CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

AUGUST 2006

How Federal 

Policies Affect the 

Allocation of Water

CBO

© Ingram Publishing
Pub. No. 2589
The Congress of the United States O Congressional Budget Office

CBO

How Federal Policies Affect 

the Allocation of Water

August 2006

A

PAPER

Preface

The drought conditions of recent years have focused attention on the nation’s use of 

freshwater resources. This Congressional Budget Office (CBO) paper examines the mechanisms that govern water allocation, how they affect the benefits that accrue to society from its 

use of water resources, how those effects might change over time, and what influence federal 

policies could have on such considerations. The paper was prepared in response to a request 

from the Ranking Member of the Subcommittee on Water and Power of the House Committee on Resources. In keeping with CBO’s mandate to provide objective, impartial analysis, the 

paper makes no recommendations.

Natalie Tawil of CBO’s Microeconomic Studies Division prepared this paper under the supervision of Joseph Kile, David Moore, and Roger Hitchner (formerly of CBO). Greg Hitz, Jim 

Langley, and Robert Murphy made contributions to the analysis. Bob Dennis, Arlene Holen, 

Julie Middleton, Bob Shackleton, Derek Trunkey, and Tom Woodward provided comments. 

Tom Zacarias of National Crop Insurance Services and Craig Bell of the Western States Water 

Council provided useful information, and Gary Libecap of the University of Arizona reviewed 

the paper. (The assistance of an external reviewer implies no responsibility for the final product, which rests solely with CBO.)

Christine Bogusz edited the paper, with assistance from John Skeen. Maureen Costantino prepared the paper for publication and designed the cover, and Lenny Skutnik printed the initial 

copies of the paper.

Donald B. Marron

Acting Director

August 2006

Contents

Summary vii

The Allocation of Water Resources 1

Water Uses 1

Private Rights to Use Water and the Impact on 

Potential Reallocations 2

The Role of Prices in Facilitating Reallocations 4

The Increasing Costs of Inflexible Water Allocations 8

Water-Rights Claims of Indian Tribes 9

Environmental Laws 9

Population Shifts to Arid States 10

Drought and Climate 11

Policy Options to Facilitate Reallocations 13

Facilitating Water Markets 13

Encouraging the Efficient Use of Water 16

Encouraging the Efficient Provision of Water 19

Appendix: Marketing Features of Indian Water-Rights Settlements 21

Tables

1. Freshwater Withdrawn from Surface and Groundwater 

Sources, by Category of Use and Region, 2000 2

A-1. Selected Indian Water-Rights Settlements 22

Figure

1. Drought Relief: Net Federal Outlays for Agriculture 12
VI HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Boxes

1. Apportioning Interstate Water Resources 4

2. “Pricing” Groundwater in Agriculture 6

3. Paying for California’s Central Valley Project 7

4. Interstate Commerce in Water 14
Summary

Use of the nation’s freshwater resources attracts 

particular scrutiny in times of drought. When water is 

scarce, people are more aware of its importance. The 

mechanisms that govern the allocation and use of water 

are complicated, however. To examine how society uses 

its water resources, this Congressional Budget Office 

analysis addresses several major questions:

B What are this country’s water sources, and how is the 

water used?

B What determines the underlying allocation, and does 

that allocation maximize water’s potential benefits to 

society as a whole? 

B What policies might the federal government consider 

toward that end?

Sources and Uses of Water

In the United States, freshwater resources are drawn from 

surface sources and groundwater sources. Nationally, surface waters account for about three-quarters of withdrawals; in the arid West, however, groundwater sources supply a larger percentage of withdrawals than in the East.

Nationwide, 40 percent of withdrawals are for agricultural use. In the West, agriculture accounts for 74 percent 

of withdrawals; in the East, where irrigation is less common, agriculture accounts for 11 percent of withdrawals. 

Although much of the water withdrawn for agriculture is 

consumed in irrigation, as much as 20 percent might return to its sources, albeit altered in terms of its content. 

Another 40 percent of withdrawals nationwide are for 

thermoelectric power. Those withdrawals return most of 

the water, altered only in temperature, to its sources. 

Thermoelectric power accounts for 64 percent of withdrawals in the East and 11 percent in the West. (Hydropower in the West uses only in-stream resources, so it has 

no associated withdrawals.) Residential, commercial, and 

industrial entities account for the remaining 20 percent 

of national freshwater withdrawals.

The Impact of Inflexible Water

Allocations

The water withdrawn for those various uses is allocated 

on the basis of state laws that determine property rights 

to use it. Market transfers of water—by sale, lease, or exchange—are constrained by the way states define property rights in water use. In the national economy, markets 

generally use prices to allocate scarce resources across uses 

and over time to maximize the overall net benefits to society. Markets in water-use rights, however, are not widespread. Water prices typically reflect the expense associated with physically accessing and delivering it. Such 

prices do not convey the opportunity costs—the economic benefit forgone when water is dedicated to a particular use—and thus do not allocate the resource to its 

highest-value use.

