may be applied, is provided in the Appendix.

The term "alternatives" is not meant to imply that these techniques are necessarily equal to plant treatment or to each other in their cost or in

their ability to reduce or treat a specific kind of sewage, nor that all

are suitable in every situation. These alternatives are simply a nonexhaustive list of technologically viable techniques for reducing water pollution.

Attention should perhaps be called to the distinction between plant and

nonplant techniques. The distinction is somewhat confusing because many

of the treatment processes used in a plant could also be used outside the

plant. Making the distinction on the basis that plant treatment is

capital intensive, whereas nonplant abatement is not, is also confusing,

because nonplant techniques may likewise involve large capital expenditures.

Thus we have chosen a classification scheme based on whether the abatement

technique Is applied Inside or outside of the treatment plant and the main

interceptor sewer leading into the plant, i.e., "inside or outside the

fence."

The distinction made here between plant and nonplant techniques is illustrated by Figure 1, which shows two versions of a typical municipal sewer system.

To the left of the river on the figure is a "combined system," and to the

12
Exhibit 1

Alternative Techniques for Abating Wastewater Pollution

I, Wastewater Prevention, Control, and Reduction Techniques

A, Prior to Discharge into Waterway

1, Reduction in Water Use

2, Active Control and Modification of the Sewer Collection System

a. Injection of High Molecular Weight Polymers into the

Collection System

Selective Retention and Control of Flow in the Collection

System

c. Pretreatment in the Collection System

d. Controlled Flushing of Sewers

3, Enhancement of New and Rehabilitation of Existing Collection

Sewers

a. Enlargement of Sewers

b. Separation of Storm and Wastewater Collection Systems

c. Design and Construction of Collection System to Prevent

Infiltration and Inflows

4, Control of and Restrictions on Release of Certain Substances

into the Sewer System

5, Influence on Decisions of Households and Industry to Connect

to the Municipal Sewer System

B. During and After Discharge into Waterway

1, Selective Routing of Effluent Discharge

2. Low-Flow Augmentation of Receiving Waters

II, Wastewater and Effluent Treatment Techniques

A, Prior to Discharge into Waterway

1. Treatment in Conventional and Advanced Waste Treatment Plants

2. Land Treatment of Wastewater

3. Community Septic Tanks

A. Raw Sewage Lagoons

B, During and After Discharge into Waterway

1, In-stream Aeration

2» Treatment of Overflow

13
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right Is a "separate system." For either system, techniques or processes

which would be applied within the Interceptor sewer and/or the treatment

plant (I.e., "Inside the fence," as shown In Figure 1), are here defined

as "plant techniques." Those techniques which would be applied "outside

the fence" are here defined as "nonplant techniques."

Figure 2 illustrates the application of some of the techniques listed in

Exhibit 1. Note that the nonplant techniques include actions taken

completely outside the municipal sewage collection system and treatment

plant. V

ORGANIZATION

A description of existing cost-sharing programs is given in Section III,

The procedure for obtaining grants from EPA is outlined. The eligibility

for and size of EPA grants are discussed, both in terms of legislative

authority and in terms of actual practice. In addition to EPA, the

programs of other Federal agencies which provide cost-sharing assistance

to municipalities for collection and/or treatment of wastewater are briefly describedo These other agencies are the Farmers Home Administration, the Department of Housing and Urban Development, and the Economic

Development Administration, Legal, administrative, and other institutional

conditions affecting the selection of nonplant techniques are also

evaluated in Section III to see what changes might be made to provide

additional incentives for local interests to select techniques that are nationally efficient.

In Section IV the theoretical relationships between cost sharing and the

selection of techniques are derived and discussed. The demand for pollution abatement is shovm to depend on the level of Federal cost sharing.

Necessary conditions for encouraging local communities to select the

nationally least-cost technique (s) for pollution abatement and the

nationally efficient scale of pollution abatement are derived. Characteristics of equity, i.e., fairness, of cost-sharing rules are presented

and applied to existing rules.

In Section V the efficiency implications of existing and alternative

cost-sharing programs are considered. Case examples are given of

15

\
/

/

16
cost-sharing biases for certain abatement techniques. The relative costs

to Federal and nonfederal participants of alternative cost-sharing programs

as applied to historical abatement are compared.

Section VI explores the effects of user fees on the Federal and grant

recipients' cost shares. User fee requirements as legislated and as set

forth in grant program regulations are discussed. The effective change

in cost shares attributable to user fee arrangements is determined. The

resulting impacts on decisions regarding abatement programs, and on residential as compared with industrial communities, are assessed.

The study is summarized in Section VII, Findings of the study regarding

the existing EPA Construction Grant Program and alternative programs are described. Suggestions are made for further research.

17
Section II References

Federal Water Pollution Control Act Amendments of 1972, PL 92-500, 92nd

Congress, S. 2770, Oct. 18, 1972.

Sec. 207, PL 92-500.

"Rivers Cleanup Aid Cut," The Washington Post, January 11, 1974, pp. A-1, ACosts of Construction of Publicly-Owned Wastewater Treatment Works: 1973

Needs Survey. Environmental Protection Agency, Washington, D.C.

November 1973.

Waste Treatment Fund Allocations. Senate Committee on Public Works.

93rd Congress, 1st Session, Calendar No. 604, Report No. 93-630,

December 13, 1973. p. 6.

18
SECTION III

DESCRIPTION OF EXISTING COST-SHARING PROGRAMS ^ AND INSTITUTIONAL CONSTRAINTS

This section is divided Into three parts. The first provides background

information on the grant program and discusses the grant eligibility of

the various abatement techniques. The cost shares awarded by EPA are

shown. The second part provides a brief description of cost-sharing

programs of other agencies for wastewater pollution abatement. The third

part describes institutional constraints on the selection of various

techniques.

CONSTRUCTION GRANT PROGRAM

Grants for construction of treatment works are authorized under Title II

of the 1972 Act. According to Sec. 201(g)(1), "The administrator is

authorized to make grants to any state, municipality, or intermunicipal or interstate agency for the construction of publicly owned treatment works."

In addition to the enabling legislation, the grant process is further

governed by regulations codified in the Code of Federal Regulations under

Title 40, Sec. 35.900 et seq

.

The objective of the Construction Grant Program as expressed in EPA literature

la "to assist and serve as an incentive in construction of publicly owned

treatment works which are required to meet State and Federal water quality

2 standards." The objectives of the program are carried out by the sharing

of construction costs of wastewater treatment facilities with municipalities

(i.e., cities, towns, boroughs, counties, parishes, districts — except

school districts), associations, management agencies, and other public

bodies created by or pursuant to state law and having jurisdiction over

disposal of sewage.

19
The EPA Grant Program makes awards for any or all of the following three

steps: (1) Facilities Planning , during which the applicant's problem Is

Investigated In detail, existing facilities are assessed, alternative

approaches to problem solving are evaluated, and environmental Impact

and cost-effectiveness studies are made; (2) Preparation of Detailed

Construction Plans and Specifications , during which the facilities are

planned, public hearings are held, and blueprints are prepared; and (3)

Construction , during which the facilities are built.

According to Sec. 202(a) of the 1972 Act, the share of cost to be borne by

EPA is 75% of the cost of construction of a treatment works. This appears

to be the current legal maximum Federal cost share.*

It may also be asked if this is the minimum legal cost share. The answer

hinges on the definition of "treatment works." Until recently, as reflected

in the interim grant program regulations, it was required that a fundable

Step 3 project result in an operable treatment works. Thus, under former

Interpretation, the legal minimum, as well as maximum. Federal cost share

was 75% of total eligible construction costs of a completed facility.

However, program requirements for a minimum grant of 75% of total construction

costs were criticized, and have since been changed. According to the

3 . Senate Committee on Public Works, this requirement did not allow a state

the flexibility ... to use its annual allocation of grant funds among as many projects on its priority list as It wishes, on the basis

of what can be accomplished In a given year, rather than to tie

up all Its funds in a few large projects at the top of a state's

priority list.

The Committee further stated that "phased funding," whereby a portion of a total facility would be approved for a grant, would not under the 1972 Act

commit the grant program to eventual funding of the total facility, nor

create a pool of reimbursable claims against the grant program for an ultimate grant of 75% of the full construction costs of the completed

facility.

*The effective or real cost share borne by the Federal government may

exceed 75% of the costs of construction because local Interests can retain

some of the Industrial user fees collected against the Federal share. This

additional Federal subsidy Is explained In Section VI.

20
Section 203 of the 1972 Act has since been Interpreted to allow states to

divide Individual treatment works into separate parts for the purpose of

funding. This new interpretation is reflected in the final program

regulations which provide for grants of 75% of the construction cost of

segments of treatment works. "Segment" is defined as "any portion of an operable treatment work^" and its completion need not result in an operable

treatment works.

It appears, in summary, that the Federal share must comprise a minimum 75%

share of the eligible construction costs of an approved project, but that

the approved project no longer need result in a completed facility.

Available funds for grant awards are allocated among the states in the

ratio of the estimated cost of constructing all needed publicly owned

treatment works in each state to the estimated cost of construction of

4

all needed publicly owned treatment works in all of the states. Computation

of the ratios are based on a "Needs Survey," biennially revised, for public

waste treatment works.* The specific allocation formula^ recently developed

by Congress and used to allocate the 1975 allotment of Federal funds is

the following: Half of each state's share is based on the ratio of the

individual state's total construction needs to the total of all states'

total construction needs. The other half is based on the ratio of the

individual state's costs to all states' costs for the following three

specific categories of pollution control facilities: secondary waste

treatment plants; advanced waste treatment facilities to meet water quality

standards; and new interceptors, force mains, and pumping stations. In

addition, the formula provides that no state will receive less than it

received in fiscal year 1972.

Eligible public bodies apply for grants through their state water pollution

control office. The state office reviews each application, coordinates

the plans outlined with other relevant projects in the state, makes recom- mendations for changes, and if approving of the plan, places the application

*The most recent survey was conducted in 1973 and the results reported

in Environmental Protection Agency, Costs of Construction of Publicly-Owned

Wastewater Treatment Works; 1973 "Needs" Survey .

21
on a priority list which It then sends to the EPA regional administration.

The EPA administration, one of ten regional EPA offices, makes the grant

award. The total amount of grants made to applicants in a state is limited

by the state's allocation of grant funds.

Applicants receive grants according to their order of priority as determined

by the state priority ranking criteria. Evaluations and priority line-ups

made by the state water pollution control offices are based on EPA guidelines

and state guidelines which have been approved by the EPA regional administration. Provisions of the 1972 Act and EPA regulations and guidelines establish

some mandatory criteria for project approval and certification of priority

for grants by state offices, allowing other criteria to be determined by

the state with EPA concurrence. For the most part, the state options are intended to allow for environmental or other relevant differences among

areas.

The application and award process works as follows: After determining that

a problem exists, the applicant, say a town represented by a town mayor,

makes initial inquiry to its state water pollution control agency. (The

title of the state office varies from state to state; e.g., in Alabama it

is the Water Improvement Commission; in Kansas, the Division of Environmental

Health, State Department of Health; and in Washington, the Washington State

Department of Ecology.) The state office hears the inquiry and suggests

that the applicant make a formal application for a Step 1 grant. Upon

approval, the town assesses its existing wastewater disposal facilities,

present and projected waste loads, and alternative approaches which it might

take to deal with its problem — typically alternative plant processes and

facilities. The plans are submitted to the state agency, which evaluates

the plans and tries to mesh them witli other wastewater disposal efforts in

the area. Grants for subsequent Steps can be made either as amendments

to the original grant application or separately. The state office and/or

the EPA regional office may follow up the award process with an investigation

of the functioning of the facilities which were constructed.*

*Informatlon on the grant process was obtained from the following

sources: Interviews with EPA staff; EPA, Federal Assistance Programs

of the Environmental Protection Agency, Reprinted from the Catalog of Federal

Domestic Assistance , Washington, D.C., June 1973, Sec. 66.015; and from

Final Regulations, Federal Register . February 11, 1974.

22
Eligibility for Grants as Defined in Legislation

Much difference in opinion appears to exist regarding eligibility of nonplant

techniques for construction grants. For this reason, we first explore the

1972 Act for statements regarding eligibility and then "examine eligibility

practice under the existing program.

A review of the Act reveals a number of passages which suggest inclusion

of nonplant techniques for grant consideration. Recalling that the Act

authorizes grants for construction of publicly owned treatment works,

consider how it defines "treatment works" in Sec. 212(2) (A):

The term 'treatment works' means any devices and systems used

in the storage, treatment, recycling, and reclamation of municipal

sewage or Industrial wastes of a liquid nature ... or necessary

to recycle or reuse water at the most economical cost over the

estimated life of the works, including intercepting sewers, outfall

sewers, sewage collection systems, pumping power, and other equipment, and their appurtenances; extensions, improvements, remodeling,

additions, and alterations thereof; elements essential to provide

a reliable recycled supply such as standby treatment units and

clear well facilities; and any works, including site acquisition

of the land that will be an integral part of the treatment process

or is used for ultimate disposal of residue resulting from such

treatment

Section 212(2) (B) adds the following items to the definition of treatment:

. . . any other method or system for preventing, abating,

reducing, storing, treating, separating, or disposing of

municipal waste, including storm water runoff, or industrial

waste, including waste in a combined storm water and sanitary

sewer systems.

This Is indeed a very broad definition which would appear to include

practically any technique Imaginable by which water pollution from

municipal waste and storm water could be abated. Similarly, the definition

of construction, as given in Sec. 212(2), does not limit grants to a particular kind of "treatment works."

Other passages of the Act emphasize that projects for which grants are awarded should use the most cost-efficient alternatives.^ The intent

appears to be to encourage the most efficient technique, regardless of

whether It be "plant" or "nonplant."

23
There are, however, other passages In the Act which might be Interpreted

to prohibit consideration of certain of the nonplant techniques. Most

important to the restrictive interpretation of eligibility are the

requirements in the law for a non-polluting discharge and provision of

the best practicable waste treatment technology (BPT) (now generally

defined as secondary treatment) before any discharge into receiving waters.

For examples, Sec. 201(a)(1) states that ". . . it is the national goal

that the discharge of pollutants into the navigable waters be eliminated

by 1985 . . . ." Section 201(b) states the following: "Waste treatment

management plans and practices shall provide for the application of the

best practicable waste treatment technology before any discharge into

receiving waters . . . . " Finally, Sec. 301(b)(1) states that:

There shall be achieved . . . for publicly owned treatment

works in existence on July 1, 1977, or approved . . . prior

to June 30, 1974 . . . effluent limitations based upon

secondary treatment ....

"Before any discharge into receiving waters" is sometimes interpreted as disallowing grants for techniques whose application is after the sewer

outfall system. Accordingly, low-flow augmentation and in-stream aeration

would be ruled ineligible for grants.

The above sections may also be interpreted as placing decided emphasis on

treatment as opposed to other forms of abatement. Such an interpretation

might result from the fact that a specified level of treatment is explicitly

required by the law and that attention is on improving the quality of the

effluent discharge. The focus on treatment before discharge might tend to

lessen attention to techniques aimed at prevention, control, and reduction

of wastewater, as well as treatment techniques applied in the stream.

An alternative interpretation of eligibility as defined in the Act, and one which we think is more defensible, is the following: Emphasis on treatment

techniques Is inherent in the legislation, insofar as goals and requirements

are stated in terms of achievement of nonpolluting discharges and minimum

treatment standardsc Likewise, emphasis is^ on action prior to effluent

24
discharge. Nonetheless, the legislation does not appear to exclude from

grant eligibility any of the nonplant techniques discussed in this report.*

For one thing, we could find no requirement in the law that the BPT be plant

treatment, nor that secondary treatment be provided In plants. Furthermore,

we do not see that the requirement that the best practicable treatment

technology be applied before discharge necessarily rules out grants for

techniques to reduce, control, or pretreat wastewater prior to BPT treatment. Neither do we see that the law prohibits grants for techniques which

are applied after discharge, so long as they are used in conjunction with

treatment prior to discharge and not in lieu of it. To the contrary, there

are sections of the law which appear to suggest use of such nonplant techniques. Consider, for example, Sec. 302(a):

Whenever . . . discharges of pollutants from a point source . . . with the application of effluent limitations required under

Section 301(b)(2) of this Act, would interfere with the attainment or maintenance of that water quality . . . , effluent

limitations (including alternative effluent control strategies )

. . . shall be established ....

In conclusion, under one interpretation which might be given to the 1972 Act,

all of the nonplant techniques appear eligible for grants. In particular,

techniques such as land disposal and community septic tanks, which can provide the equivalent of secondary treatment with no direct discharge into

a waterway, appear especially to satisfy the tenets of the 1972 Act.

Techniques which prevent or reduce the generation of wastewater also

appear to comply with the lav; by reducing the discharge of pollutants

into waterways. Nonplant treatment techniques, which alone or in combination

with each other or plant techniques, are able to fulfill water quality

standards likewise appear compatible with the law.

With respect to types of costs, i.e., capital cost, land, labor, and management costs, made eligible for funding under the law, the main indication

of eligibility appears in the definition of construction , which is defined

in Sec. 212(1) as follows:

*An exception might be techniques requiring expenditure for collection

systems in new communities, grants for which are implicitly prohibited by

Sec. 211 of the 1972 Act.

25
, . . preliminary planning to determine the feasibility of

treatment works, engineering, architectural, legal, fiscal,

or economic investigations or studies, surveys, designs,

plants, working drawings, specifications, procedures, or other necessary actions, erection, building, acquisition,

alteration, remodeling, improvement, or exterior of treatment works, or the inspection or supervision of any of the

foregoing items.

Thus, while the law is not specific with respect to cost eligibility by

type of costs, eligible costs would appear to Include labor, equipment,

materials, and management necessary to obtain the treatment works. There

appears, however, no intent in the 1972 Act to fund operation and maintenance

of the facility once constructed.

Eligibllltv for Grants in Practice

Let us now examine eligibility of alternative techniques and costs under

the grant program as set forth In policy documents, publications, and as described by EPA grant officials.

First, it appears that the general philosophy of the program is centered

quite heavily on treatment per se, and the term "treatment," as used in

program literature, appears devoid of the additional meanings given it in

the 1972 Act, where the definition was extended to Include control, prevention,

and other forms of abatement. It also appears that the term "works,"

broadly defined in the Act to include any method or system for pollution

abatement, is often translated in program literature to "facilities," and

thence to "plant. "^

The emphasis on the treatment plant and its immediate appurtenances (i.e., the

interceptor and outfall sewers) appears in the following statement of project

eligibility set forth in an EPA program brochure:

. . . (eligible costs Include) those to construct new treatment

plants, to expand or Improve existing plants, to construct

Interceptor and outfall sewer lines or to provide pumping,

power, and other equipment necessary to operate a sewage treatment system. Under certain conditions, sewage collection systems and projects to control pollution from combined sewers

may also receive Federal assistance.^

26
Allowable and unallowable project costs as further defined in the U.S. Code

of Regulations are listed in Exhibit 2.

Let us now examine eligibility specifically in terras of plant and nonplant

techniques. Table 2 shows for some of the techniques listed earlier in

Exhibit 1 the current maximum Federal percentage share of costs which would,

in principle, apply. From the Table, it appears that (a) 14 of the 19

techniques are eligible for a Federal grant covering 75% of capital cost;

(b) only 4 of the 19 techniques involve land costs which are interpreted

as an integral part of the treatment process, and, therefore as eligible

for a grant equal to 75% of these costs; and (c) none of the techniques

is eligible for Federal grants for land site acquisition (land not an integral part of the treatment process) or for 0 & M Costs. In-stream

aeration, low-flow augmentation, publicly-owned individual septic tanks

on private property, water-use and waste-reduction programs, and controlled

flushing of sewers (which is regarded as part of 0 & M) , are the techniques

currently considered ineligible for Federal cost sharing of capital costs.

These, together with all the other techniques except land treatment, com- munity septic tanks, and treatment of wastewater overflows, are also

ineligible for Federal cost sharing of any land costs. In contrast, all

of the 19 techniques would be eligible for a planning grant, provided they

related to the particular facility under consideration.

While most of the nonplant techniques appear in principle eligible for a grant for capital costs, few appear actually to have been funded to any

significant degree. It is, however, difficult to determine to what extent

the general paucity of grant awards to nonplant techniques is attributable

to a more restrictive practice of cost sharing than is indicated by

Table 2. Techniques other than plant treatment only became eligible for

cost sharing under the 1972 Act, and few grants of any kind have as of

this time been made under this law.

Let us now look at Federal cost sharing from a historical standpoint. We

can see from Table 3, which shows cumulative grants by EPA and other Federal

agencies from the inception of the Construction Grant Program through 1972,

that EPA grants have averaged only about 36% of eligible construction

27
Exhibit 2

Allowable and Unallowable Project Costs

Under the Construction Grant Program

Allowable Costs:

Costs of the grantee which are reasonable and necessary are allowable.

Necessary costs may include but are not limited to:

(a) Coats of salaries, benefits, and expendable material incurred by the

grantee for the project.

(b) Costs under construction contracts.

(c) Professional and consultant services.

(d) Facility planning directly related to the treatment works.

(e) Sewer system evaluation.

(f) Project feasibility and engineering reports.

(g) Relocation and land acquisition costs required pursuant to the Uniform

Relocation Assistance and Real Property Acquisition Policies Act of

1970, 42 U.S.C. 4621 et seq . , 4651 et seq ., and regulations issued

thereunder.

(h) Costs of complying with the National Environmental Policy Act, including

costs of public notices and hearings.

(i) Preparation of construction drawings, specifications, estimates, and

construction contract documents.

( j ) Landscaping.

(k) Supervision of construction work.

(1) Removal and relocation or replacement of utilities, for which the

grantee is legally obligated to pay.

(m) Materials acquired, consumed, or expended specifically for the project,

(n) A reasonable inventory of laboratory chemicals and supplies necessary

to initiate plant operations,

(o) Development and preparation of an operation and maintenance manual,

(p) Project Identification signs.