The state laws governing property rights and the pricing 

mechanisms that conceal opportunity costs make the current allocation of water relatively inflexible. That inflexibility might become increasingly costly in the future, as it 

exacerbates pressures on federal spending and reduces the 

potential gains to the economy from the use of water resources. Four developments in particular augment demand pressures: the settlement of Indian tribes’ claims on 

water rights currently held by others; environmental laws 

that require greater amounts of water be retained in natural courses; growing populations in arid states; and the recurring impacts of droughts, which may increase in frequency and intensity as a result of shifts in precipitation 

patterns.
VIII HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Policy Options to Facilitate

Reallocations

Broader use of markets in deciding how scarce water resources are allocated could improve on the current system 

of administrative allocation that has emerged under state 

law. Because markets offer flexibility in balancing supply 

and demand—by providing incentives to reallocate water 

among users, to use less water, and to provide more water—they could mitigate society’s costs of adjusting to 

changing conditions. 

The federal government could facilitate market transfers 

of water by clarifying the potential for broader water marketing using its jurisdiction under the commerce clause of 

the Constitution and federally reserved water rights. The 

commerce clause gives the Congress the authority to allocate interstate waters to serve the national interest—even 

if doing so means overriding state law. The Congress 

could clarify legal uncertainties regarding the rights of Indian tribes to lease water to different intrastate and interstate users. The government could also increase its efforts 

to promote water banks—institutional mechanisms that 

facilitate the market exchange of various types of surface 

water and groundwater rights and storage entitlements.

To facilitate efficient water use, policymakers could reconsider subsidies that support the use of water at prices 

that do not reflect opportunity costs, as well as subsidies 

for agricultural production that encourage additional 

planting and excess irrigation. The government could 

also assess the impact of refining or expanding programs 

that address the demand for water directly—using approaches such as cost sharing for improvements to irrigation systems and conservation plans for irrigators who get 

water from federal infrastructure projects. 

To encourage the efficient provision of water, policymakers could reexamine the level of federal support for 

research and development (R&D) to augment supplies. 

When multiple state and local governments and privatesector entities face a similar problem, they tend to invest 

too little in R&D because each balances the potential cost 

against only its own expected benefits, rather than the 

benefits that can accrue to the economy as a whole. 

Therefore, policymakers could contemplate the level of 

federal support for R&D in desalination and waterpurification technologies or for the collection of water resources data to refine water management as a public investment that might provide a positive return.
How Federal Policies Affect the

Allocation of Water

The Allocation of Water Resources

The nation accesses freshwater from precipitation and 

underground sources, stores surface water with dams and 

reservoirs, pumps water from aquifers and uses them for 

storage, and transports and distributes water through 

canals and pipes. Surface water makes up 76 percent of 

the freshwater supply, and groundwater accounts for 24 

percent. 

In the East, where annual precipitation generally ranges 

from 30 to 60 inches, 84 percent of freshwater comes 

from surface sources and 16 percent from groundwater 

sources. In the West (excluding the Pacific Northwest), 

where annual precipitation generally ranges from 5 to 20 

inches, 67 percent of freshwater comes from surface 

sources and 33 percent from groundwater sources.

The U.S. Geological Survey publishes data on water 

withdrawals, but national data on water consumption 

(withdrawals net of return flows) are not available. The 

relationship between withdrawals and consumption depends on the type of use and its impact on the quantity 

and quality of the return flows.

Water Uses

Agriculture accounts for 40 percent of freshwater withdrawals nationally, but the proportion is much lower in 

the East (11 percent), where irrigation is less prevalent, 

than in the drier West (74 percent). (See Table 1.) Withdrawals for irrigation are largely consumed. According to 

data for 2000, well over half of the water used for agriculture was probably consumed, as much as one-fifth was 

most likely lost in transport, and the remaining one-fifth 

or so returned to original sources. Such return flows are 

generally altered in terms of their pesticide, fertilizer, and 

mineral content. 

The production of thermoelectric power also accounts for 

about 40 percent of freshwater withdrawals nationwide. 

In the East—where power plants use water from the 

Great Lakes, major rivers, and the Atlantic ocean for their 

cooling systems—thermoelectric power production accounts for 64 percent of water withdrawals. In the West, 

it accounts for only 11 percent, because hydroelectric 

power, which is more common there, uses only in-stream 

water resources (and therefore requires no water withdrawals). 

Although a relatively large proportion of withdrawals is 

associated with thermoelectric power, water consumption 

by that sector is very limited. Once-through cooling systems, which use 88 percent of thermoelectric withdrawals, return water to its source, altered only in terms of 

temperature, after circulating it through heat exchangers.1 Less common closed-loop systems recycle the water 

they use but, in replacing losses, may consume more than 

half of their withdrawals.

Residential, commercial, and industrial uses account for 

the remaining 20 percent of freshwater withdrawals. Such 

withdrawals are higher in the East (roughly 25 percent) 

than in the West (about 15 percent) and are largely consumed. Return flows, composed primarily of sewage effluent, are a small proportion of withdrawals.2

1. The Environmental Protection Agency’s (EPA’s) rules effectively 

prevent the use of once-through cooling by new power plants 

because of the potential impact on wildlife.

2. See W.B. Solley, R.R. Pierce, and H.A. Perlman, “Estimated Use 

of Water in the United States in 1995,” Circular 1200 (Reston, 

Va.: U.S. Geological Survey, 1998), and S.S. Hutson and others, 

“Estimated Use of Water in the United States in 2000,” Circular 

1268 (Reston, Va.: U.S. Geological Survey, 2004).
2 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Table 1.

Freshwater Withdrawn from Surface and Groundwater Sources, by Category of 

Use and Region, 2000

(Percent)

Source: Congressional Budget Office based on data from S.S. Hutson and others, “Estimated Use of Water in the United States in 2000,” 

Circular 1268 (Reston, Va.: U.S. Geological Survey, 2004). 

Note: The relationship between water withdrawals and water consumption depends on the type of use and its impacts on the quantity and 

quality of return flows. The U.S. Geological Survey currently publishes data on water withdrawals but not water consumption.

a. These are public and private suppliers serving at least 25 people or having at least 15 connections. The water may be for residential (56 

percent in 1995), commercial (17 percent), or industrial purposes (12 percent) or for thermoelectric power (0.3 percent). During 2000, 

suppliers in this category provided about 85 percent of the nation’s population with drinking water. 

Private Rights to Use Water and the Impact on 

Potential Reallocations

State laws determine private property rights to use water, 

but those rights are incomplete.3 Reallocations are constrained under state laws in two respects. First, the laws 

incorporate restraints on water use, and thus on water 

transfers, that would interfere with the water rights of 

others. Second, in times of water shortages, holders of 

water rights are either subject to proportional reductions 

in use or obliged to reduce their use to ensure that those 

who preceded them in obtaining rights to the same 

source of water can claim their full allocation. Those two 

elements of state law differ in form under the riparian 

doctrine common in the East and the prior appropriation 

doctrine common in the West. 

Rights Under the Riparian Doctrine. In the East, the 

ownership of land adjacent to a body of water (riparian 

land) generally conveys the right to use the water in a way 

that is “reasonable.” A qualifying landowner may initiate 

new uses at any time, and others may need to adjust their 

use in response. Any qualifying landowner can make 

“natural” use of the water (to meet his or her residential 

needs) regardless of the consequence to others who own 

riparian land. “Artificial” uses (for irrigation and industrial purposes) are subject to restrictions on the basis of 

the reasonableness of the use.4 Determining what is reasonable involves consideration of the purpose of the use, 

the suitability of the use to the body of water, economic 

and social values of the use, the extent of harm caused, 

the practicality of avoiding any harm by adjusting the 

methods or quantities of use, and the fairness of making 

the user who causes harm bear losses. When the water 

supply is deemed insufficient to satisfy the reasonable 

needs of all qualifying landowners, they must reduce their 

use in proportion to their rights—sometimes based on 

the amount of adjacent land they own.

Category of Use Surface Ground Both Surface Ground Both Surface Ground Both

Irrigation and Livestock 31 70 40 4 48 11 70 81 74

Thermoelectric Power 52 0 39 76 1 64 16 0 11

10 23 14 11 38 15 10 15 12

Self-Supplied Industrial 6 4 5 8 9 8 2 2 2

Aquaculture and Mining 1 2 2 1 4 1 2 1 2 ____ ____ ____ ____ ____ ____ ____ ____ ____

Total 100 99 100 100 100 99 100 99 101

United States East West

Public Supplya and Self-Supplied 

Residential

3. For a discussion of the origin and evolution of state water law, 

from which this discussion draws heavily, see David Getches, 

Water Law in a Nutshell, 3rd ed. (St. Paul, Minn.: West Publishing 

Co., 1997).

4. In practice today, owners of riparian land must obtain permits 

from a state agency to use water. Permits may also be available to 

others who do not own riparian land. The charters incorporating 

most cities give them power to procure water for public purposes 

and to supply the domestic needs of their residents, and states 

have modified the riparian doctrine by introducing exceptions 

that allow municipal uses.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 3

Under the riparian doctrine, water rights transfer with the 

transfer of land. A qualifying landowner can transfer the 

water rights separately only if the recipient uses the water 

on the riparian land and meets the test of reasonable use. 

An owner of riparian land cannot transfer water out of a 

watershed.

Rights Under the Prior Appropriation Doctrine. In the 

West, the right to use a quantity of water generally belongs to anyone who first diverts that water from its natural setting and puts it to a “beneficial use” anywhere. A 

water right is specified in terms of the date it is established, its purpose of use, the quantity of water, the rate 

of flow, the point of diversion, and the time when the 

water may be taken. The right remains valid as long as it 

continues to be used for the purpose for which it was 

established. All states relying on the prior appropriation 

doctrine consider agricultural, residential, commercial, 

and industrial uses to be beneficial. Most states accept 

recreation as a beneficial use, and some specify that scenic 

or aesthetic uses are also beneficial. The doctrine shields 

appropriators’ rights from impingement associated with 

changes in the terms of water rights and accords no preference to uses with higher relative economic or social 

value compared with uses established earlier in time.5

When water is in short supply, rights-holders who have 

made appropriative claims earlier (senior appropriators) 

have priority over parties who made later claims to water 

from the same source—those junior appropriators may 

receive only some, or none, of the water to which they 

have rights.

Under the doctrine of prior appropriation, water rights 

can be conveyed with a transfer of land and retain their 

priority, but an appropriator can transfer the water rights 

separately (for use on a different parcel of land, for a different purpose, at a different time, or with a change in the 

point of diversion) only if the transfer does not impair 

other appropriators’ ability to exercise their vested rights. 