28
Exhibit 2 (Continued)

Unallowable Costs:

Costs which are not necessary for the construction of a treatment works

project are unallowable. Such costs include, but are not limited to:

(a) Basin or areawide planning not directly related to the project.

(b) Bonus payments not legally required for completion of construction in

advance of a contractual completion date.

(c) Personal injury compensation or damages arising out of the project,

whether determined by adjudication, arbitration, negotiation, or otherwise

(d) Fines and penalties resulting from violations of, or failure to comply

with, Federal, state, or local laws.

(e) Costs outside the scope of the approved project.

(f) Interest on bonds or any other form of indebtedness required to

finance the grantee's share of project costs.

(g) Ordinary operating expenses of local government, such as salaries

and expenses of a mayor, city council members, or city attorney;

except as provided in §35.940-4 for allowance of indirect costs of

the grantee in accordance with an indirect cost agreement negotiated

and incorporated in the grant agreement.

(h) Site acquisition (for example, sewer rights-of-way, sewer treatment

plant sites, sanitary landfills and sludge disposal areas); except

as provided in §35.950-3(a) for land which will be an Integral part

of the treatment process or that will be used for ultimate disposal

of residues resulting from such treatment, if approved by the

Administrator.

(1) Costs for which payment has been or will be received under another

Federal assistance program.

( j ) Costs of equipment or material procured in violation of §35 . 938-4 (b)

which provides for award to the low responsive, responsible bidder.

Source: "Final Construction Grant Regulations," Federal Register , XXXIX,

No. 29, February 11, 1974, p. 5268.

Grants for areawide waste treatment management planning are provided

for under Sec. 208 of the 1972 Act. For fiscal years through June 30, 1975,

these grants are to be 100% of the costs; beyond that time, 75% of the costs

are allowed. on
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31
cost. During this period, the legal maxltnuin cost share was 50-55%, rather

than the present 75%. Thus to average 36%, many projects must have been

funded below the maximum levels.

Note that the effective cost share, i.e., the percentage of total (construction plus 0 & M) costs, is lower than the 36% share of construction costs

since 0 & M costs were not shared by EPA. An EPA share of 24% of total

costs was estimated by dividing EPA grants by estimated total project

costs, which included construction plus estimated 0 & M costs. The 0 & M

costs were estimated on the basis of eligible construction costs as shown

in Table 3 and on the assumptions that construction on the average comprises

65% of total costs and 0 & M comprises 35% of total costs of wastewater

9

treatment plants. ,

COST SHARING BY OTHER AGENCIES

Other Federal agencies which cost share with nonfederal groups in water

pollution abatement are the Department of Housing and Urban Development

(HUD), the Farmers' Home Administration (FHA) in the Department of

Agriculture, and the Economic Development Administration (EDA) in the

Department of Commerce. The maximum percentage cost shares of these

agencies are shown in Table A. It should be noted, however, that these

agencies do not always actively fund projects, due to insufficient funds.

hud's grant program provides aid to municipalities in construction of new

sewer facilities. Eligible projects are construction of sewers for the

collection, transmission, and discharge of sanitary wastes, and storm

sewer systems for collection, transmission, and discharge of storm water.

Sewage treatment works are excluded.

FHA provides grants to public, quasi-public, or non-profit organizations

serving rural areas for the installation, repair, improvement, and

expansion of a rural waste disposal system, including sewer lines, waste

collection, and treatment of all wastes. In addition, guaranteed or insured loans are made for project costs not covered by the money grant.

32
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33
EDA makes grants to private or public nonprofit organizations representing

redevelopment (depressed) areas for construction of sewer systems,

including collection, transmission, and treatment facilities. In addition,

direct loans are made if local matching funds are not available.

Thus, all three of the agencies provide grants for collection of sewage,

whereas only two, FHA and EDA, provide funds for treatment.

INSTITUTIONAL CONSTRAINTS TO ABATEMENT

The purpose of this section is to identify and discuss characteristics of

existing Institutions or grant program arrangements — other than costshare eligibility — which may bias municipalities against efficient choices

in pollution abatement.

One aspect of the grant program which may influence municipalities in their

selection of techniques is the influence of state and EPA design standards,

guidelines, and technology transfer manuals. If these are conservative

and emphasize the well-established processes, which nearly always are processes to be used in treatment plants, they may direct municipalities

away from consideration of more innovative techniques.

Another related characteristic of the grant process which may cause bias

in choice of techniques is the fact that the training and experience of

many state and EPA officials who review applications are often geared

towards plant engineering. Any preference at that level for traditional

plant/engineering solutions may exert a strong bias on the local applicant

whose objective is to achieve a high priority ranking for his project.

Another factor, which may be in part attributable to state and EPA program

operations, is the apparent widespread failure of municipalities fully to

consider abatement alternatives. Greater emphasis by state and EPA officials

on plans which consider a wide range of alternatives would contribute to

adequate identification of the cost-effective abatement approach.

It is customary practice to base architects ' /engineers' fees for design

of a facility on the amount of capital costs. This practice may give

them incentive to design capital-intensive facilities. Thus the designs

34
for abatement facilities provided to municipalities may be biased against

nonplant and/or low capital techniques, and, consequently, the municipality

may not give adequate consideration to these techniques.

The municipality's relative ability to fund the different kinds of costs

comprising its share of pollution abatement may also cause a bias at the

local level. Municipalities may find it easier to allocate funds to

capital costs than to current operations. When funds are short and

expenditures must be cut, servicing the debt issue normally takes precedence over current maintenance and operating requirements. Hence a municipality may be better able to sustain funding of capital-intensive

techniques than non-capital-intensive techniques, and may, therefore, tend

to have its abatement activities biased towards capital-intensive techniques,

apart from any Federally-induced bias.

Limits to the area of jurisdiction or authority of municipalities may

restrict the choice of techniques. As has been pointed out in studies of

wastewater management, implementation of certain types of abatement

systems, collective facilities, and integrated operation of systems requires

flexibile area-wide institutional arrangements. Moreover, studies have

shown potential cost savings achievable through integrated systems as compared with conventional treatment. But in many places, regional water

quality management systems are still in the planning stages despite the

fact that current law supports regional planning. Institutional arrangements are generally not sufficiently flexible to allow deliberate variation

in quality of discharge at one point to be compensated for at another

point, or by another method where treatment costs are less. Thus, decisionmaking bodies may not have the legal authority to plan and coordinate the

use of techniques in all areas of relevant concern and may, therefore,

be forced to accept less than best solutions.

Another problem which may interfere with efficient choice of size or kind

of techniques is the use of sewerage systems as growth management tools.

Some communities are using their authority with respect to sewage disposal

as a substitute method of controlling other community developments, such

35
as the rate of population growth. In the words of the chairman of the

Fairfax County, Virginia, Board of Supervisors, "We've used sewers as a 11

growth management tool. It's a bad one but It Is the only one we've had."

Another example Is provided by the Northern Virginia Conservation Council

which recently requested EPA to halt any further expansion at four of the

Washington, D.C. area's major sewage treatment plants. According to the

council, a major reason for its action was that "their enlargement would

12

lead to more growth in the area, which they consider undesirable."

Local decision makers may also resist a tie-in with a regional treatment

system or other solutions which would eliminate their basis for control.

It was reported recently, for example, that the Prince William County,

Virginia, Board of Supervisors was considering building its own treatment

plant rather than participate in a regional effort now underway, despite

estimates that costs would thereby be quadroupled. The reported rationale

was that "the regional plant would remove control of sewer line construction

13

and operation — and thus of growth — from the county."

A very powerful institutional barrier to unbiased consideration of techniques

may be found in the 1972 Act itself. Short of a major change, the high

cost and relatively short time horizon for compliance with the high effluent

standards set in the law, together with the emphasis on plant treatment,

may preclude availability of Federal grants for other kinds of techniques,

such as waste-flow reduction, active use of the collection system, and

in-stream aeration. These and other techniques might otherwise be used

alone or in combination with plant treatment to achieve similar levels of

water quality at lower cost.

There are likely a host of additional special circumstances which cause

techniques to be favored or disfavored. Examples of techniques which

appear to have been disfavored by circumstances are those for correcting

the problem of storm overflow. Both separation of combined sewers and

other applicable techniques, it may be recalled, meet criteria of eligibility

for program grants. Yet construction grant funds generally have not been

available for correcting storm overflow. ""^^ This "backburner" attitude at

36
the program level, conveyed to local communities, means fewer project

applications to deal with the problem. One reason for such a position

is a practical one — immense cost of correction. EPA has estimated the

capital cost of solving the storm overflow problem by sewer separation

at $70 billion in 1973, and by alternative methods such as storage and

treatment at $25 billion. (And some communities, if given the choice,

may opt for sewer separation since separation generally requires a lower

proportion of 0 & M rosta. )'^^ Another reason may be that there are differences in opinion as to what should be done to correct the problem.

But in any case the cost involved is so great that little has been done

from the standpoint of cost sharing. A similar bias has existed until

recently against raw sewage lagoons, but for a different reason. In this

case, the problem has been doubt within the grant program as to the degree

of treatment achievable by lagoons.

37
Section III References

1. Final Construction Grant Regulations, Construction Grants for Waste

Treatment Works. Federal Register, XXXIX, No. 29, February 11, 1974.

2. Federal Assistance Programs of the Environmental Protection Agency.

Reprinted from the Catalog of Federal Domestic Assistance, Washington,

D.C. June 1973, Sec. 66.015.

3. Waste Treatment Fund Allocations. Senate Committee on Public Works.

p. 9-11.

4. PL 92-500, Sec. (205) (a)

.

5. Environmental News. Environmental Protection Agency, January 10, 1974,

p. 2.

6. PL 92-500, Sec. 212(s)(c).

7. The Federal Water Pollution Control Act Amendments of 1972, Highlights.

Environmental Protection Agency, Washington, D.C. December 1972.

8. Federal Grants for the Construction of Municipal Waste Water Treatment

Facilities. Environmental Protection Agency, Washington, D.C.

9. Cost to the Consumer for Collection and Treatment of Wastewater. Environmental

Protection Agency. Washington, D.C, Government Printing Office.

Water Pollution Research Series, No. 17090, July 1970. Table 24.

10. Kneese, Allen and Blair Bower. Managing Water Quality: Economics, Technology,

Institutions. Baltimore, The Johns Hopkins Press, 1968. p. 97-179, and

Davis, Robert K. The Range of Choice in Water Management, A Study

of Dissolved Oxygen in the Potomac Estuary. Baltimore, The Johns

Hopkins Press, 1968. p. 124-126.

11. "Fairfax Sewage Plan Set," The Washington Post, March 27, 1974, p. C-1,

Col. I.

12. "Sewage Plant Work Halt Sought," Washington Star-News, January 27, 1974,

p. B-4, Col. 3.

13. "Prince William Tables Funds for Sewer Plant," The Washington Post,

February 5, 1974, Sec. C.

14. Research and Demonstration Program to Achieve Water Quality Goals: What

the Federal Government Needs to Do. General Accounting Office.

Washington, D.C, Government Printing Office. Volume 1, No. B-166506.

Report to Congress. January 1974. p. 339.

15. Ibid.

38
SECTION IV

THEORETICAL RELATIONSHIPS

This section begins with a selective survey of the theoretical literature

pertaining to cost sharing pollution abatement specifically and water

projects in general. The demand for pollution abatement by grant recipients

is shown to depend on the percentage cost shares borne by grant recipients.

Cost-sharing conditions are derived for encouraging the efficient techniques

and scales of pollution abatement projects,

SELECTIVE SURVEY OF

THE LITERATURE

This survey provides a brief overview of some of the work that has been

done in relating cost sharing in water projects to the selection of the

least-costly techniques and of the efficient scale. Equity considerations

are also discussed. The survey starts with an examination of what has

been done specifically in the wastewater area. The rest of the survey

deals with the theory of cost sharing as it has been developed for water

resources in general,

Robert Davis, in his study of alternative approaches to water quality

management in the Potomac estuary, noted some of the biasing effects of

existing Federal financing arrangements.^ He illustrated how differences

in the eligibility of techniques for grants may make the most expensive

system in terms of total cost become the least expensive system as viewed

by the local sector. He also pointed out that differences in the kinds

of costs associated with the various techniques, e.g., relatively high

operating and low capital costs for treatment by polymers compared with

relatively high capital and low operating costs for micros training, can result in a larger Federal cost share for, and hence a local bias towards.

39
the more capital-intensive technique under current cost sharing rules.

Richard Raymond has taken a direct look at the cost-sharing bias in pollu2 tion abatement. Using estimated costs of selected wastewater treatonent

alternatives in the Cleveland-Akron area, he showed that if a cost-sharing

rule does not cover all cost categories equally, when applied to alternative techniques having different compositions of cost (i.e., different

proportions of capital relative to operation and maintenance relative to

land costs), projects with higher national costs may appear cheaper to

a community than projects with lower national costs. He developed a method of measuring the maximum increase in cotal cost to the nation

("maximum bias") generated by unequal cost shares among cost categories,

(See Chapter V for a case example taken from Raymond's work.)

In its final report, the National Water Commission (NWC) has commented

3 on the efficiency and equity of the EPA grant program. It criticizes

Federal subsidies in general as being unfair, promoting inefficiency,

and failing to achieve desired results. It criticizes the 1972 Act

specifically for its inequity in deflecting 75% of capital costs from

local users to national ta>:payers; i,e,, for providing a 75% Federal

cost share for a project that benefits essentially a local area. The

Report also dispenses with redistribution as an equity rationale for

high Federal cost sharing, saying that full sewer charges represent small

proportions of family budgets, and furthermore, that redistribution and

abatement goals should be decided independently. With respect to

efficient techniques, the NWC again criticizes the grant program on the

grounds that it has not stimulated the search for lea.^t-cost solutions,^

The NWC recommends that the grant program be continued until the backlog

of needed facilities has been eliminated. It recommends a grant cutoff

date within 10 years, hoping that cities will be induced to expedite their

abatement programs to fall within the grant period. Both on economic

and equity grounds, the NWC further recommends municipal waste treatment

as an "ideal" enterprise to put on a self-sustaining basis through use

of user fees and service charges,^

AO
More theoretical work has been devoted to cost sharing in the general

area of water resource development (i.e., flood protection, recreation,

fish and wildlife, navigation, irrigation, hydroelectric power, municipal

and industrial water, and shoreline protection) than in pollution abatement per se . The survey that follows covers cost sharing as it has been

applied to some of the purposes mentioned above. However, only those

applications that have relevance to the pollution abatement problem are included.

Mark Regan was an early advocate of cost sharing of water projects by

9 local interests in proportion to their benefits. He recognized that

local interests had different objective functions than the nation and

that these differences, if not compensated for by cost sharing might

encourage local support of projects that were not nationally efficient.

Edward Renshaw, another leader in recognizing the significance of cost

sharing, investigated the economic efficiency effects of having different

cost-sharing rules for alternative techniques of providing a given water

resource project."''^ For flood protection, for example, he pointed out

that local int»irests would pick that alternative with the highest ratio

of Federal to local costs, other things equal, even though that selected

alternative might not be the cheapest for the nation,

James Loughlin has also examined cost sharing in water resource development,''""'' He concludes that differences in cost-sharing policies within

an agency and among agencies lead to national inefficiencies and inequities,

Loughlin recommends a uniform approach to sharing the costs of flood protection to bring about greater efficiency and equity,

Harold Marshall has derived the necessary conditions in cost sharing for

encouraging local interests to select the least-cost combination of

techniques and the nationally efficient project scale for providing any

12

given water resource project. The condition for encouraging the

selection of the least-cost combination of techniques is that local groups

be charged the same percentage cost share for each technique available

to them. The necessary condition (called the Association Rule) for

41
encouraging local support of the nationally efficient scale is that local

13

groups be charged according to the benefits that they receive. Marshall

shows that current cost-sharing rules for many of the water programs do

not meet these conditions. (These conditions will be discussed in detail

later In this section.)

Marshall and Broussalian have extended the conventional evaluation of

cost sharing, which centers on efficiency effects, to examine the equity

implications, where equity is considered both in terms of fairness and

redistribution of income.''"^ In the same study the general cost-sharing

programs of the grant agencies (EPA, EDA, FHA, and HUD) are evaluated on efficiency grounds and compared to those programs of the construction

agencies (Corps of Engineers, Bureau of Reclamation, and Soil Conservation

Service).

Rafuse and Sherman have taken a somewhat unique approach to determining

cost shares for flood protection projects. They maintain that the net

benefits from a flood control project are not additive among benefiting

districts, and therefore that local cost-sharing requirements should not

be based on an addition of these benefits. They introduce the "net

fiscal benefits criterion" as an alternative method for determining what

local interests should be willing to pay. The criterion requires that

local interests be required to pay a share of the project cost that is

equal to the net fiscal benefits (e.g., increased tax revenues minus

increased local government expenses) that they expect to realize from the

18 project, Rafuse and Sherman recognize that their criterion will not

necessarily achieve efficient project decisions, but they emphasize that

19 it has merit in achieving equity among cost-sharing participants.

Chapters 15 and 16 of the NWC Report, entitled "Paying the Costs of Water

Development Projects" and "Financing Water Programs," deal directly with

20 Federal financing programs. The Report concludes that cost-sharing

policies should be consistent among alternative techniques for accomplishing

a given purpose. The Report further concludes that Federal financial

assistance should be clearly identifiable and not obscurred by subsidized

21

repayment schemes. Finally, the NWC provides the following general

rule on subsidies: "Direct beneficiaries of water projects who can

be Identified and reached should ordinarily be obliged to pay all

42
project costs that are allocated to the services from which they benefit,"

However, the cost-sharing decision to charge direct beneficiaries is more complex in pollution abatement than in other water programs, such as flood control, because pollution abatement is a project purpose which

often aims to reduce the costs imposed by one group of people on another.

That is, the polluters are not necessarily the beneficiaries. The

"polluter pays" principle need not be in conflict with the "beneficiary

pays" principle on efficiency grounds. On equity grounds, however,

either of these principles may be considered superior, depending upon

the decision maker's value system. Marshall has described this particular

problem in relation to the cost sharing of salinity control in the

Colorado River Basin, where those who cause salt pollution are not

23 necessarily those who benefit from desalting. A local community which

benefits from sewage treatment could be required to contribute a large

percentage of abatement costs. It could in turn charge user fees and

effluent cliarges on local residential and industry groups that may both

benefit from abatement and/or cause the pollution that requires abatement,

DERIVATION OF DEMAND

Implicit in the analysis of the incentive nature of cost sharing is the

assumption that the level of cost sharing does affect grant recipients

in their demand for pollution abatement. Other things being equal, we

can expect the demand for pollution abatement by local communities to

depend on the price to them of that abatement and the value that they

place on that abatement. Furthermore, the relationship between the

quantity demanded by grant recipients of pollution abatement and the

local cost share is hypothesized to be an inverse relationship. This

hypothesis is explained with the model below.

Assume that the grant recipient's benefit or welfare function can be

expressed as

= (Q,M), (1)

where B = benefits accruing to the grant recipient,

Q = unit measure (i.e., quantity) of pollution abatement, and

M = all other goods and services available to the grant recipient,

measured in dollars.

43
'["he yjnnt rccipiont Is constrained In his purchase of M and Q by the amount

of wealth, i.e., his budget, available to him. Therefon- the recipient

will maximize his welfare (other things being equal) subject to the budget

constraint which satisfies the relationship

R = M + cPQ, (2)

where R = budget of the recipient,

c = proportion that the nonfederal cost share bears to total

project cost (i.e., nonfederal percentage cost share),

P = national price per unit of Q,

cP = recipient's price per unit of Q, and

cPQ = total costs of Q to recipient.

All functions are considered continuous. To isolate the effect of cost

sharing on demand, we shall assume that the percentage cost share (c)

changes and that the national prices (P) remain constant.*

Figures 3 and 4 show graphically the derivation of demand for pollution

abatement as a function of cost sharing. An indifference curve (I)

represents combinations of M and Q to which the grant recipient is

indifferent. For higher levels of M and Q, the local group achieves

higher levels of satisfaction as represented by 1^ and being located

up and to the right of I^, in Figure 3. The slope of these indifference

curves represents the marginal rate of substitution (trade-off) of M for

Q that the grant recipient is willing to make, based on his judgment of

the value of benefits from extra units of M and Q. These Indifference

curves are derived from the welfare function in equation (1)

The lines C.^, C^, and represent the local budget constraints for

different local cost shares c^^, c^, and c^ where ^ ^2 ^ ^3* slope

of the budget constraints is equal to the negative value of the grant

recipient price, i.e., (cP). As the local cost share of Q diminishes,

the budget constraint pivots at point R and Intersects the horizontal Q

axis at points farther to the right. The points of tangency between the

*Thls assumption is made for convenience of illustration. In practice

the purchase of extra units of pollution abatement might even decrease the

national price through economies of scale. Thus the local demand curve would still be downward sloping.

AA

Indifference curves and the budget constraints indicate the economically

efficient combinations. Hence, as the grant recipient's cost share

decreases from c^^ to to c^, the recipient's absolute price per unit of

Q decreases, and the grant recipient will Increase his purchases from

to to respectively, as shown in Figure 4. Thus, the grant

recipient's demand for pollution abatement, other things equal, is shown

graphically to depend inversely upon the percentage cost share that he

must pay.

If the sole purpose of cost sharing for pollution abatement were to

encourage local interests to provide more and more abatement, then it

follows from this demand analysis that reducing the local cost share would

help serve that purpose. But since the Federal budget is limited and

there are other projects competing for scarce Federal funds, we know that

it may be inefficient to simply allocate Federal money for 100% of

abatement costs to the exclusion of other types of projects.

An alternative to cost sharing for inducing greater abatement is to

require a high level of abatement. Let us assume, for example, that

Federal abatement standards or controls are Imposed on local communities

and that they are enforced. Figure 5 shows the resulting kinked demand

function (DD) for abatement where Q is the enforced level.

o At least level of abatement will be demanded regardless of the cost

share, and the quantity demanded of additional levels of abatement will

vary inversely with the local cost share.