A transfer impairs rights if it results in other appropriators being deprived of water (in terms of its quantity or 

quality) or if their obligations to senior appropriators 

mount, as exemplified in the following situation. Most 

senior appropriative rights belong to irrigators. Transferring those rights may harm downstream users whose 

appropriations rely on return flows from irrigation. Protecting the rights of those junior appropriators can frustrate water transfers from agriculture to potentially more 

productive municipal or industrial uses.6 Junior appropriators may also claim harm if they are deprived of the 

return flows from change in a senior appropriator’s use—

if, for instance, the senior appropriator uses less waterintensive crops or more-efficient irrigation systems, salvages water, and transfers it for use on different land or 

for new purposes.7

Transferring water outside a watershed is not expressly 

prohibited under the prior appropriation doctrine, but 

various state laws limit such transfers through requirements to protect the equities and interests of the area of 

origin. For example, Nebraska prohibits transfers from 

agriculture to other uses,8

 and Idaho does not allow 

transfers that “would significantly affect the agricultural 

base of the local area.”9 Some states explicitly restrict the 

right to use water outside the watershed where it originates. Their statutes focus mostly on intrastate exports, 

but some, like Alaska’s, address interstate exports. (See 

Box 1.)

Rights to Use Groundwater. The rights to use groundwater may be based on the notion that water is a shared 

public resource, on ownership of overlying land, or on

5. Generally, states require users to obtain permits to appropriate 

water. The states issue those permits on the basis of requirements 

designed to protect water users and consider the public interest. 

Some state courts have held that states have a “public trust” obligation not to allow water to be used inconsistently with public 

purposes. Although water rights manifested in a permit are rarely 

disturbed, the public trust doctrine may negate existing appropriations that are contrary to the public interest.

6. Rather than using rights to withdraw water as the basis for transfers, some observers suggest basing transfers on water consumption so that the water associated with the return flows from the 

now-transferred appropriative rights is retained in the original 

watershed. One problem with that approach is that consumptive 

use is difficult to measure. See Terry Anderson and Ronald N. 

Johnson, “The Problem of Instream Flows,” Economic Inquiry, vol. 

24, no. 4 (1986), pp. 535-553; and Ronald N. Johnson, Micha 

Gisser, and Michael Werner, “The Definition of a Surface Water 

Right and Transferability,” Journal of Law and Economics, vol. 24, 

no. 2 (1981), pp. 273-288. 

7. If recapture and reuse of water occurred within the original land 

and for the original purpose, it would be allowed without regard 

to the harm caused to a downstream appropriator, as long as the 

amount diverted did not exceed the amount originally specified in 

the permit.

8. Neb. Rev. Stat. §46-294(1)(I).

9. Idaho Code §42-222(1). 
4 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

established uses (or some combination of those three). 

Most states do not recognize private ownership rights to 

groundwater and consider it subject to management as 

public property; as a result, users could lose access to the 

resource and have no recourse. States that rely on the correlative rights doctrine limit landowners to a “reasonable” 

share of the total groundwater supply, usually based on 

the acreage they own.10 States that recognize prior appropriation rights to groundwater may modify the doctrine 

to set reasonable pumping levels.11 The exercise of private rights by owners of overlying land or appropriators is 

governed by the tort doctrines of nuisance and negligence, which impose liability for harm to other users 

and property owners.

The Role of Prices in Facilitating Reallocations

Market economies rely on prices to allocate resources 

among uses and over time to make the most efficient use 

of them. Although some functioning water markets

Box 1.

Apportioning Interstate Water Resources

Sources of water are not neatly confined by state borders. For interstate surface water, states clarify their 

administrative division through compacts, which are 

Congressionally ratified agreements. The Colorado 

River Compact, for example, aims to divide the river’s 

water between the Upper Basin states (Colorado, 

New Mexico, Utah, and Wyoming) and the Lower 

Basin states (Arizona, California, and Nevada). In 

1922, the compact’s signatories had one estimate of 

the river’s average annual flow of 16.8 million acrefeet, based on an examination of river flows from 

1896 to 1921.1 A second estimate, based on river 

flows from 1906 to 1921, put the average at 18.1 

million acre-feet. The agreement essentially splits the 

difference and relies on an average annual flow of 

17.5 million acre-feet. (In fact, it apportions more 

water than actually exists.2 Studies of river flows over 

the past 400 years, based on an analysis of tree rings, 

have put the average annual flow at 13.5 million acrefeet.) 

For interstate groundwater, the laws of each state govern access to and use of an aquifer’s resources withdrawn in its jurisdiction, even if those resources are 

accessible from multiple states. For example, there is 

no coordinated apportionment, even for the largest 

aquifer crossing state boundaries—the High Plains 

aquifer, which extends over 174,000 square miles and 

involves eight states: Colorado, Kansas, Nebraska, 

New Mexico, Oklahoma, South Dakota, Texas, and 

Wyoming. 

1. One acre-foot is the volume of water that would cover one 

acre to a depth of one foot. Equivalent to 325,851 gallons, it 

approximates the amount of water used by a four- to fiveperson household over a period of one to two years.

2. The states of the Upper Basin have never used their full 

apportionment of 7.5 million acre-feet. As of 2000, they used 

about 4.8 million acre-feet. Recent projections suggest their 

use will increase by about 700,000 acre-feet by 2025 and by 

nearly 1.1 million acre-feet by 2050. See Robert 

Jerome Glennon and Peter W. Culp, “The Last Green 

Lagoon: How and Why the Bush Administration Should 

Save the Colorado River Delta,” Ecology Law Quarterly, vol. 

28, no. 4 (2002), pp. 916-917.

10. Under the absolute ownership doctrine, landowners have an 

unlimited right to withdraw water found beneath the land they 

own. There are no restrictions on use and no liability for causing 

harm to other owners of overlying land. Only Texas assigns 

groundwater rights on the basis of absolute ownership.

11. Some states control the mining of aquifers so that depletion 

occurs over a predictable number of years, and some western states 

identify “critical areas” where new well drilling and pumping may 

be severely curtailed or prohibited.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 5

exist,12 water prices, rather than incorporating the opportunity costs of a given use, more commonly reflect only 

the expenses associated with physically accessing and delivering water that is administratively allocated according 

to state law. The prices may also be influenced by government subsidies. For example, subsidies have reduced water prices paid by irrigators in western states and provided 

part of the investment in public water systems nationwide. When markets for a resource are few, and the prices 

charged for that resource arbitrary, it is likely that the resource will not be efficiently allocated.

Agriculture. The federal government, through the Bureau 

of Reclamation, is the “wholesale” supplier of about half 

of the surface water withdrawn for irrigation. (Surface 

water accounts for about 60 percent of irrigation withdrawals.) The bureau’s 250 or so dams and nearly 350 

storage reservoirs in 17 western states divert more than 40 

million acre-feet of water from rivers.13 (About onequarter of the water that is diverted is lost in operational 

spills and transport, yielding a supply of about 30 million 

acre-feet.) More than 25 million acre-feet is withdrawn 

for irrigation, and the rest is for residential, commercial, 

and industrial uses.14 The “retail” suppliers of surface 

water for almost all irrigators are nonprofit entities, 

mainly irrigation districts, that enter into supply contracts for water deliveries and use their conveyance systems to distribute water to their members. The estimated 

average price charged by those entities for such water 

(largely in the West) was $16 per acre-foot delivered in 

1998.15 (Prices for groundwater are comparable; see

Box 2.)

Subsidies by the Bureau of Reclamation have reduced the 

prices that irrigators pay for water. In constructing western water projects, with the original aim of encouraging 

settlement, the federal government spent $24.0 billion 

(in nominal dollars) from 1902 to 2004. Under reclamation law, $19.3 billion of that is “reimbursable”—to be 

repaid by the projects’ beneficiaries. Irrigators are responsible for 46 percent of the total, with power users followed by municipal and industrial water users responsible 

for the rest. Determinations by the federal government 

that irrigators were not able to pay shifted $2.9 billion of 

their $8.9 billion debt to other project beneficiaries, primarily power users.16 Also, lawmakers, through specific 

legislation, and the courts subsequently reclassified $2.7 

billion of irrigators’ debt as nonreimbursable. As of 2004, 

irrigators had repaid $1.3 billion of their remaining $3.3 

billion debt.17

For irrigators, the Bureau of Reclamation bases its water 

supply charges on recovering the associated capital costs 

and operation and maintenance (O&M) costs for the 

federal facilities. Irrigators’ interest-free payments—

which are due over a 40- or 50-year period—do not incorporate the opportunity costs of the federal expenditures. Over a 40-year repayment period at a borrowing 

cost of 4 percent annually, the government recovers only

12. To find out about the characteristics necessary for a functioning 

market, see B.C. Saliba and D.B. Bush, Water Markets in Theory 

and Practice: Market Transfers, Water Values, and Public Policy

(Boulder, Colo.: Westview Press, 1987). For a comparison of specific markets, see D.S. Brookshire and others, “Market Prices for 

Water in the Semi Arid West,” Water Resources Research, vol. 40 

(2004). Studies of individual markets and their challenges can be 

found in K.D. Frederick, “Marketing Water: The Obstacles and 

the Impetus,” Resources, vol. 132 (1998), pp. 7-9; R.A. Kaiser and 

L.M. Phillips, “Dividing the Waters: Water Marketing as a Conflict Resolution Strategy in the Edwards Aquifer Region,” Natural 

Resources Journal, vol. 38 (1998), pp. 411-444; and R.C. Griffen 

and F.O. Boadu, “Water Marketing in Texas: Opportunities for 

Reform,” Natural Resources Journal, vol. 32 (1992), pp. 265-288. 

More formal modeling of water markets in the context of specific 

problems can be found in M.L. Weber, “Markets for Water Rights 

Under Environmental Constraints,” Journal of Environmental Economics and Management, vol. 42 (1999), pp. 53-64; and M. Weinberg, C.L. Kling, and J.E. Wilen, “Water Markets and Water 

Quality,” American Journal of Agricultural Economics, vol. 75 

(1993), pp. 278-291.

13. One acre-foot is the volume of water that would cover one acre to 

a depth of one foot. Equivalent to 325,851 gallons, it approximates the amount of water used by a four- or five-person household over a period of one to two years.

14. The diversions amount to between 40 percent and 85 percent of 

the annual flow of major western rivers such as the Colorado, Rio 

Grande, Sacramento, San Joaquin, and Snake.

15. Ralph Heimlich, Agricultural Resources and Environmental Indicators, Agricultural Handbook No. AH722 (U.S. Department of 

Agriculture, Economic Research Service, February 2003).

16. Because that transferred obligation is generally scheduled to be 

credited at or near the end of a project’s repayment period, $94.5 

million in revenues from power users had been dedicated to repay 

the federal government by 2004.

17. E-mail communication from Karl J. Stock, Office of Program and 

Policy Services, Bureau of Reclamation, July 24, 2006.
6 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

49 percent of its true cost. In some instances, the reimbursable costs of existing reclamation projects have yet to 

be recovered, and water users’ payments may not even 

cover O&M costs (see Box 3).