If the standards or controls were not enforced, then the effective demand

function would be dD, i.e., it would take on the general downward slope

of the function derived in Figure 4,

This type of demand analysis might be extended to explain in part why

with the 75% Federal capital grants provided for in the 1972 Act, or even with a 100% Federal grant, the abatement levels that are considered

needed may be greater than those levels demanded by the nonfederal sector.

For example, some aspects of higher levels of abatement (e,g,, community

growth) might be considered as costs to the community but not to the

nation. In addition, some aspects (e.g., downstream abatement benefits

46
$

Local

Price

(cP)

- D

Figure 5. Demand for pollution abatement, with and without enforcement

external to the abating community) are considered as benefits to the

nation but not to the comminity. Finally, the community recipient may

put up all of the nonfederal cost share and yet receive only a part of

the nonfederal benefits, Thus it is quite possible that the optimal

level of abatement to the nation may be greater than what the community

will provide even with a 100% Federal subsidy.

Consider Figure 6, where has been designated as some nationally

desirable target level of abatement, but where no enforcement exists for

compelling the community to implement Q^. Even where tlie local cost

share approaches zero percent of total project costs, the community will

implement less than Q^, leaving a gap of - between what is regarded

as needed (optimal from a national standpoint) and what the community is

willing to build.

It is quite conceivable that a community might exhibit such a demand

function when it takes the narrow viewpoint that the only benefits and
$

Local

Price

(cP)

- Q

0

Figure 6, Insufficient demand for pollution abatement

costs of pollution abatement are those accruing directly to it.*

CONDITIONS FOR EFFICIENCY

Two kinds of efficiency are discussed in this paper. The first is

efficiency in production, which is reached when the least-cost combination of techniques has been chosen for providing pollution abatement.

The second is efficiency of scale, which is reached when the level of

pollution abatement is such that no addition to or subtraction from

that level could yield positive net benefits. The efficient mix of

techniques and efficient scale can be determined simultaneously. However,

local community decisions on techniques and scale may not be made simultaneously, and therefore the two cases are handled separately.

The following assumptions are made, A grant recipient (e,g,, local or state government) and a Federal agency (in this case EPA) share the costs

of a project providing water pollution abatement. The grant recipient

and the Federal donor agency may apply different criteria for evaluating

the project. Grant recipients would be expected to be most interested

in benefits that accrue locally to them and the Federal agency must

*If the situation depicted in Figure 6 were to exist, a 100% Federal

cost share might even be ineffective as an inducement to encourage Q . A subsidy In excess of 100% or enforced standards would, theoreticalSy

be alternative means of inducement.

48
consider benefits that accrue nationally, i.e., benefits that accrue locally as well as spill over local boundaries. Both the grant recipient

and the nation as a whole are assumed to have downward sloping demand

functions for project outputs. That is, the higher their respective

cost shares, other things being equal, the less output they will demand.

Finally, the production function for abatement is assumed to be characterized, at least after an initial stage, by diminishing marginal returns

to successive input units.

Techniques

The purpose of this section on techniques is not to Identify those leastcostly techniques, but to determine what conditions cost sharing must

meet to encourage grant recipients to seek techniques for abating pollution

that are least costly to the nation (a recognized objective of the 1972

25

Act ), as well as to themselves,

A necessary condition for least-cost production to the nation is that

M -!l * (3)

8T^/ 8T2 P2

where Q = units of output of pollution abatement,

T^, T^ = are units of techniques 1 and 2,

P^, = national cost or price per unit of techniques 1 and 2.

and P2 are assumed to be constant*in the relevant range of demand for

techniques 1 and 2, This assumption seems reasonable in that the prices

would not be expected to vary much with the size of one project.

This necessary condition (3) is derived as follows. Assume that benefits

to the nation (B) from pollution abatement are a function of Q and that

Q = Q(T^, T^). Assume further that the nation has some budget constraint

for pollution abatement (S). To find the maximum of B[Q(T^, T^) ] subject

to the constraint that S = P-j^T^ + P2T2> we make the problem unconstrained

by use of the Lagrange multiplier (X) and maximize the new expression

W = B(Q) + X (S - P^T^ - P2T2), . (4)

where W now is a function of T^, T2, and X.

*This assumption is essential for the derivation.

49
A necessary condition for optimization Is that the partial derivatives

of W with respect to each variable must equal zero. By doing this for

the two techniques we have

aw ^ 9B . 9(i + X (-P.) » 0, and (5)

9T^ " 3T^

9W 3B . 3^ + X (-P ) = 0. (6) " 3Q

Placing the negative terms to the right side of the equations and dividing

the first expression by the second yields

3B . 3^ y4l • IS Ml • 3Q 3Tj^/ 3Q 3T2* XP2

Simplifying equation (7) results in the condition to be demonstrated,

m M ' (3)

3T^/ 31^ P2

This means that each technique will be used up to that level at which

the extra output realized per extra dollar spent is equal for the two

techniques. The Federal agency, as an agent for society as a whole, is

expected to select techniques according to this least-cost principle.

To illustrate how a grant recipient will choose among techniques, we

examine his behavior under the assumption that he attempts to maximize

his benefits from abatement subject to his budget constraint, A necessary

condition for his least-cost production is that

c P

- 1111 . (8)

where c^, C2 - grant recipient's cost shares (proportions) of techniques

1 and 2 respectively,

26 This condition is derived as follows. Assume that recipient benefits

(B^) are a function of Q and that the recipient has some budget constraint

R. To find the maximum of B^^ [Q(Tj^, T2) ] subject to the constraint that

R = ^l^l^l ^2^2^2* make the problem unconstrained by use of the

Lagrange multiplier and maximize the expression

50
V = (Q) + X (R - c^P^T^ - C2P2T2), (9)

where V is now a function of T^, X, c^^, and C2.

By setting the partial derivatives of V with respect to and equal

to zero, we obtain

= ^ • 1Q_ + ^ ^"^1^1^ " " ^^^^ 9Q 9T^

1V_ = ^ . M + ^ ^"S^2^ " °- ^^^^ 9T2 9Q 9T2

Placing the negative terms to the right side of the equations and

dividing the first expression by the second yields

' /_R • IQ = ^""i^i . (12)

9Q / aq 9T2 XC2P2

Simplifying equation (12) results in the condition to be demonstrated,

(8)

Note that identical cost shares (c^ = C2) must apply to each technique

if cost sharing is to induce the grant recipient to select the nationally

efficient combination of techniques. If c^ > C2, the recipient will be

biased by cost sharing to choose less of technique 1 and more of technique

2 than is nationally efficient. If C2 > c^, he will be biased to choose

less of technique 2 and more of technique 1 than is nationally efficient.

Only when c^ = C2 does the recipient's maximizing condition (8) become

equivalent to the least-cost condition for society (3). This condition

for equal cost shares can be extended to as many techniques as are reasonable

substitutes for providing a given level of output,*

*The c^ = c does not apply under all situations because the

B = B[Q(Tj^, 12)1 formulation is not completely general. For example,

taking the narrow view that the nonfederal group is represented by a single city that might apply for a grant, locational differences of an abatement project might affect the distribution of benefits and therefore

the choice of techniques. Whereas society's benefits from abatement of

a given city's sewage might be the same whether it is produced by a given

combination of abatement techniques upstream or downstream of the city,

(continued on next page)

51
Rather than assume the grant recipient attempts to maximize his benefits

from abatement subject to his budget constraint, we can adopt an alternative assumption regarding his behavior in the case where water quality

standards are enforced. In such a case, we can assume that he regards

as given, a level of abatement that must be met.

The necessary condition under the new assumptions is derived as follows.

The recipient attempts to minimize his costs (C^) subject to the constraint

that the level of abatement meets a specified level (Q^) • Making the

problem unconstrained by the Lagrange multiplier, we can minimize the

expression

By setting the partial derivatives of C^^ with respect to and equal

to zero, we obtain

= c P - X 8^ = 0, and (14)

!fR - c P - X 30_ - 0. (15)

31^ ^ 3T2

Dividing the first expression by the second and simplifying, we find the same condition derived earlier,

^1^1

2 2

Tlius identical cost shares is a necessary condition for encouraging grant

recipients to select the nationally efficient technique both under conditions of constrained budgets and of enforced levels of abatement.

(continued from previous page) the benefits received by that city will

vary with the location of the treated effluent. If the abatement is

above the city, more benefits will accrue locally than if the abatement

occurs below the city. Thus the necessary condition that c^ = C2 might

not apply under these assumptions because the distribution of benefits

may vary by technique. By taking the broader view of the nonfederal group,

which Includes cities below and above the particular city applying for a grant, the nonfederal benefits as a collection of regional benefits will

be relatively unchanged by the kind of locational differences described

in the example.

52
This mathematical derivation of equal cost sharing by technique is based

on dlf ferentlable, convex, curvilinear isoquants that do not intersect

the horizontal and vertical axes, thereby eliminating the possibility

that one technique alone would be the efficient choice. The following

graphical analysis in Figure 7 allows for corner solutions, which are likely to occur in pollution abatement under some circumstances.

Assume that level of pollution abatement can be produced with those

combinations of techniques 1 and 2 indicated by the isoquant abc. Assume

further that the recipient's share of benefits is the same for output

Q^^

for any combination of techniques 1 and 2 on abc. Isocost R depicts the

locus of quantity combinations of techniques 1 and 2 that will be of equal

cost to the grant recipient with Federal cost sharing, Isocosts and S2

depict the locus of quantity combinations of techniques 1 and 2 that will

be of equal cost (to the nation) in producing solely with techniques 2 and 1, respectively, where > S^.* The recipient and Federal isocosts

are not parallel because c^ 7* c^. In this case, the slope of

R, ~*^2^2''*^1^1' steeper than the slope of S^^ and S^, ~^2^^1* Because

the recipient's cost share of technique 2 is considerably higher than his

share of technique 1, he will choose a production process using more of

technique 1 than will the Federal agency seeking national efficiency.

If the absolute value of the slope of R is less than that of line segment

be, the grant recipient chooses technique 2 only. The recipient will

stop choosing technique 2 alone and pick the combination of techniques 1

and 2 indicated at b if the absolute value of the slope of R exceeds

that of line segment be but is less than that of ab**. The corner solution

*For any given price ratio, a family of isocosts exists for the nation.

The same holds true for the grant recipient for any given cost-sharing

proportion and price ratio. Three isocost lines (R, and S^) are focused

upon here out of the families of isocosts to illustrate the impact of cost

sharing on the selection of least-cost techniques.

**If R becomes parallel to be or ab, the grant recipient would find

any combination of techniques 1 and 2 on those respective line segments

to be of equal cost in obtaining .

53
Figure 7. Cost share for efficient technique (s)

54
at a, picking only technique 1, will become least cost to the recipient

only wtion tlie absolute value of the slope of R exceeds that of line

segment ab. Thus, with this Isoquant that meets the axes, there are ranges of cost shares that might induce grant recipients to select the

nationally efficient technique (s)

Figure 7 shows that under the assumed conditions the least-cost technique (s)

for the grant recipient is technique 1. The cost to the nation of producing

with technique 1 is Yet society can realize at a lower cost,

S^, by using only technique 2, The grant recipient will select the same technique (s) as the Federal faction for producing only when the slopes

of both factions' isocosts are more nearly equal. If R were to have a slope with an absolute value less than that of line segment be, then both

the Federal agency and the recipient will choose to produce with technique

2 exclusively, and the savings to the nation (net efficiency gain) from

producing with technique 2 instead of 1 would be the difference in the

costs represented by minus S^. The implication of this analysis is

that where one technique alone is nationally efficient, a limited range

of cost shares might encourage the grant recipient to choose the nationally

efficient technique. But to handle all possible configurations of isoquants

and be assured that the local cost share is in the proper range, it would

seem pragmatic to make c^ = the general rule for all pollution abatement

projects,*

The implications of existing cost-sharing rules for efficiency in production

are evaluated in Section V, where percentage cost shares are displayed by

technique and category of cost for various approaches to pollution abatement.

Scale

The necessary condition for determining the nationally efficient scale of

a water project has traditionally been to equate marginal benefits to

*In addition to the kinked isoquant shown in Figure 7, curvilinear, convex isoquants or straight-line isoquants, both of which touch the axes,

might also be representative of the mix of techniques that would provide

level of abatement. The shape of the isoquant depends on the productivity

relationships of the particular techniques examined. The c^ = c^ rule is

appropriate for all of these isoquants.

55
marginal costs. I.e., to maximize net benefits, where benefits represent

the change In value of goods and services that result from having a project

as compared to not having it, and where costs include all expenses of con- struction; interest; and of operation, maintenance, and replacement.

Construction agencies such as the Army Corps of Engineers, the Bureau of

Reclamation, and the Soil Conservation Service traditionally were supposed

to plan all projects to that scale or size where net benefits are maximized.

Additional objectives such as environmental quality and regional development

are considered today in the planning of water projects by these construction

agencies.

The grant agencies that are most important in providing financial assistance

for sewage treatment and collection facilities—EPA, HUD, EDA, and FHA

have objectives that are less specific than the construction agencies in

terms of a benefit and cost criterion. Their objectives are more mission

oriented, and without detailed criteria regarding the efficient scale or

size of a project. For EPA, for example. Title II of the 1972 Act,

Sec, 201(a), states that "it is the purpose of this title to require and

to assist the development and implementation of waste treatment management

plans and practices which will achieve the goals of this Act," In terms

of scale. Section 204 (a)(5) states the following:

, . , that the size and capacity of such works relate directly to

the needs to be served by such works, including sufficient reserve

capacity. The amount of reserve capacity provided shall be approved

by the Administrator on the basis of a comparison of the cost of

constructing such reserves as a part of the works to be funded and

the anticipated cost of providing expanded capacity at a date when

such capacity will be required.

Needs, as a basis for determining scale, is more ambiguous than a net benefits

criterion. The 1^72 Act does not provide a clear description of the nationally

efficient scale of abatement.

The nationally efficient scale of pollution abatement, i.e., where net

benefits are maximized, is emphasized in this study. Economies of scale,

i.e., where the average cost of abatement decreases at larger levels of

abatement, will be examined from the standpoint of how it relates to

maximizing net benefits.

56
A strong argument on efficiency grounds (to be discussed below) can be

made for planning abatement projects to the scale where net benefits are maximized. Even where some target level of abatement is established, to ensure the efficient scale the target level should ultimately be based

on a net benefits criterion. Thus the following discussion of the

28 Association Rule (AR) is provided to demonstrate the cost-sharing

condition (i.e., the AR) which will encourage grant recipients to seek

the efficient scale of pollution abatement from their standpoint as well

as from the nation's standpoint, where maximizing net national benefits

from abatement is assumed to be the national objective.

Assume the following:

B = B(Q) C = C(Q)

Bp = B - c = c

b = % / dB c = ^ /dC

dQ / dQ (16) dQ / dQ (17)

where B = total benefits accruing to the nation,*

B = benefits accruing to grant recipient,

R

B„ = widespread benefits not assignable to grant recipients,

b = proportion of B accruing to grant recipient at the margin,

C = total costs accruing to the nation,

C = costs borne by grant recipient,

K C„ " costs borne by the Federal government,

rc " proportion of C paid by grant recipient at the margin, and

c = constant cost share exogenously determined in legislation.

For national economic efficiency, pollution abatement should be provided

at that scale where net national benefits are maximized. Assuming continuous

*Examples of potential benefits from pollution abatement are the

following: value of recreational opportunities gained; reduced costs of

purifying water supplies to meet drinking water or other standards; value

of gains from enhanced commercial and sport fisheries; and reduced costs

of processing water for production purposes.

57
and smooth functions, this condition Is

dB ^ dC* (18)

dQ dQ

The last Increment In scale adds benefits just equal to the marginal costs

of production. If a pollution abatement project Is underbuilt or overbuilt

with respect to the scale that Is nationally efficient, then too few or

too many resources respectively have been allocated to that project.

To maximize their net benefits, grant recipients will choose, if possible,

that scale where

^ ^ ^

(19)

dQ ° dQ

Grant recipients cannot gain net benefits by altering the size of the

project when this condition is satisfied. Rearranging equations (16) and

(17) , we have

^\ ^ . dB

dQ ^ dQ (20)

^""^ ^ . dC (21)

dQ ' dQ .

By substitution into equation (19), we obtain the following condition:

. dB . dC

dQ " dQ . (22)

This maximization condition for local Interests shows, by comparing it

with condition (18), that the scale desired by grant recipients will equal

that picked by the Federal agency only if b = c. This condition, i.e.,

that costs are shared in the same proportion as benefits at the margin, is

called the Association Rule (AR) . If b > c, grant recipients will choose

a scale larger than the nationally efficient level and dB/dQ < dC/dQ.

*For a derivation of this condition and of the condition for maximizing

efficiency in the presence of a budget constraint, see Stephen A. Marglin,

"Objectives of Water-Resource Development: A General Statement," Design of

Water Resource Systems , Maass, et. al. (Cambridge, Massachusetts: Harvard

University Press, 1962), pp. 31-36.

58
If b < c, they will choose a scale smaller than the nationally efficient

level and dB/dQ > dC/dQ.*

Figure 8 illustrates the AR graphically. Demand functions MNB and MRB

represent the willingness-to-pay for pollution abatement by the nation and

by grant recipients respectively,** The downward slopes depict diminishing

marginal benefits to each faction for extra units of abatement. Assume for

illustrative purposes that 75% of MNB accrues locally, as measured by MRB.

Assume further than the marginal national cost curve, MNC, represents the

least-cost combinations of techniques for providing each level of output.

Net national benefits are maximized at Qo because dB/dQ = dC/dQ, i.e,,

MNB = MNC, Grant recipients will be encouraged to select up to Qo only

when they pay a cost share of 75%, which makes dB /dQ = dC /dQ at Qo K K

(l,e., MRB = .75 MNC = MRC).**'»> If the grant recipients are charged 50%

of costs, they will choose up to Q2. The national efficiency loss would

amount to abc if the project were built to this scale, A 90% share to

grant recipients would induce them to choose up to Q^^. If the project

were built to this scale, an efficiency loss of area aed would result,

equal to the foregone amount by which extra national benefits would have

exceeded extra national costs up to Qo.

The mathematical and graphical analyses show that the AR meets the necessary

condition for encouraging grant recipients to choose the nationally

*lt is recognized that there may be other policies than cost sharing

that would encourage grant recipients to seek the nationally efficient

scale. However, since this study is focused on cost sharing, we are evaluating in detail only cost sharing policies as incentives for encouraging local behavior that is nationally efficient,

dB ^^R

**MNB and MRB are respectively — and -^q— .

***These results are not affected if non-linear marginal functions

replace the stipulated linear ones, since both MRB and MRC will still

coincide at Qo.

59
Figure 8. Cost share for efficient scale

60
efficient project scale,* Implementation of the AR, however, might be

considered difficult in that information on benefits that accrue to the

grant recipients and to the nation at large is necessary in order to

apply the rule. Alternatives to the AR will be evaluated in Section V,

Now let us examine economies of scale in abatement as they relate to

maximizing net national benefits. As the level of abatement increases,

the average cost per unit of abatement will decrease under certain

conditions. Thus large cities with large abatement projects may benefit

from economies of scale, whereas small cities with small abatement projects

may pay higher unit costs. This part of the study examines the efficiency

implications of varying local cost shares in proportion to community size

to encourage nonfederal interests to take advantage of economies of scale.

As the size of pollution abatement facilities increases, it is reasonable

to expect that the average cost (AC) to the nation per unit of abatement**

will first decrease and ultimately increase, as shown in Figure 9,

The characteristic "U"-shaped AC curve demonstrates economies of scale

from increasing abatement (Q) up to Q , the minimum AC point, and disecon- m

omies of scale from increasing abatement beyond Q^,*** (Note that marginal

cost (MC) always intersects AC at its minimum point)

*Application of the Association Rule is not inconsistent with the

application of the same percentage share to all cost categories and techniques,

as discussed earlier in this section. Cost shares could vary by project

according to the Association Rule; but to encourage selection of least-cost

techniques, the selected percentage for any given project must be applied

equally among techniques to satisfy the same percentage rule,

**The average cost function is assumed here to represent the least-cost

combination of techniques.

***There is some controversy as to whether or not AC does ultimately

bend upwards. Data on the operation of plants seem to support the contention

that, in the relevant range of demand for abatement, AC declines. The

analysis presented in this section applies to either type of AC situation,

the "U"-shaped curve we describe on a priori grounds, or the decreasing

AC curve that operators have suggested.

61
62
Several factors contribute to the economies of scale that are reflected

In the decreasing portion of the AC function. Increased specialization

and more efficient utilization of management occurs with larger operations;

more efficient equipment can be utilized in large scale operations; and

finally, partial neutralization of wastes by mixing from different sources may reduce treatment costs. Eventually, however, the following factors

will tend to push the AC for abatement up. With a large labor force,

plants may become unionized, causing higher wage costs. Disposal of

sludge becomes more and more costly with greater quantities, particularly

in a heavily urbanized area with limited disposal areas. Because collection is an expensive part of total abatement costs, routing from sources

at greater and greater distances from a central plant becomes prohibitively

expensive.

It was stated earlier that the efficient scale of abatement would be that

level where marginal benefits (MB) to society from abatement just equaled

marginal costs. This efficient level of abatement could be to the left of

Q , say at Q- ; at Q ; or to the right of Q , say at There is no

m' 1 m m 2 economic efficiency argument for providing Q , for example, unless MB

m m

happens to be society* s marginal benefit function.