Public Supply. The public supply of water comes primarily from local or regional public entities or from privately owned concerns that take in, treat (in most cases), 

and distribute the resource. Two-thirds of retail water deliveries are for residential use, 13 percent are for commercial and industrial uses, and the remaining 20 percent are 

for agricultural and other uses. The average prices for residential and nonresidential water delivery were $1,013 

per acre-foot and $1,147 per acre-foot, respectively, in 

2000.18 In that year, water providers obtained one-fifth 

of the public supply from wholesalers at an average price 

of $580 per acre-foot.19

Direct federal spending and federally supported spending 

by states and municipalities have also subsidized the provision of public water. Although public water supply systems are built primarily by local communities and financed mainly by users, over time providers have failed to 

take in adequate revenues for procuring and treating supplies and for operating, maintaining, and replacing their 

water infrastructure. The federal government supports 

those systems through various spending programs—including the Drinking Water State Revolving Funds and 

loans and grants administered by the Rural Utilities Service of the Department of Agriculture—and, to a lesser 

extent, through tax preferences. In 1999, subsidies

Box 2.

“Pricing” Groundwater in Agriculture

Groundwater accounts for about 40 percent of total 

irrigation withdrawals and the major share of onfarm water resources. The costs of accessing groundwater involve capital expenditures for wells, pumps, 

and power plants, and the costs of the energy needed 

to power the pumps. In 1998, typical capital costs to 

access on-farm groundwater resources were in the 

range of $20,000 to $200,000. The Department of 

Agriculture estimated total U.S. energy expenditures 

for all on-farm irrigation water pumping at more 

than $1.2 billion in 1998. Average energy expenditures were $32 per acre. (Energy costs vary widely, depending in part on the depth of the water, the efficiency of the pumping system, and the needs for 

pressurization.) An estimate of the average energy 

cost per acre-foot of water, using the national average 

total depth of water applied from all sources through 

the irrigation season in 1998 (20.9 inches), would be 

about $18.1

1. Ralph Heimlich, “Agricultural Resources and Environmental 

Indicators,” Agricultural Handbook No. AH722 (Department of Agriculture, Economic Research Service, February 

2003). 

18. Environmental Protection Agency, Community Water System Survey 2000, Volume I: Overview, EPA 815-R-02-005A (December 

2002). Average water sales and water-related revenues, from which 

the agency derived those average prices, increased by 12 percent in 

real (inflation-adjusted) terms between 1995 and 2000.

19. Ibid. The differential does not appear to be explained by treatment costs. Seventy-one percent of all water systems treat their 

water, and wholesalers treat over three-fourths of their deliveries. 

Only a portion of the price difference between agricultural and 

public water supply uses can be attributed to treatment and basic 

transportation costs. For example, with irrigation contract prices 

of $2 to $31 per acre-foot for Central Valley Project water in 

California during the late 1990s, prices for an acre-foot of water 

charged by most of the state’s urban water suppliers approached or 

exceeded $1,000. Between $100 and $300 of the price difference 

is explained by the treatment and transportation costs of providing the water to municipal areas in the southern and coastal portions of the state. See Marca Weinberg, “Assessing a Policy GrabBag: Federal Water Policy Reform,” American Journal of Agricultural Economics, vol. 84, no. 3 (August 2002), pp. 541-556.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 7

provided the equivalent of 10.8 percent of the total investment in water systems.20

Opportunity Costs. Prices based on the costs of accessing 

and delivering water, and influenced by subsidies, bear 

little relation to the opportunity costs of water use—the 

value that society places on the best alternative use. Opportunity costs (which are better reflected in marketdetermined prices) play an important role in determining 

whether society’s use of a resource is achieving the greatest 

possible net benefits when the productivity associated 

with an additional unit varies among alternative uses.

Various studies have concluded that the value of one 

additional unit of water used in agriculture is generally 

less than in industrial or municipal uses.21 In the case of 

agricultural use, that conclusion depends on the amount 

of water used in crop production and the price of the 

crop produced.22 A 2003 study of a specific out-of-basin 

transfer of surface water originally used for agriculture 

Box 3.

Paying for California’s Central Valley Project

California’s Central Valley Project—the country’s 

largest water supply project—began deliveries in 

1940 and was completed in 1979. Irrigators are responsible for paying $1.3 billion of the project’s federal construction cost of $3.6 billion (in nominal dollars). Originally, irrigators had renewable 40-year 

water service contracts that provided for water deliveries but not necessarily for repaying the $1.3 billion 

by the end of the contract term. The Bureau of Reclamation intended for the contract prices to cover only 

operation and maintenance (O&M) expenses and a 

portion of construction costs. However, the prices 

were not even sufficient to cover O&M expenses, 

which increased over time. Deficits accrued in the 

O&M accounts, and no payments were made for 

construction costs.1

In 1986, federal legislation imposed a final repayment deadline of 2030 for all Central Valley Project 

facilities located within the Sacramento-San Joaquin 

valleys. According to the most recent figures available, as of September 30, 2004, irrigators had met 

14.2 percent of their total repayment obligation.2

The Bureau of Reclamation has recently renegotiated 

expiring water service contracts, and new 25-year 

contracts went into effect in the spring of 2006. 

Questions remain as to whether the contracts provide 

for meeting capital repayment obligations by 2030, 

however.3

1. Congressional Budget Office, Water Use Conflicts in the West: 

Implications of the Bureau of Reclamation’s Water Supply Policies (August 1997).

2. See the Central Valley Project’s Schedule of Irrigation Capital 

Rates by Contractor, 2006 Irrigation Water Rates, Schedule 

A-2Ba, available at www.usbr.gov/mp/cvpwaterrates/

ratebooks/irrigation/2006/IRR%202006%20Sch%20

A-2Ba%20F.Z08.pdf. 

3. Letter from Joel D. Kaplan, Deputy Director, Office of Management and Budget, to Representative George Miller, 

September 13, 2004.

20. See Congressional Budget Office, Future Investment in Drinking 

Water and Wastewater Infrastructure (November 2002), p. 38. That 

estimate applies to the combined investment in drinking water 

and wastewater systems.

21. A 1983 study put the range of the value for an additional acre-foot 

of water in agriculture at $9 to $103. For water in domestic uses, 

the range was $19 to $322; for water in industrial uses, it was zero 

to $160; and for water in recreational uses, $2 to $17. (See Office 

of Technology Assessment, Water Related Technology for Sustainable Agriculture in US Arid/Semiarid Lands, OTA-F212, 1983, as 

referenced in William Boggess and others, “Economics of Water 

Use in Agriculture,” in Agricultural and Environmental Resource 

Economics, Gerald A. Carlson and others, eds. (New York: Oxford 

University Press, 1993, pp. 319-391.) Also see Gary Libecap, 

Transaction Costs: The Owens Valley Transfer to Los Angeles, Working Paper No. 10801 (Cambridge, Mass.: National Bureau of Economic Research, 2004); and National Research Council, Water 

Science and Technology Board, Water Transfers in the West: Efficiency, Equity, and the Environment (Washington, D.C.: National 

Academies Press, 1992), p. 150.

22. Heimlich, Agricultural Resources and Environmental Indicators.
8 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

found large improvements in the net benefits that society 

could obtain from its use of water—an annualized 

67 percent increase in overall social welfare.23 A 1984 

study modeling comprehensive intrastate water trading in 

California found that moving 11.5 percent of total agricultural water supplies to urban uses in 2020 would 

equalize the value of an additional unit of water (net of 

transport and other costs) among different sectors, maximizing the net benefits to society.24

More broadly, a 1992 study modeled intrastate and interstate trading for Colorado River water, taking into account not only the economic values in agricultural and 

municipal/industrial uses but also the values of some 

nonconsumptive uses such as in-stream flows for hydropower production. The researchers concluded that consumptive-use markets alone would yield 50 percent

(intrastate markets) to 64 percent (intrastate and interstate markets) of the total possible improvement in net 

social benefits from optimal water allocation when values 

associated with the nonconsumptive uses of water were 

also considered.25

Large differences between the net benefits to society from 

actual water use and the hypothetical best use are not surprising given that a 1986 survey of 196 Bureau of 

Reclamation-supplied irrigation districts (which account 

for more than 70 percent of total irrigated acreage in bureau-supplied districts) indicated that many users faced a 

price of zero for an additional unit of water. Forty-eight 

percent of the districts assessed their members a fixed 

charge per acre that was independent of the amount of 

water delivered. Thirty-eight percent of the districts coupled a fixed charge for an initial volume of water with a 

quantity-based rate for excess use. However, that 

quantity-based rate was typically not triggered in normal 

years, so those irrigators generally also faced a price of 

zero for an additional unit of water.26 In 1997, when researchers revisited the districts, the situation was largely 

the same—district prices provided little information to 

irrigators about the opportunity costs of using an additional unit of water.27 In 2004, the prices faced by irrigators on the western slope of the Rocky Mountains in 

Colorado for an additional unit of water ranged from 

zero to $6.52 (per acre-foot), while municipalities in the 

same counties charged between $326 and $1,026 (per 

acre-foot at average volumes used by four- or five-person 

households).28

The Increasing Costs of Inflexible 

Water Allocations

Currently, constraints on reallocating water are embodied 

in state laws and in pricing mechanisms that mask opportunity costs. Over time, inflexible allocations may exacerbate pressures on federal spending and reduce the net 

benefits that society derives from water use because of 

four developments augmenting demand pressures: the 

settlement of Indian tribes’ water-rights claims, environmental laws requiring that greater amounts of water be 

retained in natural courses, shifts in the population toward arid states, and the possibility that changing precipitation patterns as a result of climate change could intensify droughts.

23. Keith C. Knapp and others, “Water Transfers, Agriculture, and 

Groundwater Management: A Dynamic Economic Analysis,” 

Journal of Environmental Management, vol. 67 (2003), pp. 291-

301. The transfer prompts an increase in the use of groundwater 

for agriculture and a reduction in the replenishment of the 

affected aquifer. If the market incorporates the effects on the water 

table level, the water sellers obtain relatively small gains from the 

transfers.

24. H.J. Vaux and R.E. Howitt, “Managing Water Scarcity: An Evaluation of Interregional Transfers,” Water Resources Research, vol. 20 

(1984), pp. 785-792. 

25. J.F. Booker and R.A. Young, “Modeling Intrastate and Interstate 

Markets for Colorado River Water Resources,” Journal of Environmental Economics and Management, vol. 26 (January 1994), pp. 

66-87.

26. The quantity-based rate, when triggered, was either decreasing 

with the volume used (so irrigators faced a declining price for 

additional use) or constant in 86 percent of those districts. The 

remaining 14 percent used a purely quantity-based rate and 

almost all of them had a constant per-unit price.