An abatement program for a small city might have a benefits function such

as MB^; that is, extra benefits from abatement become small at relatively

low levels of Q once the pollution load requirements of that city have

been met. A large city, on the other hand, might show a benefits function

such as MB2 , illustrating greater marginal benefits at all scales of

abatement than the small cityo

If- the grants for construction to the cities are 75%, this means that the

grant recipient cities would incur 25% of the abatement costs, as indicated

by their average cost (ARC) function in Figure 9 (ARC = .25AC). Note

that due to economies of scale, the large city pays less in absolute

amount (ARC2) per unit of abatement than does the small city (ARC^)

With the MB function in different positions, however, the small city might

pay less per unit of abatement than the large city (assuming that AC

rises over the relevant range) . The significant finding of this analysis

63
is that there is no economic efficiency rationale for giving one city

more in percentage terras than to another simply because the absolute AC

of abatement differs between the two. In fact, varying cost shares in

relation to city size, other things being equal, may lead to inefficient

scales of abatement. The analysis does indicate that under some clrcumrstances it might be advantageous to cities and to the nation for cities

to join in the contructlon of regional treatment plants that will yield

economies of scale, thereby reducing the absolute cost per unit of

abatement to the individual participating cities and to the nation. For

example, in Figure 10 the efficient scale of abatement for city 1 and

city 2 would be and Q2 respectively when they operate singly. But,

if they were to combine their efforts in a regional facility at a joint

level of abatement of Q^, the cost to the nation per unit would be AC^,

which is lower than what would have been paid for separate facilities,

AC^ and AC^. Joint operation would also reduce each city's share of the

costs under a fixed Federal grant program,

CHARACTERISTICS

OF EQUITY

In economics equity is given two meanings: one is fairness , and the

other is redistribution of income . Both concepts of equity are discussed

here but the emphasis in this study is to determine characteristics of

equity by which to evaluate existing and alternative cost-sharing rules

to see if they assure fair treatment to communities seeking financial

assistance for pollution abatement.

29 Shoup has defined six characteristics of a fair fiscal policy from which

we have selected three that seem pertinent to the evaluation of grants

for pollution abatement,* The selected characteristics are relevancy,

continuity, and certainty,

*Others (e,g., Richard Musgrave, The Theory of Public Finance , McGraw

Hill: New York, 1959) besides Shoup have examined equity. However, Shoup's

equity characteristics are defined in such a way that they can be applied

to existing and alternative cost sharing rules for pollution abatement.

Thus his characteristics of fair treatment were chosen in making this

evaluation of equity.

6A
$

MB

MC

AC

Ql Q2

Figure 10. Efficient scale with regional abatement

65
For a cost-sharing rule to satisfy the characteristic of relevancy , it

must treat all project participants equally with respect to the relevant

circumstances affecting them. What are regarded as relevant circumstances

may vary with one's point of view. The grant recipient, for example,

might consider only the benefits that accrue to him as being relevant,

whereas the Federal agency that administers a grant would be expected to

consider all benefits, local and widespread, as relevant in planning a project. A different group, such as a development agency, might suggest

ability to pay as a relevant circumstance on which to base cost sharing.

In this study "benefits received" are assumed to be the relevant circumstance. Accordingly, grant recipients would have to contribute a cost

share in proportion to the benefits that they receive from pollution

abatement in order to meet the relevancy characteristic of equity,*

For a cost-sharing rule to satisfy the continuity characteristic, no major

change in the relative share of costs borne by the Federal grantor and the

local grantee would result from a small change in the relevant circumstances,

i.e., the benefits they receive. Thus, given an increase in the ratio of

local to national benefits, the resulting change in the local cost share

will not differ greatly from the change in the local cost share that would

result from adding the next, equal increment of local to national benefits.

To satisfy the characteristic of certainty , a cost-sharing rule must treat

grant recipients equally at different points in time whenever the same

relevant circumstances occur so that the cost-sharing responsibility can

be anticipated with reasonable certainty. The grant program should specify

the relevant circumstances on which cost-sharing rules are based in order

to eliminate any confusion as to whether the relevant circumstances change

over time.

It appears that existing rules fail to satisfy the relevancy characteristic

for most techniques because they do not appear to bear much relationship

to benefits received. Existing rules also fail to satisfy the continuity

*Note that the Association Rule does not necessarily satisfy this

characteristic because it applies to benefits at the margin.

66
characteristic in that small changes in the proportion of local to national

benefits that might result from changing techniques of abatement can result

in major changes in local cost sharing because of the different cost composition among categories of cost that are shared differently. Existing

rules must be labeled uncertain in that the actual percent of total costs

borne by nonfederal groups will vary among techniques over time even when

local benefits are the same ratio to total benefits for every technique.

A difficult kind of uncertainty exists in that the eligibility of many

nonplant techniques is not clear.

Relating the nonfederal percentage share of costs more closely to nonfederal

benefits received would satisfy the characteristic of relevancy. Costsharing requirements can be made more continuous and certain by applying

the same percentage to all techniques and cost categories. Local uncertainty

in general could be further reduced if all technically viable alternatives

for abatement were eligible for grants and if eligible project costs were

always in practice awarded grants.

Redistribution of income, a second concept of equity, occurs in the cost

sharing of pollution abatement when the benefits and costs of abatement

are distributed to project interests in such a way as to change the prior

distribution of income. Conflicts of interest over redistribution result

when persons from whom benefits are withdrawn or on whom taxes are imposed

consider such a redistribution to their personal disadvantage and perhaps

also not in the national best interest,* For example, the Federal taxpayers

that support through general taxes a Federal grant program that helps a community combat its wastewater problem, which is essentially local in

nature, have their income redistributed to people in the recipient community.

Equity in the redistributive sense defined here is not treated in this study.

*For a discussion of the relationship between cost sharing and redistribution, and of the implications of using cost sharing as a tool to

effect various kinds of redistribution, see Marshall and Broussalian,

Federal Cost-Sharing Policies for Water Resources , ppo 216-224,

67
Section IV References

1. Davis, Robert K. The Range of Choice in Water Management, A Study of

Dissolved Oxygen in the Potomac Estuary, p. 125-126.

2. Raymond, Richard. The Impact of Federal Financing Provisions in the

Federal Water Pollution Control Act Amendments of 1972. Public

Policy. 22:109-110, Winter 1974.

3. Water Policies for the Future. National Water Commission. Washington, D.C.

U.S. Government Printing Office. Final report to the President and

to Congress of the United States. 1973. p. 77, 485-525.

A. Ibid . , p. 78.

5. Ibid . , p. 79.

6. Ibid .

7. Ibid . , p. 80.

8. Marshall, Harold E. , The Relationships Between Local Cost-Sharing and

Efficient Water-Resource Development (unpublished Ph.D. dissertation.

The George Washington University, 1969), p. 56-89, has a more

comprehensive survey of the literature on cost sharing.

9. Regan, Mark. Sharing Financial Responsibility of River Basin Development.

In: Economics and Public Policy in Water Resources Development,

Smith, S. C. and Castle, E. N. (eds.). Ames, Iowa State University

Press, 1961. p. 215.

10. Renshaw, Edward F. Toward Responsible Government: An Economic Appraisal

of Federal Investment in Water Resource Programs. Chicago, Idyia

Press, 1957. p. 50.

11. Loughlin, James C. Cost-Sharing for Federal Water Resource Programs with

Emphasis on Flood Protection. Water Resources Research. 6^(2) ;377,

April 1970.

12. Marshall, Harold E. Economic Efficiency Implications of Federal-Local

Cost Sharing in Water Resource Development. Water Resources Research.

6(3): 673-682, June 1970.

13. Ibid. , p. 67A-676.

1^- Ibid . , p. 677-679.

15. Marshall, Harold E. and Vartkes L. Broussalian. Federal Cost-Sharing

Policies for Water Resources. National Bureau of Standards.

Springfield, Va., National Technical Information Service. No. PG-208-

304. National Water Commission. 1971. p. 201-214.

68
16. Ibid., p. 121-128.

17. Rafuse, Robert W. Jr. and Michael D. Sherman. The Implications of the

Net Fiscal Benefits Criterion for Cost Sharing in Flood Control

Projects. Mathematica Report. Washington, D.C. IWR Report 71-12.

Institute for Water Resources, the Corps of Engineers. 1971. p. ii,

49-51.

18. Ibid . , p. 51.

19. Ibid. , p. ii.

20. Water Policies for the Future. National Water Commission, p. 485-525.

21. Ibid., p. 494.

22. Ibid . , p. 495.

23. Marshall, Harold E. Salinity Control and Cost Sharing. In: Proceedings

of the Western Resources Conference, 1973. Boulder: University of

Colorado, July 9 and 10, 1973. In press.

24. Marshall, Harold E. Cost Sharing as an Incentive to Attain the Objectives

of Shoreline Protection. National Bureau of Standards. Washington,

D.C. NBSIR 73-294. Corps of Engineers. December 1973. p. 21-23.

25. PL 92-500, Sec. 212(2)B.

26. Marshall, Harold E. Economic Efficiency Implications of Federal-Local

Cost Sharing in Water Resources Development, p. 674-675.

27. U.S. Congress, Senate. Policies, Standards, and Procedures in the Formulation

Evaluation, and Review of Plans for Use and Development of Water and

Related Land Resources, Sen, Doc. 97, 87th Congress, 2d sess., 1962,

V(c)(2).

28. Marshall, Harold E. and Vartkes L. Broussalian. Federal Cost-Sharing

Policies for Water Resources, p. 58-65, and Marshall, Harold E. Economic Efficiency Implications of Federal-Local Cost Sharing in

Water Resource Development, p. 675-677.

29. Shoup, Carl S. Public Finance. Chicago, Aldine Publishing Co., 1969. p. 23,

69
SECTION V

EFFICIENCY IMPLICATIONS OF EXISTING

AND ALTERNATIVE COST-SHARING PROGRAMS

In this section we evaluate the existing and alternative cost-sharing

programs with respect to the efficiency conditions outlined in Section IV.

Some case examples are given of biases for particular techniques of abatement caused by existing cost-sharing rules.

TECHNIQUES

It was shown in Section IV that identical cost shares must apply to each

technique considered for the purpose of abatement if the grant recipient

is to be encouraged by cost sharing to select the nationally efficient

combination of techniques under all conditions. Current rules for cost

sharing pollution abatement, as described in Table 2, are not identical

for all techniques. Thus communities may be biased towards nationally

inefficient techniques for pollution abatement.

The hypothetical example in Table 5 illustrates how cost-sharing, unevenly

applied among alternative techniques, can make the most costly technique

to the nation become the least costly technique to the local community.

The three techniques shown in the table are assumed to be equal in terms

of benefits from abatement, but to differ greatly in total cost.* By

comparing the last two columns, we can see that the ranking of techniques

*The assumption of equal benefits here is made to simplify the example.

Benefit-cost analysis could be used to demonstrate bias effects even where

benefits differ among techniques and where the local-Federal distribution

of benefits differs by technique.

70
in order of largest to smallest cost to the nation is techniques 1, 2,

and 3; whereas, the ranking in order of largest to smallest cost to the

local community is just the inverse, techniques 3, 2, and 1. The potential

local bias is even greater than Table 5 implies, however. The cost of

technique 1, for which the Federal government pays 75%, can be a maximum

of four times as much as technique 3, for which there is no cost sharing,

and still be preferred by the local community as the cheaper technique.

The maximum biases among techniques are computed by dividing the nonfederal

percentage cost share of one technique by that of another. Thus the bias

of technique 1 over technique 3 (^]^.3) calculated by dividing the nonfederal cost share of technique 3 by the nonfederal share for technique 1.

That is, 1.00/. 25 equals A. Similarly, technique 2, with 50% cost sharing,

can cost twice as much as technique 3, which is least-cost to the nation,

and still be of lesser cost to the local community. That is, the ^2.^ is

1.00/. 5 or 2.*

Table 5, IMPACT ON LOCAL PROJECT COST OF

DIFFERENT COST-SHARING RULES: AN ILLUSTRATION

Total Project

Nonfederal Federal Total Project Cost to the Local

Techniques Cost Share Cost Share Cost to the Nation Community

1 25% . 75% $50,000 $12,500

2 50% 50% $30,000 $15,000

3 100% 0% $20,000 $20,000

*RayTnond has discussed the potential or maximum bias inherent in

Federal cost-sharing rules in "The Impact of Federal Financing Provisions,"

pp. 5-6.

71
The roHt-sharing rule to eliminate these biases is to cost share each

technl(iiic in tho same proportion. This rule will be effective no matter what

actual perct'utage figure is chosen.

To encourage consideration of new technologies that might not be known at the

time legislation is drawn up, the cost-sharing eligibility condition could be

specified simply as all technically viable alternatives, thereby leaving

room for expansion of eligible techniques. As long as the same percentage

rule applies to all techniques, there will be no problem with choosing the

nationally efficient technique(s) , because the community will be seeking a technique that is simultaneously least costly to it and to the nation.

A related problem that results from cost sharing all technically viable techniques is determining what part of that technique provides abatement per se,

and consequently what part of the costs of that technique should be cost

shared under the abatement program. For example, rehabilitation of the

collection system to prevent infiltration is a technique that serves at

least two purposes: expanded collection capacity and abatement benefits

inherent in reduced infiltration. On efficiency grounds, only those costs

that can properly be allocated to the purpose of abatement should be cost

shared. Furthermore, the cost share applied to those allocated costs must

equal the share applied to other techniques of abatement. A higher Federal

subsidy would result in an overutilization of improvements in collection

as an abatement technique, whereas providing no Federal subsidy would bias

communities against improvements in collection as an abatement technique

although in fact it might be the most efficient technique.

Allocating costs accurately between abatement and other purposes in a collection rehabilitation project that serves multiple purposes is a difficult task.* Because reaching a proper allocation of costs among purposes

*The theory and practice of cost allocation has not been undertaken

in this study. For a description of three commonly used methods of allocating

costs among multiple-purpose projects in water resource programs, see Marshall and Broussalian, Federal Cost-Sharing Policies for Water Resources , pp. 29-34 and pp. 251-253.

72

II
in difficult, two approaches that do not require cost allocation are conHldered licre for encouraging efficient techniqueCs) in a multiplepurpose project. One is to share the costs of a technique that satisfies

multiple purposes, but at a lower rate than techniques that satisfy only

the pollution abatement purpose. If designed properly, this rule would

have the same impact of sharing equally all techniques where only those

costs applicable to abatement are eligible. The problem still remains,

however, of choosing the appropriate reduced cost share. A Federal share

that is too high will encourage overutilization of the given technique for

abatement, and a Federal share that is too low will encourage underutilization of that technique.

Another approach is to use benefits as an index to costs in determining

either the cost allocation or the appropriate reduced cost-sharing rate

for a technique satisfying multiple purposes. However, the distribution

of benefits among purposes has no necessary relationship to the costs, and

using benefits as an index is therefore not recommended.

Without in-depth investigation into this problem^ the only concrete suggestion

that can be made regarding the cost sharing of techniques serving more

than one purpose is that, on the basis of an efficient allocation of resources to abatement, a lower Federal cost share should be applied to

techniques that provide benefits other than abatement than to techniques

which provide abatement only, and that the cost share should decrease as the cost of providing these other benefits increases relative to the cost

of providing abatement. Thus, existing practice which excludes collection

systems in new communities from grant eligibility appears compatible with

this efficiency criteria. It would further appear that repairs to old

collection facilities for the purpose of reducing infiltration be Federally

shared to some extent, although not at as high a rate perhaps as a technique

for treatment only.

Rehabilitation of collection works to prevent infiltration is just one example of a technique that serves more than one purpose. Other existing

(and future) techniques for abatement might serve multiple purposes, and

thus a reduced Federal cost share would properly be applied to them also.

73
The previous discussion has dealt with eliminating biases by cost sharing

all techniques for abatement equally. But to eliminate the bias from

unequal cost sharing of techniques, it is not sufficient just to require

that certain categories of costs be eligible for the same percentage cost

share for all techniques. Biases to choose certain techniques still

result when cost-sharing rules which do not cover equally all categories

of costs (i.e., different percentage shares are provided for capital as compared to 0 & M or land costs) are applied to techniques with different

cost composition (i.e., techniques with differing ratios of capital costs

to 0 & M and land costs). Because 0 & M costs, for example, are not shared

at all by the Federal government, while capital costs are (see Table 2),

grant recipients will be biased towards capital-intensive techniques even

though all techniques may be eligible for the same percentage share of

capital cost. Likewise, grant recipients will try to avoid projects

requiring expensive acquisition of lands for the project site. These

responses occur because the effective nonfederal cost share is unequal

among techniques (i.e., c^ ^ c^)

Table 6 shows the impact on local costs of a cost-sharing rule which

does not apply equally to all categories of cost. The cost figures in

the table are actual estimates for three alternative treatment techniques

evaluated for the Cleveland-Akron area.''" All techniques are purported to

meet effectiveness standards, but they differ in the amount of total

costs and in their relative proportions of capital, 0 & M, and land costs.

Construction costs (comprising capital and eligible land costs) of the

land treatment technique account for about two-thirds of the total costs

of that technique, and substantially less for the other two techniques.

The land treatment technique has the highest cost to the nation ($183,200

compared with $148,500 and $144,600). The effect of the cost-sharing rule,

however, is to make the land treatment technique the least costly to the

local community ($92,525 compared with $100,350 and $106,725).

The maximum biases among the techniques are calculated from the local

percentages of total national costs, as shown in the far right column of

Table 6. The B^,^, for example, is .74/. 51 or 1.45. This means that

74
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than the physical-chemical plant technique, i.e., nearly $70,000

dollars more, and still be the least costly to the community.* Similarly,

The 1.33, and the B^^^ is 1.09.

The efficiency implication again is that local communities may select

techniques that are not cost-effective to the nation. The cost-sharing

rule to eliminate this bias is to share all categories of cost for all

abatement techniques in the same proportion.

There are, however, alternative cost-sharing rules for arriving at the same

(or nearly same) effective cost share for all techniques which may be used

in lieu of applying the uniform rule across all cost categories. Some

of these alternatives are discussed in the event that institutional or other constraints preclude application of the uniform rule.

The possible cost categories to share are land, capital, 0 & M, any combination of the three, or none. The "none" category can be dismissed as a plausible alternative because we are assuming that some grant program will

be administered. Although, as we have seen above, applying a uniform

percentage to all categories of costs would be optimal on efficiency grounds,

let us suppose that for some reason only one category of cost could be

Federally funded. As an example, let us assume that Federal grants can

be made for capital expenses only. This assumption parallels actual

Federal cost sharing practice in wastewater pollution abatement, wherein

0 & M costs have traditionally not been shared.** Let us further assume,

*Note that Table 6 represents one particular case and is not intended to Imply

anything about the general cost relationship of the three techniques discussed.

**There are several reasons for sharing only capital. Practical financing

problems face the Federal and nonfederal administrators of 0 & M grants in

that these grants would accrue to local communities over time and they would

probably vary with growth conditions, inflation, and other uncontrollable

variables. Operation and maintenance grants are entirely open-ended drains

on grantors' budgets. Capital grants, on the other hand, are easier to

administer because they are more precise in total amount and in the time of

allocation. Given these and other considerations, it is not surprising that

grantors would not want to share 0 & M costs.

It is recognized that, theoretically, 0 & M alone could be funded rather

than capital with the rules to be developed. But since capital is most likely

to be funded in practice, we focus on it in the examples.

!

76
to keep the problem simple, that most of the costs are attributed to either

capital or 0 & M. Thus nonfederal interests are biased against choosing

techniques that are 0 & M intensive.* Moreover, grant recipients might

be expected to cut the quality and degree of 0 & M below what might be

attained with Federal aid.

To counteract these biases, several approaches might be considered. One

is to award an add-on Federal capital subsidy for a project design that

Incorporates the appropriate level of 0 & M and another add-on capital

subsidy over time based on the quality of performance of the grant recipient

in the actual 0 & M of the abatement project. These incentives might be

criticized on the grounds that existing water quality standards require

a certain quality of abatement and that extra capital subsidies are unnecessary for inducing good 0 & M planning and performance. However,

when no penalties are imposed for failure to comply with standards, the

add-on subsidy becomes relevant.

Under a program of subsidizing capital only, another approach to eliminating

the bias against techniques that are 0 & M intensive is to vary the Federal

capital grant among techniques so that the grant as a percentage of total

projects costs, i.e., the effective grant, will be uniform across all techniques. It was shown in a hypothetical example in Table 6 that grant

recipients would be biased towards technique 1 even with the same Federal

capital share among all techniques, because the ratio of capital costs to

other costs was higher for technique 1 than for techniques 2 and 3. If

the percentage of total costs could be equalized among techniques by making

the Federal capital share vary among techniques, this bias could be

eliminated. **

*Due to the compensation arrangement for architects/engineers that

is based on construction costs (see Section III), a bias also exists for

the contractor-planner to design capital-intensive abatement projects.

**Calculating the percentage cost shares for any particular project for

different techniques would not be difficult in that project plans include

costs by categories.

77
With the uniform rule applied across all roHt cateoglres, any Riven percentage

share of total costs would encourage community selection of the nationally

efficient technique. However, with subsidization of capital only, the

percentage figure would have to be transposed into an effective capital

cost share that would vary with every change in the composition of cost

categories. For example, to make the effective local total cost shares

equal in Table 6, let us say at 25%, the local share for construction would have

to be 38% for technique 1, 58% for technique 2, and 72% for technique 3.

Applying these different rules to construction for each technique would have

the same effect as charging local Interests 25% of all categories of costs.

Yet another approach to reducing the bias against 0 & M intensive techniques

while sharing only capital costs is to restrict the effective Federal

share for all techniques by some predetermined percentage. Such a constraint

will prevent a capital-intensive technique under a capital cost-sharing

program from receiving a much higher grant award than a less capital-intensive

technique. Table 7 illustrates the determination of a percentage constraint

and the biases among techniques with and without imposing that constraint

As shown in rows 1 and 2 of the table, the three abatement techniques

differ greatly in the relative composition of cost categories, ranging from

practically all capital in the case of the collection and outfall systems,

to only about one- third capital in the case of in-stream aeration. The

third row of the table shows the computation of project cost to the local

community under the existing grant program of a 75% Federal share for

capital and a zero percent Federal share for 0 & M. The fourth and fifth

rows give the percent of total costs borne by the local and Federal sectors

respectively. The Federal share comprises 70% of the total cost of technique 1,

49% of technique 2, and 25% of technique 3. The percentage Federal cost-sharing

constraint which will be just adequate to eliminate the bias is equal to the

effective Federal cost share for that technique for which the Federal cost

share is lowest. Accordingly, in this example, the constraint will be the

lowest percentage in row 5, i.e., 25%.

78
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In the sixth row we calculate the maximum biases. Under the assumed rule

of !i Ti"/, Federal capital cost share, the dollar cost to the nation of

technique 1, the most capital-intensive project, could exceed by about

two-and-one-half times the cost of the least capital-intensive project,

technique 3, and still be favored by the local community.* That Is, the

maximum bias of technique 1 over technique 3 (^^^.3)' .75/. 30, or 2.5.

Similarly, ^-^.2 ^2*3 displayed in Table 7.

Limiting Federal capital grant funds to an amount equal to 25% of total

project cost for all techniques is a constraint that would eliminate the

bias towards techniques 1 and 2 as compared to technique 3. The modified

cost rule would be that the Federal grant program would pay 75% of capital

costs and 0% of 0 & M costs, but that the Federal share will not exceed

25% of total project costs. In the example, the cost to nonfederal interests

is raised from 30% of total project costs to 75% for technique 1, from 51%

to 75% for technique 2, and remains 75% for technique 3. Thus the value

of the bias between all three techniques becomes one, which means there

is no cost-sharing advantage of one technique over another, when the

constraint is imposed.

Note what occurs if the constraint on the Federal capital share is set

above or below the maximum percentage required to eliminate the bias, in

this case 25%. If we assume a 40% Federal limit, for example, row 7 shows that the B^^^ and the ^2-3 ^^^^"^ t)e 1.25. Thus whenever the constraint

is above the lowest effective Federal cost share, the biases will not be

totally eliminated. If, on the other hand, we assume a lower constraint, say,

in this example, 10%, the local shares as a percentage of total costs would

all be 90% and the biases 1, i.e., there would be no cost-sharing advantage

of one technique over another. In this case picking a constraint under

25% is in effect an "overkill" of the bias, because once it reaches 25%

there is no more bias to be eliminated.

*For example, other things equal, a local community would be indifferent

to a project utilizing technique 3 at a cost of $10,000 as compared to a project utilizing technique 1 at a cost of $24,900. This represents a potential national efficiency loss of $14,900.

80
Instead of estimating the appropriate funding constraint on a case by case basis, it could be expressed as a single percent to be applied to

all projects and incorporated into the cost-sharing rule. Such a constraint

would be Homewliat arbitrary and would not necessarily eliminate all potential

biases among techniques. However, if set sufficiently low, it would reduce

the extremes of bias between techniques with very different cost composition,

and would likely eliminate all biases between techniques that have a relatively high percent of costs of the type shared.

There are then approaches to the sharing of one category of cost that will

encourage nationally efficient decisions on the part of nonfederal interests

even where techniques differ with respect to their cost composition. The

constraint approach seems a practical one for at least reducing large

biases among techniques. The constraint approach has the additional

desirable feature of providing a percentage limit to Federal expenditures

for any given project. If the decision were made to disburse a given

Federal budget among more projects, setting the Federal constraint at a lower percentage would be an effective approach in accomplishing this

objective.

SCALE

It was shown that the Association Rule (AR) , i.e., charging grant recipients

a cost share equal to their benefit share at the margin, would encourage

local communities to choose a scale of pollution abatement that is nationally

efficient in terms of maximizing net national benefits. The scale implications of alternative rules are considered here to see how they rate according to the objective of maximizing net national benefits.*

The basic 25% nonfederal share for capital and land processes allowable

under the existing rule appears lower than the likely share of total project

benefits that would accrue to nonfederal interests at the margin. This

*It was pointed out earlier that EPA has no stated objective to

maximize net national benefits in pollution abatement. If such an objective

were to be established, however, it would be useful to see how existing

rules rate.

81
statement is based on the following rationale: Whereas many of the benefits

from a community abatement project are likely to accrue downstream from

the community building that project, generally moat of the abatement benefit

will accrue within a geographical area that may be identified as a county, state, regional group of states, or as one or more of the 173

economic accounting areas that have been recommended by the Water Resources

Council for measuring regional development impacts. Because the nonfederal

benefit share can be defined as all benefits that accrue at the municipal,

state, and regional levels, and because most of the project benefits are likely to accrue within these boundaries, it seems reasonable to expect

a high proportion of project benefits to be nonfederal.* The proportion

of benefits in total and at the margin for nonfederal interests is therefore expected to be higher than the current cost share that is indicated

by a 25% nonfederal capital share. It may be true that the community that

receives an abatement grant and that has to build the project may receive

only a very small proportion of total nonfederal benefits, but the ratio

of nonfederal to Federal benefits remains high. This situation may be

indicative of the need for effective regional cost-sharing management

systems, and not necessarily larger Federal grants to the community.

The existing Federal share of 75% seems high even for large cities and

regions, where downstream and widespread users of water receive some benefits of abatement. It seems particularly high for small communities that

might use septic tanks or spray irrigation and impact little on water

quality in other areas. At the same time, existing Federal cost-sharing

arrangements exclude from funding a technique such as low-flow augmentation

that is likely to have more direct downstream or widespread impacts than

techniques such as community septic tanks, which are eligible for funding.

This difference in eligibility seems in conflict with achievement of both

efficiency and equity.

If the nonfederal share of benefits at the margin exceeds the cost share,

then there will be an ef f iciency-in-scale bias for overdevelopment of

abatement; i.e., nonfederal interests will be encouraged by the cost

share to devote too many resources to pollution abatement, other things

*We do not deal here with the problem of collecting from the various

project beneficiaries their portions of the nonfederal cost share.

82
being equal. Yet there appears to be a deficit in pollution abatement

activities, and few new plants for treatment are being built under the

1972 Act. This is true even where the state contributes extra money so

that the community's cost share Is even further reduced (down to 12.5%

for capital in New York communities). We feel that this discrepancy does

not suggest that Federal cost sharing is necessarily too low, but rather

that other factors may be limiting development. For examples, institutional

constraints (see Section III) and uncertainty regarding ultimate allocation

of Federal money may actually be more significant than cost-sharing rules

in discouraging certain kinds and levels of abatement activities. Limited

local funds and competing demands of alternative local investment opportunities yielding greater local benefits might result in few funds available

for abatement. Abatement projects might be particularly at a competitive

disadvantage for scarce funds where communities bear most of the nonfederal

cost share but only receive a small proportion of the more widespread

nonfederal benefits. In some cases communities responsible for abatement

may be interested primarily in disposing of wastewater, rather than in

abating pollution resulting from the wastewater. With this narrow view,

the community sees its major wastewater problem as simply disposal, and

therefore it is concerned with collection and transmission more than

abatement. If communities perceive their benefits only from the standpoint of collection, then this might explain in part why even with availability of a 75% Federal capital grant, communities have not been induced

to undertake many new projects for pollution abatement.

Effluent standards and other government regulations today make consideration

of abatement activities mandatory for communities. So whether or not

they perceive the benefits of pollution abatement accruing to them per se,

they are faced with legal abatement requirements and penalties which

may or may not be imposed for failure to comply. Given this requirement,

possible penalties, and a responsible attitude on the part of communities,

it seems reasonable to assume that local communities will perceive some benefits from abatement, even if it is simply to meet improved standards.

We assume, therefore, in the following discussion of scale, that communities

do receive some positive net benefits from abatement.

83
Although the AR is the appropriate cost-sharing rule for eliminating any

overbuilding or underbuilding bias in terms of the net benefits maximization

criterion (see Section IV), there are practical drawbacks to this ruld.

Drawbacks are the fairly detailed information requirements on the incidence

of benefits; the political acceptability of a rule that probably reduces

drastically the Federal share and calls for a varying rather than fixed

percentage rate among projects; and the relatively complex nature of the

rule in practice. For this reason, we consider alternatives to the AR,

as well as to the existing rules.*

We know that the level of cost-sharing, other things being equal, has

some incentive effects on the pollution abatement that local communities

will demand (see Section IV). We also know that an objective of the EPA

grant program is to encourage abatement of wastewater pollution. A

practical cost-sharing alternative then will involve the application of some positive Federal share to pollution abatement. In the following

discussion we shall consider alternative cost-sharing rules in two ways:

how they affect scale and how much they would have cost the Federal and

nonfederal participants if they had been applied in meeting the historical

abatement that has been sponsored by EPA.

Table 8 describes historical cost sharing for EPA and three of the four . cost-sharing alternatives discussed in this section: (A) the current rule;

(B) an equal percentage rule for all cost categories but costing the same amount

of money as A; and (C) the current rule imposed with a percentage constraint.**

Each rule is examined in terms of how much it would have cost Federal and

nonfederal participants had it been applied in meeting historical abatement

*For an evaluation of alternative cost-sharing rules for encouraging

the selection of the nationally efficient scale, see Marshall and Broussalian,

Federal Cost-Sharing Policies for Water Resources , pp. 173-240.

**The fourth rule discussed earlier was a varied cost share applied

to different cost categories such that the effective nonfederal share

among techniques is equal. This rule was omitted from the table because

of the lack of data necessary to illustrate it.

84
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85
costs of projects sponsored by EPA through 1972. Total costs of abatement

to which the rules are applied are $20,600 million, of which $13,400 is

for construction and $7,200 is for 0 & M.*

Historically the Federal share of total costs is estimated to have

averaged 24%. This is based on average Federal shares of 36% for con- struction cost (K) , and zero percent for 0 & M costs. The Federal absolute

share was $4,900 million and the nonfederal share is estimated to have

been $15,700 million.

Rule A is the current rule that applies only to construction costs. Given

the $13,400 million construction cost and the $7,200 million estimated

0 & M cost, the nonfederal share of total costs would be $10,550 million.

Thus a nonfederal share of 25% of capital would be equivalent to approximately

51% of total costs.

Rule B is designed to cost nonfederal interests the same amount of money

as was spent for Rule A ,** but with the local cost share equal across

all categories of cost. Equilibrating the cost shares among cost categories

demonstrates that any potential biases among techniques resulting from

sharing cost categories differently could be eliminated without any

change in the absolute nonfederal or Federal costs that are borne. In

fact, by encouraging consideration of less capital-oriented techniques

that may be less costly to the nation, nonfederal, Federal, and total

costs of achieving a given level of abatement might be reduced.

Rule C applies a constraint on the size of the Federal grant under the

current cost-sharing rule. The purpose of the constraint is to ameliorate

the biasing effect of unequal cost sharing of cost categories. The

*The capital costs of EPA projects through December 1972 were taken

from U.S. Environmental Protection Agency, Project Register; Waste Water

Treatment Construction Grants (Washington, D.C. : Environmental Protection

Agency), December 31, 1972. The method of estimating total costs is

described in Table 8.

**Actual dollar amounts are slightly different due to rounding of

the percentage share figures.

86
percentage chosen here for Illustration of the constraint is 37%.* Applying

the 37% constraint against the current 75% Federal share for capital could

reduce or leave unchanged Federal expenditures relative to Rule A, depending

on the ratio of capital to total costs. That is, as the ratio of capital to

total costs rises above the level where the constraint becomes effective, the

Federal responsibility becomes fixed for Rule C, whereas it continues to

increase for Rule A. A nonfederal absolute share of $12,978 million becomes

a minimum with Rule C. Had it applied historically, and assuming that

abatement controls or standards did not compel communities to implement the

level of abatement assumed in Table 8, we might expect that the actual

expenditures in total and for each participating party would have been less

with Rule C than with the other rules. Expenditures would probably have

been less because some projects would have received less Federal funding and

would have, therefore, been less attractive to nonfederal interests.

Also, some of the bias among techniques due to different compositions of

cost categories (see Table 7 and its explanation) would have been eliminated

or reduced with Rule C because of the constraint. Given the techniques in

Table 7, for example, imposition of a 37% constraint would eliminate the

B^,2 reduce the ^-^.^ ^^'^ ^2*3* lower the percentage constraint

on the Federal cost share, the stronger would be the correction to the bias

among techniques and the stronger would be the restraint on the scale of

abatement demanded by the nonfederal interests.

Whichever of these approaches is taken, a percentage target must still be

chosen. An effective Federal share of total costs less than the 49%

implied by existing rules would probably tend to encourage more efficient

scales of abatement. However, since available information regarding the

incidence of abatement benefits is not comprehensive, further research

is needed before some specific figure is selected.

*The 37% share is an average of 24%, the Federal percentage of

total costs paid on average from the inception of the EPA program to

present (Table 3), and of 49%, the Federal percentage of total costs

implied in the current law and in the composition of capital versus 0 & M

assumed in Tables 7 and 8.

87
If cost sharing were to be used as a tool simply to encourage higher

levels of abatement with no regard for the nationally efficient scale,

then the appropriate direction of Federal cost sharing would be up

rather than down. As shown in Section IV, local interests will tend

to demand larger quantitites of abatement, other things equal, as the

Federal cost share is raised. It is recognized, however, that allowing

larger Federal contributions will result in funding fewer abatement

projects with a given Federal budget.

Although no specific percentage is recommended here for cost sharing pollution

abatement, the following general conclusions for encouragement of the

least-cost technlque(s) and the efficient scale are reached. Whatever

percentage is selected, it should apply uniformly across all techniques

and cost categories within techniques. If only one cost category can be

shared, then the most efficient rule would be to vary the cost share of

that category among techniques so that the effective nonfederal cost

share by technique will be the same for a project or in general for all

projects using those techniques. If the variable cost share by cateogry

were not acceptable on institutional grounds, then a Federal percentage

constraint might be used to eliminate some of the biases resulting from

different cost compositions.*

Cost sharing by the Federal, versus nonfederal, sector has been the exclusive

focus here, and cost sharing by other groups has been ignored. If the

nonfederal sector (state, for example) applies different rules in conjunction with a Federal agency that has implemented the rules outlined here,

the implications for scale and techniques may vary from the above description.

The principles outlined for the Federal agency apply, however, equally

as well to nonfederal participants. To assess the total impact of cost

sharing, the cost-sharing rules of all participants would have to be

considered.

*Because there are an infinite variety of rules that might be designed

for sharing one type of cost or for constrained cost sharing, we do not

attempt to make any general statement about how equitable they will be.

88
Section V References

1. Raymond, Richard. The Impact of Federal Financing Provisions in the Federal

Water Pollution Control Act Amendments of 1972. p. 6.

89
SECTION VI

EFFECTS OF USER FEES ON COST SHARES*

Legislated user fee arrangements appear to affect the efficiency of the

present grant program in that they influence the effective cost shares

of Federal and nonfederal interests, and thereby create biasing effects

in the selection of abatement techniques and in decisions regarding scale.

User fee arrangements also appear to have differential impacts on residential as compared with industrialized communities.

This section is divided into four parts. The first part examines the

legislative description of user charges. The second presents four alternative interpretations of the effects of user fees on cost shares, and assesses

the validity of each. The third part critiques the current practice of

excluding interest charges from industrial user fees. The final part

assesses the impact of user fees on selection of abatement techniques, on selection of the scale of abatement facilities, and on subsidization of

residential as compared with industrial communities.

*User fees for pollution abatement are charges for waste disposal levied

on users of sewerage removal and treatment services or on users of watercourses. Several reasons for imposing a fee in pollution abatement are

the following: to obtain revenue to defray the costs of providing abatement;

to encourage polluters to consider alternative and perhaps less costly

techniques of waste disposal; and to ration efficiently the use of sewerage

services

In this study the focus is on cost sharing as it affects the choice of

a particular technique or level of abatement. Accordingly, user fees are discussed here in the context of their effect on abatement cost shares,

rather than in the conventional sense of resource allocation and revenue

generation, per se .

90
LEGISLATED USER FEES

With respect to legislative requirements for user fees, Section 204 (b)(1)

of the 1972 Act states the following:

. . . The Administrator [of EPA] shall not approve any grant

for any treatment works . . . unless . . . the Applicant has

adopted or will adopt a system of charges to assure that each

recipient of waste treatment services within the applicant's

jurisdiction . . . will pay its proportionate share of the

costs of operation and maintenance ....

In effect, this section provides for collection of user fees to repay

0 & M expenses from all recipients of services.

Section 20A (b)(1)(B) requires that the Administrator shall also have

determined that the applicant has done the following:

. . . made provision for the payment to such applicant by the

industrial users of the treatment works, of that portion of

the cost of construction of such treatment works (as determined

by the Administrator) which is allocable to the treatment of

such industrial wastes to the extent attributable to the

Federal share of the cost of construction ....

In other words, user fees will be collected from industrial users to pay

that portion of the grant amount allocable to treatment of industrial

waste.

It is further specified in Section 294 (b)(3) that the grantee do the

following:

. . . retain an amount of the revenues derived from the payment

of costs by industrial users of waste treatment services, to the

extent costs are attributable to the Federal share of eligible

project costs pursuant to this title as determined by the Admistrator, equal to (A) the amount of the non-Federal cost of such

project paid by the grantee plus (B) the amount, deteirmined in

accordance with regulations promulgated by the Administrator,

necessary for future expansion and reconstruction of the project

except that such retained amount shall not exceed 50 per centum

of such revenues from such project.

In effect, this last section means that the grant recipient will retain

50% of the amount recovered from Industrial users against the Federal

grant. The 50% limit is the effective rule for retention of users fees

because the sum of the nonfederal capital cost and the amount necessary

91
for future expansion and reconstruction will under normal circumstances

exceed 50% of the amount recovered from industrial users. This may be

demonstrated as follows: The above statement from Section 20A (b)(3)

provides for retention of an amount equal to the sum of (1) the amount of

nonfederal construction cost, which under the existing program is 25% of

construction cost (K) , and (2) an amount (E) for future expansion and

replacement; i.e., a total amount equal to .25K + E. The same Section

further defines the limit of retained earnings as 50% of industrial user

fees collected against the grant. This amount may be expressed as .5(.75BK),

where 6 is the grant share allocable to industry, K is the amount of

eligible construction costs, .75K is the amount of Federal grants and .75BK

is the amount of industrial user fees collected against the Federal grant.

Only in the case of a contraction in future costs of abatement facilities

(such as might result from a drop in population, or from a technological

breakthrough reducing the costs of abatement facilities, and/or from a decline in the general price level) would the amount necessary for future

expansion and reconstruction (E) likely be less than the amount of current

construction costs (K) . A sizable contraction in future costs appears

improbable, and the estimated future replacement cost alone would generally

be at least equal to the current amount of construction cost, i.e.,

generally we would expect E _> K.

Assuming E = K, and setting the two above expressions equal to one another,

we may determine the condition whereby .25K + E will not exceed the 50%

limit:

.25K + E = .5(.758K), where assuming no future expansion, i.e., E = K

1 .25K = .375BK. (23)

li = 3.33.

In other words, for 6 < 3.33, .25K + E > .5(.75BK). Since B, the industrial

share allocable to the grant, cannot by definition be more than the whole,

i.e., B _5 1, the condition under which .25K + E will determine the amount

of user fees is impossible under the assumed situation.

92
It, however, 1h not necessary to assume that E >^ K in order to demonstrate

that the 50% limit is the effective rule. It is necessary only that

E > .125K, since for any E > .125K, .25K + E will exceed the 50% limit. In

other words, even with a large contraction in future growth or a sharp

decline in replacement costs, the 50% limit will still be the effective

rule. Even for E = 0, as was assumed by Raymond in his analysis, ''^ 50%

is the effective rule as long as the percentage of the Federal grant

allocable to industry does not exceed 67%. Thus, that part of Section 204

(b)(3) which describes what user fees may be retained appears meaningless

from the standpoint of specifying alternative allowable amounts. The

real import of this Section of the 1972 Act was probably recognized in

formulations of recent program rules and regulations, where it is simply

stated that the grantee shall retain 50% of industrial user fees collected

against the grant.

ALTERNATIVE INTERPRETATIONS

Now that we have examined the legislative requirements for user charges,

let us consider how user fee arrangements affect the Federal and nonfederal

cost shares, and illustrate algebraically the impact of user fees on the

cost shares. In assessing the effect of user fees on cost sharing we are concerned with actual user fee practice as it has been developed from

administrative directives, and not solely the legislative requirements cited

above. The complexity of existing arrangements, however, gives rise to

alternative Interpretations of the effects on cost shares. Since the

total effects are not immediately obvious, we will build towards them by

presenting four alternative interpretations (each identified by subscripts)

based on successive levels of information. In the process we point out

the limitations of the first three interpretations and suggest why the

fourth version presented (i.e., equations 30 and 31) appears to represent

most closely current practice.

We begin by restating what cost shares appear to be, based on Section 202 (a)

of the 1972 Act and ignoring user fee practice. According to this provision

of the Act, the Federal grant for treatment works will be 75% of construction

costs. Current interpretation of this provision, as we saw in Section III,

93
Is that 75% Is a maximum, but not a minimum share of construction costs

of a completed facility. Thus, based on the current interpretation of

this basic legislation, the Federal agency will bear no more than 75% of

construction costs, and the grant recipient no less than 25% of construction

costs. Their effective percentage cost shares may be expressed respectively

as

C < -^^^ (24) - TC ^ ^

, r > .25K + M + L . . and C^^ > - (25)

where C =» the Federal agency's share of abatement cost,

F

C " the grant recipient's share of abatement cost,

R

K •= total costs of construction, i.e., capital and eligible land

cost,

M * present value of operation and maintenance costs over the

life of the abatement facility,

L = land costs not eligible for Federal cost sharing,

TC " present value of total costs of a completed abatement facility

over its life.

Now we take into account the effect of the user fee provisions as they

are set forth in the legislation. The first provision, i.e., that user

fees be collected from service recipients to repay their share of 0 & M,

does not appear to affect the grant recipient's cost share.* The

legislation merely specifies how the grantee shall cover one portion of its

cost share. Thus the grantee bears the full cost of 0 & M and covers,

by Federal directive, these costs with user fees collected from recipients

of abatement services.

*Tn this paper we Investigate the relative cost shares borne by the

Federal agency, and by the local government, focusing on the amount that

each must raise against its required share, rather than on who contributes

to each share.

94
The grantee's method (s) of generating revenue to cover Its share of construction costs Is not specified by the Federal government. Thus, at its discretion, the grant recipient may also collect user fees from the Industrial

and nonlndustrlal sectors of the community to defray the grantee's share

of capital costs. None of these activities affects the grantee's cost

share, merely Its method of generating funds to pay Its share.

The second provision, directing the grantee to collect user fees from

Industry equal to Industry's share of construction grant funds and to

retain half, does appear to affect the grantee and grantor's cost shares.

Based on the information we have presented thus far, the effect appears

to be to increase the effective Federal subsidy* by an amount equal to the

retained user fees and, thereby, to reduce the grant recipient's cost share

by a like amount. Accordingly, the Federal (grantor's) cost share and the

grant recipient's cost share can now be expressed respectively as:

.75K^^^5(.75BK) ^^^^

and C„ > M^L+ .ZSK- .SC-TSBK)

where 3 = that percentage of construction costs allocable to treatment

of Industrial wastes.

The retained user fees constitute a subsidy even though they are drawn

specifically from the Industrial sector of the grantee's jurisdiction.

They are viewed as additional subsidy beyond the original grant, because

they comprise revenue ostensibly generated to cover the Federal cost share

which Is given Instead to the grantee government.

Additional Investigation of user fee arrangements, however, shows us that

the real potential cost to the grant recipient is changed somewhat further

3

from equations (26) and (27), by Federal Regulations pursuant to the 1972

Act. Regulations stipulate that a minimum of 80% of the retained amounts,

plus Interest thereon, must be set aside in a reserve fund for future

expansion and reconstruction. The amount retained in this fund each year

*As a payment by the Federal government to a local government, the

grant constitutes a subsidy. By increasing the amount of payment by the

Federal government to the local government, the retention of user fees

raises the subsidy.

95
Is equal to

(• 8) (

• • ^SgK) ^ ^^BK^ ^^^^^ ^ ^ expected life of the

^ n n project, in years. Regulations allow the remaining 20% of retained user

fees to be used as a discretionary fund by the grantee as he sees fit.*

The amount of discretionary funds received each period is equal to

(.2)(.5)(.75BK) ^ .075eK ** n n

The reserve fund can be used only for eligible project costs related to

expansion and reconstruction of the original project and only with written

approval of the Regional Administrator. The holder of a reserve fund may

apply that fund to project costs for which a grant is requested or may use

them for project costs apart from any grant request. However, if a grant

ie forthcoming, it is required that the amount in the reserve fund be

deducted from eligible project costs for purpose of determining the size

*No clear rationale for the 80/20 percentage split of retained revenue

between reserve funds and discretionary funds was found.

**User fees to recover the industrial share of the grant are collected

over the life of the treatment works in annual payments equal to .3753K

divided by the number of years of expected life, and not including an

interest component. To correctly assess their value, it is necessary to

discount to the present the amount of both the discretionary funds and reserve funds. Discounting is necessary because the retained user fees

are received in increments over time and there is a time preference for

their receipt. The present values of the discretionary funds (PV^) and of reserve funds (PV ) are as follows;

K

PV = r -O^SgK .075eK[(l + i)" - 1]

D n(l + i)J ni(l + i)"

= " .3BK ^ .3eK[(l 4- i)" - 11

n(l + i)J ni (1 + i)n

where n = the number of recovery periods over the life of a project,

i " the discount rate,

X

= the number of periods before the fund is spent, during which

user fees have been collected from industry, and

(1 + i)" - 1 is the uniform present worth discount formula to

i(l + i)" convert a stream of annual payments to a present value.

96
of the grant.* Thus, whenever a grant is received, the reserve-fund-holder

has no choice but to apply the amount then in the fund to that project,

and have the amount of the grant thereby reduced; he need not, however,

have held the fund until a grant was forthcoming.

Since only 20% of the retained amount is discretionary, and the remaining

reserve portion reduces the amount of future grants, it may appear that

the grantee's cost is reduced by just the present value of the discretionary

fund rather than by the full amount of the retained revenue as is shown in

equation (27). This was the view expressed by some EPA grant officials.

According to this third interpretation, the cost shares of the grantor and

the grantee would be expressed as:

where D = the present value of the discretionary portion of retained

user fees.

The grantee's cost share as expressed above by equation (29) is greater

than that expressed by equation (27), which deducts the full amount of

retained fees from the grantee's cost; nevertheless, it is lower than

the grantee's cost share without retention of any user fees as denoted

by equation (25)

Let us now examine the effect of the reserve portion of retained earnings

(the reserve fund) more carefully. This leads to the fourth, and we believe most realistic, interpretation of the effect of user fees on

cost shares.

*In connection with determining grants. Section 35.927-17 of the Grant

Program Regulations provides the following*

. . . allowable project costs (are to be) reduced by an amount

equal to the unexpended balance of the amounts retained by the

applicant for future reconstruction and expansion , . . , together

with interest earned thereon.

.75K + D

TC

(28)

and

M + L + .25K - D

TC (29)

97
The reserve fund Increases the Federal contribution and reduces the

grantee's effective cost share, despite the fact that it may reduce the

nominal amount of the formal grant. That is, the net effect of the reserve fund is to reduce further the grantee's cost share beyond the

reduction rendered by the discretionary funds alone. The grantee's cost

share Is further reduced because the amount accumulated in the reserve

fund is applied to eligible construction costs without an equal reduction

in the amount of grant received. Specifically, the reserve fund impacts

upon cost shares in the following several ways: (1) it reduces the total

amount of eligible project costs by the amount of the fund, (2) it

reduces the amount of the formal grant by 75% of the amount of the fund,

and (3) it reduces slightly the amount of future retained user fees which

are based on the current grant. We shall consider further each of these

effects — the first one reducing the grantee's cost share, the second

two increasing it, but the three effects in net reducing the grantee's

cost share.

Since the reserve fund (R) was originally collected against the Federal share,

reduction of eligible project costs by the amount in the reserve fund results,

in itself, in a Federal contribution of R to abatement. After reduction by the reserve fund, K - R of eligible costs are left uncovered. Since the formal grant

is provided for 75% of the remaining eligible costs, i.e., .75(K - R) the

effective formal grant is lowered by .75R, as a result of the reserve fund. Thus,

the effect of the reserve fund is first to raise the Federal contribution by

an amount R and then lower it by an amount .75R, amounting in net to an increase

of .25R. Reduction of project costs by R means that only 25% of K - R in

eligible costs remain to the community government, rather than the full 25% of

K. Hence, the effect of R observed here is to reduce the community's effective

costs by .25R.

Now we complete our assessment of the reserve fund's impact by taking into

account the third effect noted above — the reduction in the grantee's future

receipts of user fees. The reserve fund reduces the future receipt of user

fees because the amount of the grant upon which these funds are partly based

is lowered by .75R. Hare, however, we Include in the cost share expression

the impact- of the reserve fund only on future receipts of discretionary funds

98
and not on future receipts of reserve funds. The reason is that in our interpretation of cost shares, we have chosen to evaluate the reserve

fund as a function of past grants, and the discretionary funds as a function

of the current grant. The assessment of the reserve fund as an accumulated

sum based on past grants means that any reductions in the amount which might

have resulted from previous reserve funds is already taken into account.

Expanding the cost share expression to include also the present value of

future reserve funds based on the current grant would result in over-counting

the reserve fund.*

Without the reserve fund, the present value of the future receipts of discretionary

^ .0756K funds is equal to E -^-rz—7—. v \ . But when accumulated reserve funds are taken

j^]^ n(l + i)J

into account, the present value of discretionary funds is equal to

n ^ 0753 (K — R)

i 77-^-—7Ti~' As R becomes larger and is deducted from K, the present

j=l n(l + i)J

value of the discretionary fund becomes smaller. Consequently, the reduction

in the grantee's effective costs becomes less.

Therefore, the reserve fund increases the effective subsidy on current projects,

while at the same time diminishing it on future projects by reducing the amount

of future discretionary funds. However, the increasing effects of the reserve

fund on the Federal subsidy substantially outweigh the decreasing effects,

thereby resulting in a net reduction in the grantee's cost share.

By combining the observed effects of the reserve portion of retained user

fees with that of the discretionary portion (as shown in the third Interpretation)

we have the fourth, and we believe, most complete, interpretation of cost

shares under existing user fee arrangements:

.75(K - R) + R + Dp \ ^ i5

and

M + L + .25(K - R) - D

\^ i5

4

*An alternative interpretation of cost shares would evaluate both the

discretionary and reserve funds in terms of the present value of future

receipts based on the current grant.

99
where C and C„ = the real effective cost shares of the grantor and

grantee, respectively, of a completed abatement

works, as determined by Federal legislation, regulations, and current practices of the grant program

office,

R = the present value of the reserve portion of retained user fees

which have been collected from industry against its share of

past Federal grants,

D " the present value of future discretionary funds taking into

R

account the effect of the accumulated reserve fund.

Table 9 shows a grantee's abatement coats for a hypothetical project with

and without the retention of user fees. In this example, the grantee's

share of construction cost is reduced from 25% to 12%, and his share of

total cost from 78% to 73% as a result of retaining user fees collected

against the Federal grant.

In addition to the user fee effect described above, there appear to be

other, more subtle effects of user fee arrangements on cost shares. For

one thing, existing arrangements appear to provide incentive to the fund

manager to spend the reserve fund on eligible costs of projects accorded

high priority by the community, but low priority in the grant approval

process. (Likely examples of such projects are sewage collection-related,

as opposed to more treatment-related projects.) By applying the R to

costs of projects which it wishes to undertake, but for which it is unlikely

to be successful in receiving a formal grant, the community can reduce by

R the amount of costs it otherwise would incur, without reducing its overall receipt of grant funds. By exhausting the fund prior to application

for a grant which it does expect to receive, the community will avoid

having the fund reduce the amount of the grant. With this approach the

community government could, over time, realize a Federal contribution to

abatement costs equal to .75K + R + D, rather than the .75K + .25R + D„R

contribution shown by equation (30). That is, it could in this way reduce

its costs by an additional 75% R, plus the value of the excess* of D over

*D represents the present value of the discretionary fundf D„ represents

the present value of the discretionary fund, taking into account the

reducing effect of the accumulated reserve fund; therefore D >^ D^.

100
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101
D_, beyond the reduction achieved by applying R to costs for which grants

are available. This, however, represents a special case which would hold

true only if the reserve fund Is applied to costs which the community would

have otherwise Incurred In full.

Another possible Impact of the reserve fund not heretofore noted is its

effect of Increasing the reserve-fund-holder's prospects of obtaining

additional formal grants. The grant office may accord higher priority to

the grant application of an applicant having such a fund than applicants

without a fund, due to the possibility of bringing forth a relatively

larger total project with a relatively smaller additional Federal grant.

This characteristic may provide conflicting incentives to that observed

above, insomuch as it may encourage the community to apply its fund to

partial payment of major projects for which it is actively seeking grant

assistance

In any case, the retention of user fees appears to raise the effective

Federal subsidy above 75% of construction costs, and reduce the grantee's

share below 25% of construction costs. As we have seen, part of the increased

subsidy results from the discretionary portion of retained user fees and

part Is attributable to the reserve fund.

INTEREST CHARGES ON USER FEES

Existing program regulations require that user fees collected from industrial

4 users not Include an interest charge. User fees are collected In fixed

annual payments collected over the life of the facility or over 30 years,

whichever is less. The present value of the total amount collected from

^ . 75BK industry is equal to Z n(l + l) j' ^"'^ amount retained by grantees

J 1 ^ .3756K

is equal to I ^ ^^j . The user fee revenue earns interest only after

102
it is collected and placed In an interest-bearing account or securities.

As a result of the omission of an interest charge, the present value of

the amount collected from industry is less than the amount of Federal funds

spent for industrial abatement facilities. Consequently, industry receives

a Federal subsidy. Tinlpss it were the intent of the law to provide costsharing assistance to industry, as well as to the nonindustrial sectors

of communities, interest charges are needed to compensate for the time

preference of money. If industry provided its own abatement facilities,

it would forgo the use of the investment funds for other purposes. Similarly,

the Federal government forgoes the use for other purposes of funds expended

for industrial abatement facilities.

To see the substantial subsidy to industry which results from failing to

charge interest, consider the following example. Assume that under existing

arrangements a $100,000 construction grant allocable to treatment of

industrial wastes would be recovered from industry over approximately

30 years, in yearly payments of $3,333. With a 10% nominal discount rate,

the present value of the $100,000 collected in this manner is, however.

only $31,420 (i.e., $3,333 (1 + .10)^^ - 1 .10 (1 + .10)^^

= $31,420). With a 10%

nominal discount rate, the annual user fee collected from Industry should

30"

I 1 1 f I ^ 1111 be $10,610, rather than $3,333 (i.e., $100,000 .10(1 + .10)

(1 + .10)30 - 1 = $10,610,

which is $100,000 amortized over 30 years at 10%). Thus, in this illustrative example the annual user fees are less than one- third what they would

be if the time value of money were considered.

103
Omission of interest charges from user fees has at least two consequences:

(1) User fee revenue forthcoming to the Federal and community governments

is much less than it would be if industry fully paid its share of construction costs. (2) Industry receives an additional Federal contribution

towards provision of its abatement facilities, which, other things equal,

will encourage it to tie into municipal abatement systems.

USER FEE IMPLICATIONS

Now that we have shown quantitatively the effect of user fees on cost

shares under various interpretations of the user fee policy, let us consider the potential consequences of these effects.

A number of problems appear to result from the effects of user fees examined

above. A potential efficiency problem arises in that retention of user

fees collected against the Federal grant reduces the grantee's real cost

share and therefore encourages the grantee to select a larger scale of

abatement facilities. If the local community's share of costs is brought

below its share of benefits from abatement at the margin, there will be a tendency towards overbuilding of facilities.

Another efficiency problem is that retention of user fees collected against

the Federal grant gives incentive to communities to provide capital-intensive

or eligible land-intensive projects for purpose of treating Industrial wastes.

The bias towards techniques with a high proportion of eligible construction

cost results because retention raises the potential Federal contribution

to capital and eligible land costs, but does not change the Federal

contribution to 0 & M. The biasing effect is similar to that which would

result from explicitly raising the Federal percentage cost share for

construction costs relative to other cost categories, and we saw earlier

that the more unequal the cost sharing of different categories of costs,

the greater the incentive to the grantee to choose techniques with costs

which are Federally shared over techniques with costs which are not

Federally shared.

104
The incentive to treat Industrial wastes results from the fact that the

grantee can actually Improve his net revenue position by increasing construction costs attributable to treatment of industrial wastes. This may be

demonstrated as follows:

For simplicitly assume that we begin with a community which at the outset

provides no industrial waste treatment, i.e., 3 = 0; we can now calculate

the change in the net revenue position of the community (AN) which may

result from a change in construction (AK) , in ineligible land (AL) , and

in 0 & M cost (AM), attributable entirely to inclusion of industry in the

community sewerage system. To indicate the possible impacts, we examine

the change in net revenue under alternative assumptions regarding management

of the reserve fund and collection of user fees to recover the community

government's share of cost.

Let us begin by assuming that the retained user fees collected against the

industrial share of the grant are used in such a way that they do not reduce

the receipt of grant funds. This could be the case if the reserve fund were applied to eligible costs of projects with high community priority,

but low grant priority, such that the fund reduced the community's cost by

R, without reducing the amount of subsequent grants. (This case is explained

in the second part of this section.)

We further assume that the AM attributable to industry is exactly covered

by user fees collected from industry for those costs, as required in Federal

legislation. Hence, apart from possible economies or diseconomies of scale,

the net revenue position of the grantee (and of the non-industrial community)

is unaffected by changes in 0 & M costs necessitated by industry, i.e., 0 & M

costs incurred are just offset by user fees received. With respect to the

resulting AK and AL, we may make either of two assumptions: (a) that the

community government charges industrial users for industry's part of

construction and land costs not covered by a Federal grant — which it may

do at Its discretion, or (b) that the community government does not charge

industrial users for their share of these costs — which it may also do.

105
First we examine the change in net revenue to the community government

under assumption (a). In this case, the 0 & M, construction, and land

costs incurred by the community government are just offset by industry

user fees, and AM, AL, and AK cancel out of the equation. The receipt

of user fees collected against the grant, however, are unmatched by costs

incurred by the community government and the amount of these fees retained

constitutes a net revenue gain by the community government.

Av +'375AK I (1 + i)" ~ 1

^^1 " n |j.(l + i)^ J

(32)

where

AN^ = the summation of costs Incurred (negative effect) and revenue

received (positive effect) by the community government due to

provision of an abatement facility for industrial wastewater.

(Subscripts 1, 2, and 3 designate cases examined under alternative assumptions.)

AK = the change in construction cost attributable to provision

of service to industry,

(1 + i)^ - 1

iYi~+lV^^ ~ present worth formula used to convert a stream

of annual payments to a present value, where n is the

number of interest periods and i is the discount rate, and

.375AK (1 + 1)" - 1

id + = the present value of retained user fees under the

assumptions for this case.

From equation (32) we can see the net improvement in the revenue position

of the community government. Thus, in this case, the community government

has incentive to provide facilities with large eligible construction costs

to treat industry wastes.

For the second case let us continue to maintain all the above assumptions,

with the exception that we now assume the community government does not

recover revenue from industry to repay its share of construction costs

not covered by the grant. The other costs incurred by the community

106
government are again just offset by user fees, but construction costs are

not offset by user fees. The outcome In tetrms of the community government's

revenue position Is less clear.

,n AN^ = -.25AK +

.375AK

-

(1 + D'

1(1 +

(33)

Here the provision of services to Industry may or may not result In an advantage to the community government, depending upon the time over which

the user fees are to be collected and the size of the discount rate. For

short time horizons and low discount rates, the value of the retained user

fees could even In this case exceed the additional capital costs Incurred

by the community government.

For a third case, we assume that the community government recovers from

Industrial users their share of local construction and other costs, but

we now assume that It applies the reserve fund to a future project for

which a grant could be received. That Is, the reserve fund Is used In

such a way that It reduces the future receipt of grant money. Again, the

expenditures for 0 & M, land, and capital costs are assumed just offset

by receipts of user fees, thereby canceling AM, AL, and AK from the equation.

In this case the change In the community government's net revenue position

resulting from treatment of Industrial wastes will be less positive than

In the first case shown above, but nevertheless positive.

AN, + .25

[.3AK] n

(1 + 1) - 1

1(1 + 1)^

+.075AK

n

n

(1 + D" - 1

1(1 + J

(34)

+.150AK

n

(1 + 1)" - 1 1(1 + 1)^

Thus, In this case, too, It Is possible for the local community government

to Improve Its net revenue position by Increasing construction cost

attributable to Industry.

We can summarize the financial effects arising from provision of Industrial

abatement facilities, on the various parties Involved, as follows: The

Federal government pays 75% of construction costs and recoups an amount

107
equal to 37.5% of construction costs in user fees. The community government

pays 25% of construction costs and recovers an amount equal to as much as 62.5% of construction costs in industrial user fees; it pays 100% of other

costs and may receive a like amount in user fees. The industrial sector

of the community at the most pays 100% of total costs, less interest costs;

it receives 100% of abatement services resulting from the total expenditures.

The net revenue received by the community government, which may amount

to as much as 37.5% of construction costs, may be used for the benefit

of both the nonlndustrial and Industrial sectors. As inducement to Industry

to connect to the municipal system, the community government could reduce

somewhat its user charges to industry for locally-incurred costs, such that

industry would in effect pay less than 100% of costs less interest. Other

things equal, this effect would be expected to give some incentive to

municipalities to provide capital-intensive and/or eligible land-intensive

facilities for treatment of industrial wastewater, since by so doing the

community at large would benefit.

With respect to other problems arising from existing user fee arrangements,

there may be inefficient, and possibly conflicting, incentives provided as

to the use of the retained amounts. On the one hand, we have seen a possible incentive for the community to spend the reserve fund for eligible

costs of projects which are accorded low priority or considered of marginal

importance by grant program administrators but which are given high

priority by the community, such that the fund is not used on projects where

the likelihood of receiving a grant is high. With this approach, the

local community deducts the reserve fund from its costs without having

the amount of its grants correspondingly reduced. On the other hand, the

community may have incentive to accumulate the fund for use as a lever in

obtaining future grants.

Another implication of existing Federal user fee arrangements is that they

appear to favor industrialized communities over residential communities.

That is, even though benefits received for two communities may be the same,

the real nonfederal cost shares will vary according to the proportion of

108
treatment relegated to Industry needs. Construction costs to a residential

community are equal to .25K, and the subsidy amounts to 75% of construction

cost. But for an Industrialized community, the subsidy amounts to 75%

of total construction cost plus 25% to 100% of the present value of the reserve fund plus the present value of the discretionary fund, and the

local share of cost is less than .25K. Thus the communities servicing

industry are given an additional Federal contribution beyond the 75% of

construction costs, which other communities do not receive.*

In general, industrialized communities may benefit from the reserve

fund. The reserve fund provides a sure source of money which, with the

approval of the regional EPA Administrator, may be used for eligible

abatement costs at any time. The approval process is separate from the

usual grant application procedure and does not require a priority rating.

Thus the grantee-trust-fund holder has a ready source of construction

funds for which it need not compete with other communities. The reserve

fund may also give the grantee an advantage in obtaining additional grants

because, as was explained above, the Federal granting agency will be able

to generate more abatement per Federal grant dollar where the reserve fund

is applied.

A further problem with the existing user fee arrangements is that there

is no guarantee that the municipality will choose to use the discretionary

fund for wastewater abatement. Hence, a portion of the Federal subsidy

may not contribute to the grant program's objective of providing incentive

to municipalities to construct treatment works.

A final Implication of the current user fee program, perhaps obvious at

this point, is that it obscures the effective Federal and local cost shares.

As may be seen by comparing equations (25) and (31), the actual cost to

the grant recipient may differ substantially from the 25% of capital plus

100% of 0 & M implied by the main cost-share provision (Sec. 202(a)) of

*Beyond the revenue advantage gained by retention of user fees, the

local community would also benefit if economies of scale resulted from

inclusion of Industry.

109
the 1972 Act. The legislation and regulations pertaining to user fees are difficult to understand in prose and logic. As a result, community

governments' interpretations of the law, and, consequently, their ultimate

cost shares, may differ from what was intended by the legislation. Communities whose managers are skilled in the grant process may be able to utilize

the obscure provisions of existing arrangements to reduce their effective

cost share, whereas communities with less sophisticated management may

receive leas Federal contribution.

In summary, existing user fee arrangements are characterized by the following:

(1) Retention of user fees produces a potential bias towards overbuilding;

(2) retention of user fees encourages municipalities to provide abatement

services to industry; (3) retention of user fees biases municipalities

towards selection of capital-intensive and eligible land-intensive techniques

to treat industrial wastewater; (4) omission of an interest charge from

industry user fees is a subsidy to industry and reduces user fee revenue;

(5) retention of user fees results in unequal treatment of residential

communities as compared with industrialized communities: and (6) existing

arrangements obscure real cost shares.

A rationale for the policy permitting municipalities to retain user fees is

to provide the municipality with a source of future funds whereby it might

become self-supporting in abatement actlvites. And, the retention of user

fees does appear to provide a source of funds for future needs. But the

practice has efficiency and other effects which might be regarded as problems.

Returning these retained user fees to the Construction Grant Program for

redistribution among grant applicants through the regular grant procedures

would appear to eliminate the problems described above, without reducing

the amount of total funds available to municipalities.

110
Section VI References

1. Raymond, Richard. The Impact of Federal Financing Provisions In the

Federal Water Pollution Control Act Amendments of 1972. p. 7.

2. Final Construction Grant Regulations, Construction Grants for Waste

Treatment Works, p. 5263.

3. Ibid., p. 5263-4.

4. Ibid . , p. 5263.

Ill
SECTION VII

SUMMARY, FINDINGS, AND

SUGGESTIONS FOR FURTHER RESEARCH

SUMMARY

The Environmental Protection Agency (EPA) administers the Construction

Grant Program for the abatement of wastewater pollution. The Federal

Water Pollution Control Act Amendments of 1972 (1972 Act) describe to some extent the eligibility requirements for a community to apply for

EPA grants and the percentage Federal cost shares that can be awarded

for community abatement projects. The construction Grant Program, as enacted by the 1972 Act and administered by EPA, has been criticized

for being inefficient in that it encourages a mlsallocatlon of resources

in wastewater pollution abatement.

The purpose of this study is to evaluate alternative cost-sharing programs

with respect to carefully defined efficiency and equity criteria. The

emphasis is on efficiency. Findings of the study are presented describing

efficiency and equity implications of alternative cost-sharing rules and

of institutional changes affecting cost sharing.

The focus of this study is on the local incentive effects of Federal cost

sharing; that is, how Federal grants might encourage local communities to

pick one kind or size of abatement technique over another.

The existing cost-sharing program as described in the 1972 Act and implemented

by Agency regulations Is discussed in Section III. The eligibility for

grants, that is, what costs are allowable and unallowable under the Construction

Grant Program, is demonstrated to differ when examined from the standpoint

of legislation and what occurs in practice. Eligibility for Federal grants

112
is also shown to vary among the different abatement techniques. Cost

shares awarded by EPA are shown to have averaged 36% of eligible construction

costs up to 1972, as compared to the 75% maximum share now allowed for by

the 1972 Act. Institutional constraints other than cost-sharing eligibility

are identified that may bias communities against nationally efficient

choices in pollution abatement. For examples, such constraints as minimum

treatment standards, training and education biases toward plants on the

part of decision-making engineers, small areas of abatement jurisdiction,

and use of sewerage systems as growth management tools appear to play a significant role in affecting what techniques are chosen by communities

seeking assistance in pollution abatement.

The theoretical relationships between cost sharing and the selection of

nationally efficient techniques (plant or nonplant) for abatement are discussed in Section IV. A selective survey of the literature presents

the background of work done in evaluating efficiency and equity of cost

sharing in the water resources area. The local demand for pollution

abatement is shown to be inversely related to the local cost share. The

effect of abatement standards on the demand for abatement is also explored,

both for the case where standards are enforced and for the case where

standards are not enforced. The optimal cost sharing rules are then

derived for encouraging communities to select (1) the least-cost techniques

for abatement and (2) the nationally efficient scale of abatement. Existing cost-sharing rules are found to be inequitable in terms of certain

characteristics of equity that are defined in the study.

In evaluating efficiency implications of existing and alternative cost-sharing

programs in Section V, a number of problems concerning community selection

of abatement were identified in the existing program. Case examples

illustrate the bias effects on communities of current rules that apply

different cost-sharing percentages to different techniques and to different

cost categoires. Local communities under existing rules have a cost-sharing

bias to pick techniques with the minimum local financial commitments, and

these are not necessarily the least-cost techniques to the nation. Alter113
native practical cost-sharing rules are proposed that do not entirely

meet the efficiency conditions derived in the study, but that more nearly

satisfy those conditions than existing rules.

FINDINGS

(1) Same Percentage Cost Share

for All Techniques

Application of the same percentage cost share to all plant and nonplant

techniques for the purpose of abating wastewater pollution will encourage

nonfederal interests to simultaneously select the combination of techniques

which is least costly for the nation as well as for themselves. This

rule applies both to the case where communities seek to maximize net

benefits from abatement with a budget constraint and to the case where a given standard of abatement is enforced.* Applying the same share (regardless of what that share is) across all techniques will eliminate the potential cost-sharing bias for some techniques over others (e.g., for plant

over nonplant techniques) that appears to exist under the current rules.

(See Sections IV and V.)

To encourage consideration of new technologies that might not be known at

the time legislation is drawn up, the cost-sharing eligibility condition

could be specified simply as all technically viable alternatives. Nonfederal

interests would have an economic incentive to apply for grants for techniques that are cost effective.

A related problem that results from sharing all technically viable techniques

is determining what part of an activity is abatement, and consequently

what part of that activity should be cost shared. For example, rehabilitation of sewers is a multiple-purpose project that provides benefits

through abatement as well as through wastewater collection. By cost

*It is recognized that global efficiency in the sense of the efficient

allocation of resources among all national programs is not necessarily

reached by equilibrating cost shares for techniques only in pollution

abatement programs.

114
sharing only those costs under the Construction Grant Program that can properly be allocated to abatement per se, the nationally efficient scale

of abatement will be encouraged. Thus, a lower Federal cost share would

be applied to techniques that provide benefits other than abatement, and

the cost share would decrease as the cost of providing those other benefits

Increases relative to the cost of abatement.

(2) Same Percentage Cost Shares

for All Cost Categories

Application of the same percentage cost share to all cost categories of

all techniques for abating wastewater pollution will encourage community

selection of the nationally least-cost technlque(s) of providing abatement. All categories of project costs would include capital; land for

both site and process; operation and maintenance; and planning.

A bias to choose certain techniques results when different cost-sharing

percentages for the different categories of cost are applied to techniques

having different cost composition, i.e., different ratios of cost categories.

Because operation and maintenance costs, for example, are not currently

shared at all by the Federal government, while capital costs are shared,

grant recipients are biased towards capital-intensive techniques even

though all techniques may be eligible for the same percentage share of

capital cost. (See Sections IV and V.)

Assuming there are reasons why all categories of costs could not be shared,

two alternatives for encouraging local selection of the least-cost technique(s)

might be considered in lieu of the same percentage for all categories.

The first alternative satisfies the necessary condition for encouraging

the selection of the least-cost technique (s) , and the second can satisfy

it under certain situations. The first approach is to vary the share of

the single cost category to be subsidized, let us say capital as an example,

so that the local share as a percentage of total project costs (i.e., the

effective cost share) will be uniform across all techniques. A second

approach, still providing a Federal share for one category only, would

impose a constraint on the percentage of total costs that the Federal

agency could bear. The cost-sharing bias will be reduced to a degree

dependent on how low the constraint is and in some cases will be eliminated.

(See Section V.

115
Findings 1 and 2, If implemented, would enhance equity in comparison to

existing cost-sharing rules in that grant recipients would be more certain

over time of what they will receive for any given total project cost

regardless of the technique chosen or the composition of cost categories.

(See Section IV.)

(3) Consideration of a Reduced Federal

Co st Share

Nationally efficient scales of abatement would be encouraged by reducing

the effective Federal cost share. The legislation governing the Construction

Grant Program does not specify nationally efficient scales of abatement

(i.e., the maximization of national net benefits) as an objective of the

program (see Section IV) . However, the Association Rule (see Section IV)

could meet such an objective by encouraging grant recipients to choose a scale of abatement that is nationally as well as locally efficient. For

most projects, existing Federal cost shares probably exceed those that

would be obtained from applying the Association Rule (see Section V).

Lower Federal shares could be large enough to provide some incentive for

communities to expand their abatement activities and still tend to encourage

more efficient scales. Since available information regarding the incidence

of abatement benefits is not comprehensive, further research is needed

before specific percentage cost shares can be selected.

(4) Same Percentage Cost Shares for

Comanunltles of All Sizes

Varying cost shares in proportion to community size, other things being

equal, may lead to inefficient scales of development.

Over some range of abatement levels, the average cost of abatement (i.e., the

coat per unit of abatement) will fall as a result of economies of scale.

Assuming that this range of decreasing average cost extends to large scales

of abatement, big cities with large demands for abatement would be expected

to have lower average costs than small cities with less demand for abatement .

One way of encouraging small cities to demand higher levels of abatement

and thereby profit from economies of scale is to raise the percentage

cost share for small cities above that of big cities. (There may also

116
be nonef f Iciency reasons for giving small cities preferential cost shares.)

The imnlication of the preferential cost share, however, may be a less

rather than more efficient allocation of resources to abatement. That

is, the efficient scale of abatement for a small city may be much less

than that scale at which average costs are minimized (see Section IV)

Thus, if preferential Federal cost shares are offered to small cities to

encourage them to take advantage of economies of scale, the result may

be an oversized project from the standpoint of maximizing net benefits

from abatement.

Achieving efficient levels of abatement is not necessarily Incompatible

with taking advantage of economies of scale. For example, it might be

advantageous to individual cities as well as the nation for cities to

Join in the construction of regional treatment plants that would lower

the average cost of abatement to all while at the same time providing

the efficient level of abatement. Cost sharing is one of many incentives

that could be used to encourage a regional approach to abatement.

(5) User Fees Returned to

Construction Grant Program

The problems arising from the grantee's retention of half the industrial

user fees collected against the Federal grant could be eliminated without

reducing the total amount of Federal funding by returning the full amount

to EPA for redistribution through the regular grant process.

Existing Federal user fee arrangements, which allow the grant recipient

to retain part of the user fees collected from industry to repay industry's

share of the Federal grant, increase the Federal contribution to abatement

and reduce the effective cost share of the grantee. The grantee is free

to use 20% of the amount retained in any way he chooses. This 20%, the

discretionary portion, of retained user fees increases the Federal contribution

by its full amount. The grantee must hold the remaining 80% of retained

user fees in a reserve fund for use only for eligible project costs. Claims

to the contrary notwithstanding, the reserve portion of retained revenue

also results in an increase in the Federal contribution to abatement and

117
reduces the grantee's cost share. The reserve fund will usually raise

the Federal subsidy by an amount equal to 25% of the present value of the fund

although the recipient may use tho reserve fund In such a way as to reduce

his costs by the full present value of the fund. The amount of retained revenue

and hence the size of the Federal and local cost shares, depends upon

the percentage of construction costs allocable to treatment of industrial

wastes.

Efficiency problems which appear to result from existing user fee arrangements are the following: (1) Retention of user fees collected against the

Federal grant provides incentive to municipalities to provide abatement

facilities for treatment of industrial wastes which are capital-intensive

and eligible land-intensive in nature. Municipalities are encouraged to

treat industrial wastes because they may improve their net revenue position

by so doing; they are biased towards provision of capital-intensive and

eligible land-intensive techniques because capital and eligible land

expenditures enlarge the potential Federal subsidy, while expenditures

for 0 & M do not. (2) Retention may increase the grantee's tendency to

select an excessive scale of abatement by increasing further the differential

between the grantee's share of benefits from abatement and its share of

costs. (3) Part of the additional subsidy may not further the objectives

of the grant program since the grantee may choose not to use the discretionary

portion of retained revenue for wastewater abatement.

In addition, under existing user fee arrangements industrialized communities

receive a larger percentage Federal cost share than do communities which

are primarily residential even though nonfederal benefits as a proportion

of national benefits may be essentially the same for both types of communities.

The additional Federal subsidy to the grantee resulting from retained user

fees increases as the industrial component of wastewater increases, such

that the more industrialized the community, the lower the effective nonfederal cost share.

Existing arrangements also appear to give rise to incentive effects which

may not be appropriate to the program or necessarily intended under the

law. The existing program, for example, may give conflicting incentives

118
to grantees regarding use of their reserve fund. On the one hand, the

coiranunity has the Incentive to spend its reserve fund for items for which

it has strong demand but for which the prospects of receiving grant funds

are low. This may lead to use of the fund for purposes which are regarded

as relatively less Important and therefore accorded low priority by grant

administrators. On the other hand, possession of the fund may improve

the chances of a community's receiving an additional Federal grant, and

may thereby provide an Incentive to hold the fund for use in applying

for grants for large projects.*

The retention of user fees may be criticized in general on grounds that

it obscures the true Federal and local cost shares. Difficulty in interpreting the law and regulations may contribute to different ultimate cost

shares among grant applicants. (See Section VI.)

(6) Interest Charge to Industrial Users

Inclusion of Interest charges in industrial user fees would make industry

charges more reflective of the economic cost of providing abatement service

to industry, and would increase the amount of revenue available to the

Federal and community governments.

Existing program regulations require that industrial user fees not include

an interest charge. When the payments for industry's share of construction

costs are collected over a long period, without an interest charge, industrial

users tend to be substantially undercharged. As a result, industry receives

a substantial subsidy and, thereby, an incentive to connect to the municipal

abatement system, while potential public revenue is foregone. (See Section VI.)

(7) Elimination of Legal and Other

Institutional Constraints

There are a number of possible institutional obstacles which may discourage

selection of certain techniques even if they are the cost-effective choices.

*As noted above, the existing user fee arrangements also provide incentive

to communities to treat industrial wastewater in the municipal system.

The desirability of this incentive effect was not investigated.

119
If, for Instance, State and EPA design standards, guidelines, and technology

transfer manuals are very conservative and emphasize the well-established

processes, they may bias municipalities towards treatment plant processes.

Examination of these documents for bias and inclusion of necessary revisions

will help to encourage selection of cost-effective techniques.

The training and experience of many state and EPA officials who review

applications are geared towards traditional plant/engineering solutions.

Educational and promotional efforts to encourage planners to consider

nonplant techniques might lead towards more comprehensive evaluation of

alternatives during the initial planning stages.

Architects ' /engineers ' fees for design of a facility traditionally have

been based upon the amount of capital costs — a practice which may bias

designs for abatement facilities towards capital-intensive and away from

nonplant and/or low capital techniques. Basing the fees on 0 & M costs,

as well as capital costs, might avoid this bias.

Another institutional problem is that small jurisdictions may not be in a position to implement certain kinds of abatement techniques, to organize

collective facilities, or to integrate use of multiple techniques; hence,

they may not be able to adopt the cost-effective approach to abatement.

Further development of regional management systems are needed to overcome

this problem.

Emphasis in the law, the regulations, and the program of some techniques

more than others may lead to preferences for these techniques by grant

applicants who perceive them as "favored" in the grant approval process.

Uniform treatment of abatement techniques would avoid this bias. (See

Section III.)

If the seven findings that are identified above were to be acted upon and

appropriate changes implemented in the Construction Grant Program, the

following results could be expected: the local cost-sharing bias for

capital-intensive and eligible land-intensive techniques would be reduced;

the local cost-sharing bias for some plant over nonplant techniques would

120
be reduced; Federal and nonfederal expenditures on nonplant techniques

would increase relative to plant techniques; the connnunlty demand for

nonplant techniques would increase; and the degree of abatement per

national dollar spent would increase.

SUGGESTIONS FOR FURTHER RESEARCH

The research evaluation undertaken for this report uncovered additional

areas of research that might be of value to EPA in meeting its objectives

of encouraging efficiency in abatement and of treating cost-sharing

parties equitably.

One type of research needed is the investigation of incentive effects of

institutional requirements (i.e., minimum treatment standards, minimum

levels of discharge, etc.) on communities' selections of techniques of

abatement. It might be demonstrated, for example, that institutional

requirements as well as cost sharing represent critical elements in biasing

nonfederal interests in favor of certain kinds of abatement techniques.

A second research problem of relevance to this study is the determination

of the optimal points in time at which to reduce or eliminate Federal

abatement grants. For example, given an objective of meeting a certain

level of discharge by a certain date, grant officials would like to know

at what times and by what percentages grants could be reduced to meet the

discharge level and get the abatement program ona self-sustaining basis

as soon as possible.

A third potential area for useful research is the analysis of the link

between levels of local performance in abatement and rewards or grants

based on good performance. Some states, such as New York, for example,

share up to one-third of the costs of operation and maintenance with cities

that manage their plants well. Variable Federal grants based on local

performance is one way of encouraging good performance. A loan which

makes the amount paid back inversely related to the performance of an abatement project might be another promising incentive for good local

performance.

121
A fourth topic of additional research is the determination of community

objective functions in pollution abatement. If communities do in fact

regard collection and disposal as their primary wastewater goals rather

than abatement, then the optimal approach to encouraging nationally

efficient behavior on the part of communities would have to be altered

accordingly. Incentives cannot be formulated until the objectives of

the parties to be affected are known.

A fifth area of research is the sensitivity of communities to having their

costs varied for certain techniques. This cost-sharing elasticity, i.e.,

the percentage change in the demand for abatement relative to a percentage

change in the local cost share, would enable decision makers to estimate

more accurately the impact on nonfederal demands for abatement of changing

cost-sharing rules.

122
APPENDIX

DESCRIPTION OF WASTEWATER ABATEMENT TECHNIQUES

The pollution abatement techniques discussed in the report and listed in

Exhibit 1 are here further described. The purpose is to give the reader

a better understanding of the techniques and perspective of how they might

be applied to particular wastewater abatement problems.

Table 10 shows four major problems faced by many municipal waste treatment

systems. The table gives the typical cause of the problems from a technical standpoint and possible solutions to the problems, including use of

both plant and nonplant treatment, prevention, and control techniques.

For example, a major problem is pollution from wastewater overflowing the

collection system; the immediate cause is usually insufficient flow

capacity of the sewers; and possible techniques to solve the problem

include separation of storm and wastewater sewers, temporary storage of

storm and wastewater for later transmission to the plant for treatment,

treatment of overflows. Increasing the rate of transmission to the plant,

etc. From the table it may be seen which techniques appear more applicable

to each of the particular problems.

It should be noted that all of the techniques listed are not necessarily

technically viable in all situations. For instance, some techniques such

as low-flow augmentation may be site-dependent. Techniques may be applicable only in certain cases. For example, rerouting wastewater to a larger body of water or dividing discharge among waterways to reduce the

burden on the receiving waterway obviously is a viable technique only if

alternative receiving waters are available. Also tradition and legal

constraints may restrict the use of a technique to specific circvimstances.

123
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For example, in-stream aeration has been generally regarded as suitable

for special problems only, such as restoration of a polluted area of a waterway for which raising the general water quality through advanced treatment of wastewater inflows would be a slow and costly approach. The

technique has generally not been regarded as a substitute for plant treatment per se. Following are descriptions of each technique:

Water Use Reduction Programs are measures undertaken by public agencies

to reduce the volume of water used by households and industry. Since most

water when used* becomes wastewater in the sewerage system, a reduction in

water consumption lessens the burden on sewage disposal facilities. (Note

that increasing the volume of water in the sewer system has the negative

effect of increasing the volume of wastewater which must be collected,

treated, and disposed, while increasing the quantity of receiving water

into which effluent or wastewater is discharged has the positive effect

of diluting the concentration of wastes.) Some measures which might be

undertaken by public agencies to reduce water use are (1) education

programs to teach the public water-saving practices; (2) use of water

pricing to decrease the demand for water by increasing its cost; and

(3) tax, subsidy, or regulatory programs to encourage installation of

low water-use devices and appliances, such as reduced-flow toilets and

faucets, level control and water retention devices on automatic washers,

and recycle/reuse systems which treat and reuse bath and laundry washwater

for toilet flushing and lawn irrigation.

Active Control of the Sewer Collection System is using the sewer collection

system to reduce, control, or treat wastewater prior to its entering the

treatment plant. Active control of the collection system affects what

can and should be done in the treatment system. Four of the techniques

whereby the collection system can be used to accomplish wastewater control,

reduction, or treatment are the following techniques:

(1) Injection of High Molecular Weight Polymers into the Collection

System reduces the flow resistance of wastewater and thereby

increases the transmission of wastewater through the collection

system. In effect, the technique is a substitute for enlargement of the collection pipe, in that both techniques increase

the load capability of the collection system.

125
(2) Controlled Flow In the Collection System is the selective

retention and release of wastewater from the collection system

to the treatment system for the purposes of (a) increasing

efficiency in plant operations by achieving more uniform inflows

of wastewater to the plant, and of (b) preventing overflows of

untreated wastewater from the collection system into waterways

when inflows into the system exceed transmission and/or treatment capability, (Retention to prevent overflows may require

the addition of storage facilities to the collection system.)

(3) Pretreatment in the Collection System is any treatment action

taken in the collection system to improve transmission to the

plant or to reduce later processing requirements; e.g., grit

removal may be done in the collection channel, wastes may be

ground and wastewater may be preaerated in order to satisfy

immediate BOD, decrease odor, or improve later processing.

(4) Controlled Flushing of Sewers is the deliberate washing out of

combined sewer systems periodically in order to capture for

treatment the pollutants which accumulate in the pipes during

dry periods and which otherwise would worsen the contamination

problem from storm overflow. Methods of flushing sewers include

(1) the quick discharge of sewage from tanks located in manholes,

and (2) the blocking of the lower end of laterals with quickrelease, inflatable barriers.

This study is concerned with those aspects of Enhancement and Rehabilitation

of Collection Sewers which contribute to abatement of wastewater pollution.

This would include improvement in design or construction of the collection

system which enables the system better to transmit wastewater which requires

treatment and to exclude intake of water not requiring treatment. Innovative

features may be initially incorporated in new collection systems; existing

systems may be rebuilt or repaired to include improvements. Following are

some specific measures which may be taken to improve pollution abatement

by use of the collection system.

126
Enlargement of Sewers refers to increasing the size of the sewer pipes to increase transmission of wastewater through

them. Undersized sewers may cause wastewater to be discharged

before it reaches the plant.

Separation of Storm and Wastewater Collection means the provision

of two separate, parallel systems of pipes; one for carrying

storm runoff from buildings and land and one for carrying sewage —

in contrast to a combined sewer system which carries both sewage

and storm water runoff in the same pipes. Separate systems

require a much larger construction cost than combined systems

because of the duplication of sewer lines required. Separate

systems, however, offer the advantage of reducing pollution

from sewer overflow during wet periods. Overflow is a serious

problem associated with combined systems. Combined sewers are generally designed to accommodate a maximum volume in excess

of dry-weather flow, but during storms the capacity may be

exceeded, resulting in the discharge of a mixture of storm

water and raw sewage directly into receiving waters. Separation

of the systems usually overcomes the problem of overflows,

but does not prevent the problem of pollution from wastes

present in the storm water, e.g., oily, salty runoff from

streets

Separation of sewers is not the only means of overcoming the

problem of combined sewer overflow. Possible alternative approaches

Include structural alterations , to the interceptor systems;

separation of sanitary and storm water within the combined system

by means of a pressure or vacuum sanitary sewer suspended within

existing combined sewers; increase in transmission through the

pipes and/or expansion of treatment capability (see Enlargement

of Sewers and Injection of Polymers ); storage of excess wastewater

for later transmission (see Selective Retention)

; treatment of

overflows (see Treatment of Overflows ) ; selective placement of

overflows (see Selective Routing of Effluent Discharge ) ; reduction

127
of contaminants in overflowing water by such things as pre-storm

sewer flushing (see Controlled Flushing of Sewers ) , storage of

Initial overflow with higher pollutant load, and more frequent

cleaning of streets during dry periods.

(3) Construction, Repairs, and Corrective Measures to Prevent

Infiltration and Inflows refers to efforts to prevent the

entrance of ground water Into a sewer through breaks, porous

walls, or defective joints, or of the entrance of surface

water resulting, for example, from Improper location or connection of roof drains. Reduction In the amount of

wastewater unnecessarily entering the plant conserves treatment

resources

Control of and Restrictions on Release of Certain Substances Into the

Sewer System means limitations or bans imposed by public authorities on

the release of substances into the sewer system, either by households or Industries, for the purposes of reducing treatment cost or preventing

untreatable waste from entering the system. For example, households might

be restricted in their use of detergents containing phosphates; Industries

might be required to extract certain industrial chemicals from their wastes

prior to discharge into a municipal system; and industries, for the purpose

of reducing wastewater volume, might be banned from releasing water which

could be reused by them without treatment (e.g., cooling water).

Influencing Decisions of Households and Industry to Connect or Not to

Connect to a Municipal Sewer System is a way public agencies may affect

the volume and/or composition of wastewater flowing Into the municipal

sewerage system for treatment. One direct constraint is the imposition

of a sewer moratorium which prohLblts tie-ins. Pricing policy for connection of buildings to the sewer system is another, though much less powerful,

method of influencing decisions. There are other approaches which may be

undertaken by public agencies which are perhaps less obvious and less

certain in effect than the two above. For example, an industry which ties

into a municipal system generally is charged a user charge to offset the

costs which It imposes upon the system. In practice, however, the user

128
charge may not fully cover industry's share of cost, or, by like token,

it might be excessive. Hence the user charge may bias industry's choice,

[Though not likely an instrument of policy, the relative efficiency of a municipal system may also attract (or repel) industries to (or from) a tie-in because of the possibilities of sharing in economies of scale (or

operational inef f iciences) .

] There are other public policies and practices

which through subsidization may influence industry's decision. For

example, an industry which is charged a user fee equal to the nominal cost

attributable to its wastewater disposal may nevertheless receive subsidies,

in so much as there is (a) no sales tax on equipment installed, (b) no

local property tax on the treatment facility, and (c) debt financing with

long-term, low interest, tax-exempt bonds. Yet another factor in an industry's decision to treat its own wastes and discharge directly into a waterway, or to discharge into a municipal system, is the degree of legal

accountability associated with each choice. Without sophisticated

monitoring devices, industry may reduce its accountability by mixing its

sewage with other sewage in the municipal system. Lack of accountability

also impedes the development by public authorities of an equitable user

fee schedule. Public agencies may also influence industry's decisions by

increasing the desirability of internal (in-industry) wastewater reduction

or treatment per se . This might be done by raising the cost of clean water,

thereby increasing the attractiveness of wastewater recycling and reuse. Another strategy would be to call public attention to desired and undesired

behavior by industry, relying on their concern for public image to influence

decisions. As demonstrated in Section VI, existing Federal user fee policy,

which allows grant recipients to retain half of the user fees collected

from industrial users against the Federal grant, appears to give incentive

both to municipalities to encourage industry to tie-in to the municipal

system and to industry to choose to connect.

The objective of Discharge Flow Routing and Outfall Location is to place

the effluent discharge into receiving waters so as to reduce the amount of

wastes per unit of water, and thereby, improve water quality. Given a level of effluent, one method of controlling the ratio of waste to receiving

water is to divide the discharge of effluent among several streams.

129
Another method is to extend outfall systems to larger bodies of water

where assimilative capacity is greater,

Low-Flow Augmentation of Receiving Waters is the supplementation of stream

flow during periods of low natural flow by release of water, usually

impounded during times of excess flow, for purpose of reducing the concentration of pollutants in the waterway. By increasing the flow of water

relative to waste material entering the waterway, the waste concentration

is diluted (i.e., the ratio of wastes per unit of water is reduced) and

the assimilative capacity of the water is increased. Generally low-flow

augmentation is used to guarantee that water pollution will not rise above

some maximum concentration. The technique is usually accomplished by

damming waterways upstream of the area to be diluted and storing water in

reservoirs prior to planned release. However, it may also be accomplished

by the prevention of or reduction in upstream diversions of water during

critical periods,

A Waste Treatment Plant is a series of tanks, screens, filters, lagoons,

and other process units, which are arranged in close proximity to one another and generally involve buildings, facilities and a central organization. The treatment plant is the part of a sewerage system which comes after the sewer collection system and before the outfall, or discharge,

system. The conventional waste treatment plant may combine any of a number of processes which together provide primary and secondary treatment,

i,e,, removal of suspended solids, biodegradable organics, and microorganisms from wastewater piped to it. The advanced waste treatment plant

typically adds to the conventional in-plant processes some additional

(i,e,, tertiary) biological-physical-chemical treatment techniques which

enable reclamation of high quality water from wastewater. Table 11

indicates the large array of processes which could be employed in a waste

treatment facility.

Land Treatment of Wastewater is the application of wastewater to land for

purposes of treatment and disposal. This technique goes beyond the practice

of land disposal of sludge, the solid matter remaining after plant treatment

of wastewater, in that both the liquid and solid wastes may be disposed in

130
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this manner, and the land application Is itself used as a total or partial

treatment process. The technique may be carried out in several ways:

(1) The untreated wastewater, consisting of solids and liquid, may be

spread directly onto the land. (2) The untreated solid and liquid coiaponents of wastewater may be separated, and the liquid sprayed by an irrigation-type system on the land, and the solid part either applied

separately to the land or disposed of in some other way, (3) The waistewater

may be partially treated, for instance by a period of storage in an oxidation pond or sewage lagoon, prior to land application by either of

the above methods. Objectives in land disposal of wastewater may include

land fertilization, in addition to restoration of water quality which

occurs as the water filters through natural soils. When the latter is

the sole objective, marginal land unused for other purposes may be used.

When the former objective is present, the wastewater may be applied to

fainnland, woodland, and land under reclamation. Additional possible sites

for disposal which might benefit from fertilization, as well as provide

suitable disposal land in areas where adequate farmland and woodland are unavailable, are parks and highway medians and shoulders.

Community Septic Tanks are rural sewerage systems which provide wastewater

disposal for a group of buildings. They present an alternative to the

conventional one-septic-tank-for-each-house arrangement now prevalent in

rural areas not reached by municipal sewer lines. There are three main

approaches to community disposal of wastewater in rural areas. The first

is the piping of waste from a group of buildings to a large septic tank,

normally located on public land. Aside from its large size, more extensive

collection system, and location, the community septic tank is identical

to the conventional single-building septic tank. It consists of a large,

watertight container, usually made of concrete or steel and buried underground. In the tank, naturally occurring microorganisms in the sewage

decompose it. The sludge settles on the bottom of the tank, from which

it must be removed periodically, and the clear effluent flows out of the

tank through a system of distributing tiles or pipes into the ground, where

it is absorbed and becomes part of the ground water supply, A second

approach is the periodic collection by truck of wastes from individual

132
holding or storage facilities located at rural buildings, and the transportation to a disposal area or facility. This second approach may be

necessary in areas where absorption of effluent into the ground from

septic tanks is impeded, such as in areas of heavy rainfall, or where

soil properties provide poor percolation, or where an excessive number of

septic tanks overload absorption capacity of the surrounding ground. A

third approach involves an arrangement by which a designated public

authority assumes ownership and maintenance responsibility of individual

septic tanks located on private property. As used in this report, the

terra "community septic tank" encompasses all of the above approaches to

joint disposal of rural wastewater.

A Raw Sewage Lagoon is a pond for receiving and impovinding raw sewage

while the interaction of sunlight, oxygen, bacteria, and algae decompose

the waste and restore the water to a purer state. Both gravity separation

and biological reduction are accomplished in the lagoon. Though lagoons

are more often used in conjunction with conventional treatment plants to

provide "polish treatment," raw sewage lagoons have been used successfully

alone to provide treatment. They may be particularly suitable for smaller

communities where needed land is available at reasonable costs and wastewater loads are of manageable proportions, for treatment of certain kinds

of industrial wastes, and as initial treatment facilities in newly

developing areas prior to dense settlement. In the latter case, they may

be used to provide polishing treatment if a plant is later added. The raw sewage lagoon may also be used in conjunction with land disposal

techniques, such as spray irrigation, to provide preliminary treatment.

Aeration of Receiving Waters (In-Stream Aeration) is the introduction of

air or molecular oxygen, by artifical means, into a waterway for the

puiT>ose of raising the level of dissolved oxygen (DO) , a key determinant

of water quality. If natural sources of oxygen—primarily reaeration

at the surface—are not sufficient to meet the biochemical oxygen demand

(BOD) imposed upon it (i.e., the amount of DO required for aerobic decomposition of organic matter present in the water) , the level of water

quality deteriorates. Raising the level of DO Increases the waste assimilative

133
capacity of the waterway and Is one means of Improving water quality. There

are a number of different types of systems or processes by which aeration

of rivers, streams, lakes, and ponds may be accomplished. Some systems are

site dependent, such as techniques which rely on weirs or dams. Other

systems are more flexible with respect to site, such as (1) mechanical

surface aerators which transfer oxygen by breaking the water into droplets

and Inducing turbulent mixing, (2) diffusion systems which introduce air

or molecular oxygen directly into the water through perforated tubing,

nozzles, or Jets Installed below the water surface, and (3) the side

stream pressurization system in which a small percentage of the flow

volume of river water is drawn off, mixed with oxygen under pressure and

the supersaturated mixture is diffused back into the river.

Treatment of Overflow refers to the application of treatment processes

to untreated wastewater dischaiged from a sewer system into receiving

waters when flow exceeds the system's transmission and storage capacity.

Generally, overflows occur in a combined sewer system during large

inflows of storm water and consist of a mixture of storm water and raw

sewage. Normal sewage treatment processes could be used, such as screening and straining and chlorination. Some processes may be applied

to overflows at the rate at which they occur; others require storage of

overflow for treatment.

134
BIBLIOGRAPHY

Costs of Construction of Publlcly-Ovmed Wastewater Treatment Works:

1973 Needs Survey. Environmental Protection Agency,

Washington, D.C., November 1973.

Cost to the Consumer for Collection and Treatment of Wastewater. Environmental Protection Agency, Washington, B.C., Government Printing Office,

Water Pollution Research Series, No. 17090. July 1970. Table 24.

Davis, Robert K, The Range of Choice in Water Management, A Study of

Dissolved Oxygen in the Potomac Estuary. Baltimore, The Johns Hopkins

Press, 1968. p. 124-126.

Environmental News. Environmental Protection Agency, January 10, 1974, p. 2,

"Fairfax Sewage Plan Set," The Washington Post, March 27, 1974, p. C-1,

Col. 1.

Federal Assistance Programs of the Environmental Protection Agency.

Reprinted from the Catalog of Federal Domestic Assistance, Washington,

D.C. June 1973, Sec. 66.015.

Federal Grants for the Construction of Municipal Waste Water Treatment

Facilities. Environmental Protection Agency, Washington, D.C.

Federal Water Pollution Control Act Amendments of 1972, PL 92-500, 92nd

Congress, S.2770, October 18, 1972.

Final Construction Grant Regulations, Construction Grants for Waste

Treatment Works. Federal Register, XXXIX, No. 29, February 11, 1974.

Kneese, Allen and Blair Bower. Managing Water Quality: Economics, Technology,

Institutions. Baltimore, The Johns Hopkins Press, 1968. p. 97-179.

Loughlin, James C. Cost-Sharing for Federal Water Resource Programs with

Emphasis on Flood Protection. Water Resources Research. 6^(2) :377,

April 1970.

Marglin, Stephen A. Objectives of Water-Resource Development: A General

Statement, In: Design of Water Resource Systems, Maass, et. al . Cambridge, Harvard University Press, 1962, p. 31-36.

Marshall, Harold E. Cost Sharing as an Incentive to Attain the Objectives

of Shoreline Protection. National Bureau of Standards. Washington, D.C.

NBSIR 73-294, Corps of Engineers. December 1973, p, 21-23.

Marshall, Harold E, Economic Efficiency Implications of Federal-Local

Cost Sharing in Water Resource Development, Water Resources Research.

6(3) :673-682, June 1970,

135
Marshall, Harold E. Salinity Control and Cost Sharing, In: Proceedings

of the Western Resources Conference, 1973, Boulder: University of

Colorado, July 9 and 10, 1973, In press.

Marshall, Harold E. The Relationships Between Local Cost-Sharing and

Efficient Water-Resource Development (unpublished Ph.D. dissertation.

The George Washington University, 1969), p. 56-89.

Marshall, Harold E, and Vartkes L, Broussalian. Federal Cost Sharing

Policies for Water Resources, National Bureau of Standards,

Springfield, Va,, National Technical Information Service, No, PB-208-30A.

National Water Commission, 1971, p, 121-128 and 201-214,

Methods for Financing Water Pollution Abatement from Point Sources,

Urban Systems Research and Engineering, Inc, Prepared for the Water

Quality Office of the Environmental Protection Agency, August 1971,

p. 39,

Musgrave, Richard, The Theory of Public Finance, New York, McGraw-Hill,

1959, 628 p,

"Prince William Tables Funds for Sewer Plant," The Washington Post,

February 5, 1974, Sec. C.

Project Register: Waste Water Treatment Construction Grants. Environmental

Protection Agency, Washington, D.C. December 31, 1972,

Rafuse, Robert W, Jr, and Michael D, Sherman, The Implications of the

Net Fiscal Benefits Criterion for Cost Sharing in Flood Control Projects.

Mathematica Report, Washington, D,C, IWR Report 71-12, Institute

for Water Resources, the Corps of Engineers, 1971, p, ii, 49-51,

Raymond, Richard, The Impact of Federal Financing Provisions in the Federal

Water Pollution Control Act Amendments of 1972, Public Policy,

22:109-110, Winter 1974,

Regan, Mark, Sharing Financial Responsibility of River Basin Development,

In: Economics and Public Policy in Water Resources Development,

Smith, S, C, and Castle, E, N, (eds.), Ames, Iowa State University

Press, 1961, p, 215,

Renshaw, Edward F, Toward Responsible Government: An Economic Appraisal

of Federal Investment in Water Resource Programs, Chicago,

Idyia Press, 1957, p. 50.

Research and Demonstration Program to Achieve Water Quality Goals: What

the Federal Government Needs to Do, General Accounting Office.

Washington, D.C., Government Printing Office, Volume 1, No, B-166506,

Report to Congress, January 1974, p. 44-45,

136
"Rivers Cleanup Aid Cut," The Washington Post, January 11, 1974, pp. A-1,

A-A.

"Sewage Plant Work Halt Sought," Washington Star-News, January 27, 1974,

p. B-4, Col, 3.

Shoup, Carl S, Public Finance. Chicago, Aldine Publishing Co., 1969, p. 23.

The Federal Water Pollution Control Act Amendments of 1972, Highlights.

Environmental Protection Agency, December 1972.

U.S. Congress, Senate, Policies, Standards and Procedures in the Formulation,

Evaluation, and Review of Plans for Use and Development of Water and

Related Land Resources, Sen, Doc. 97, 87th Congress, 2d sess., 1962,

V(c)(2).

Waste Treatment Fund Allocations, Senate Committee on Public Works,

93rd Congress, 1st Session, Calendar No, 604, Report No, 93-630,

December 13, 1973, p, 6,

Water Policies for the Future, National Water Commission, Washington, D,C,,

U,S, Government Printing Office, Final report to the President and to

the Congress of the United States, 1973, p, 77, 485-525,

Whipple, William Jr, Instream Aerators for Polluted Rivers, Journal of

the Sanitary Engineering Division, p, 1160-1161, October 1970,

137
NBS-1I4A (REV. 7-73)

u s. DEPT. OF COMM. BIBLIOGRAPHIC DATA

SHEET

1. IMIIM.K A i lON OK KI-I'OK i NO. 7A-479

2. Ciov't Accession

No.

3. Recipient's Accession No.

A ri 1 1 1, AMI^ i^llUTITI 1.' 4, I 1 I 1 . r A In I ' n 1 1 1 1 , 1.

ANALYSIS OF COST SHARING PROGRAMS FOR POLLUTION

ABATEMENT OF MUNICIPAL WASTEWATER

5. Publication Date

6. Perfortning Organization C-ode

7. Airi llOK(S)

Dr. Harold E. Marshall and Rosalie T. Ruegg

8. Performing Organ. Report No.

9. PI;KI 0RMINC, OKGANIZATION NAMF AND ADDRF-:SS NATIONAL BUREAU OF STANDARDS

DEPARTMENT OF COMMERCE

WAonlNulUn, U.I-.

10. Project/Task/Work Unit No. A63 7A30

11. Contract /Grant No.

12. Sponsor jn>; Orjiiin i/.at ion Nnm<' unci ('ompletc Address (Street, City, Slate, ZIP)

Office of Research and Monitoring

U.S. Environmental Protection Agency

Washington, D.C. 2OA60

13. Type of Report & Period Cov crcd Final

14, Sponsoring Agency Code

15. SDl^I'l.l'lMllNTARY NOl li.S

16. ARSTRAC'T (A 200-word or less factual summary of most sigriificant m formation. If document includes a significant

bibliof^raphy or literature survey, mention it here.) This study evaluates existing cost-sharing programs for wastewater pollution abatement

as described in the Federal Water Pollution Control Act Amendments of 1972, describes

alternative cost-sharing programs that provide improvements in terms of national

efficiency and equity criteria as defined herein, and suggests related areas for

further research. Emphasis is on how Federal cost sharing biases communities in

favor of certain kinds of techniques. The approach is to describe the current costsharing programs for both plant and nonplant techniques; to examine cost-sharing,

legal, and other institutional biases against certain techniques; to analyze efficiency and equity effects of alternative cost-sharing programs; and to describe the

incentive effects of cost sharing on nonfederal interests with respect to their

choices among abatement techniques. Findings of the study are that more efficient

abatement will result if the same percentage cost share applies to all plant and

nonplant techniques of abatement; the same percentage also applies to all categories

of cost (e.g., capital, land, operation and maintenance) for a given technique;

the same percentage applies to large and small communities; institutional constraints

on the selection of nonplant techniques are removed; and if the program provides for

Federal cost sharing of every abatement technique that is technically viable.

17. VCOKDS (six to twelve entries; alphabetical order; capitalize only the first letter of the first key word unless a proper name, .'teparated by semicolons

Cost sharing; efficiency; equity; financing; nonplant treatment; sewage treatment;

user fees; water pollution

18. AVAILABILITY [x Unlimited

[

' For Official Distribution. Do Not Release to NTIS

[ Order I'rom Sup. of Doc, U.S. Ciovernment Printing Office WashinKton. D.C. 20102. SD ( at. No. CH

[x' Order I'rom National Technical Information Service (N TIS) Springfield, Virginia 22151

19. SECURITY CLASS

(THIS REPORT)

UNCL ASSIFIED

21. NO. OF PAGES

137

20. SECURITY CLASS

(THIS PAGE)

UNCLASSIFIED

22. Price

USCOMM-OC 2e042-P74