27. A.M. Michelsen and others, “Emerging Agricultural Water Conservation Price Incentives,” Journal of Agricultural and Resource 

Economics, vol. 24, no. 1 (1999), pp. 222-238.

28. Those numbers come from Western Resource Advocates, Water 

Rate Structures in Colorado: How Colorado Cities Compare in Using 

This Important Water Use Efficiency Tool (September 2004) and 

from the Congressional Budget Office’s interviews with the six 

western slope irrigation districts—all of which obtained water 

from federally financed projects.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 9

Water-Rights Claims of Indian Tribes

The water-rights claims of Indian tribes began to be settled through restrictions on state water allocations in the 

late 1970s. The Supreme Court had earlier ruled that 

when the federal government established an Indian reservation, by implication it reserved enough water to “fulfill 

the purposes for which the reservation was made.”29 The 

reservation’s establishment date set the priority of the 

water rights, which are not subject to forfeiture for nonuse. Even though states did not account for those “federally reserved” rights as users were appropriating water, the 

federally reserved rights, when finally asserted, have 

seniority over water rights established under state laws of 

prior appropriation because Indian reservations predate 

many non-Indian settlements.

To accommodate the emerging demand for water, the 

federal government has helped states and tribes negotiate 

settlements that quantify the federally reserved rights and 

provide the associated water resources by restricting state 

water allocations. To date, the Congress has approved 20 

Indian water-rights settlements, beginning with the 

Ak-Chin Indian Water Rights Settlement Act of 1978 

and including the recent Arizona Water Settlements Act 

of 2004. In the context of those settlements, the federal 

government spent, or committed to spend, at least $1.7 

billion—directing the funds to affected irrigation districts 

and to Indian communities for economic development.

By redefining senior-most water-use rights, the settlement of Indian tribes’ water-rights claims may offer a way 

around some restrictions on market transfers of water 

resources. Considerable amounts of water might be made 

available to markets if some of the constraints associated 

with the rights as currently held by non-Indian irrigators 

no longer exist—tribes hold sizable (as yet unexercised) 

rights over large quantities of water. Under the Supreme 

Court’s 1963 Arizona v. California decision, tribes are 

legally entitled to the amount of water needed to irrigate 

all practically irrigable acreage within their reservation 

boundaries, and tribes own large amounts of land in the 

western states.30 In Arizona, for example, 19 reservations 

account for 20 million acres, or 28 percent, of the land in 

the state. The water rights associated with Wyoming’s 

1.2-million-acre Wind River Reservation affect the entire 

Bighorn Basin—which makes up 21 percent of the state’s 

land area and most of its irrigated land. Indian reservations also account for more than 10 percent of the land in 

New Mexico and 6 percent in Washington. 

Environmental Laws

The Endangered Species Act of 1973 has prompted federal expenditures addressing issues of water supply and 

allocation. Among the 663 species listed as “threatened” 

or “endangered” in 1995, 141 were affected by the diversion or drawdown of surface water, 82 by water-level 

fluctuation, 26 by water-level stabilization, 61 by watertemperature alteration, 103 by reservoirs, 71 by the drawdown of groundwater, and 14 by alteration of water’s 

salinity. Perhaps the best-known example of such expenditures are those associated with the multipurpose 

California Bay-Delta Restoration Program (CALFED), 

which has received about $325 million in federal funding 

during the 1998-2006 period. Other examples include 

$72 million (from 1989 through 2000) for the cooperative agreement for the Upper Colorado Endangered Fish 

Recovery Program, over $35 million for the 1997 cooperative agreement for Platte River research and other efforts 

relating to endangered species’ habitats along the Central 

Platte River, and $11.5 million for a 2005 cooperative 

agreement to aid four endangered species of fish in 

Colorado’s Yampa River Valley.

Beyond expenditures to ensure compliance with the act, 

the government has incurred compensation costs because 

of related changes in water-use patterns; such costs could 

mount over time. The federal government was held 

financially liable in April 2001, and later charged $13.9 

million plus interest, for diverting water from California 

irrigators to serve the needs of endangered species in 

1992 and 1994.31 The U.S. Court of Claims found that 

the diversions amounted to a physical (not regulatory) 

taking of irrigators’ private property. The body of law that 

the courts apply in judging a taking claim allows the government considerable latitude to regulate without causing 

29. Winters v. United States, 207 U.S. 564, 577 (1908). In 1976, the a taking. Thus, the courts find that most federal restricSupreme Court ruled that the federal government had reserved 

water rights for any land set aside from the public domain for a 

particular purpose (Cappaert v. United States, 426 U.S. 128). The 

ruling applies to national forests, national parks, national wildlife 

refuges, and wild and scenic rivers.

30. Arizona v. California, 376 U.S. 340 (1963).

31. Tulare Lake Basin Water Storage District v. United States, 49 Fed. 

Cl. 313 (2001)
10 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

tions do not constitute a taking unless they entirely eliminate the value of the regulated property or some fundamental right of ownership. In this case, the court decided 

that by preventing the affected farmers from using as 

much as a third of their water deliveries, the government 

had deprived them of the entire value of their contract 

right, creating a “complete extinction of all value” that 

amounted to a physical taking of property. It was the first 

time the courts found that environmental restrictions on 

the exercise of water rights could amount to such a taking 

in the context of the Endangered Species Act.

It is not clear how changes in water allocation related to 

environmental laws will affect the net benefits that society derives from its use of water resources. Allocation 

under prior appropriation tended to ignore the benefits 

associated with water in its natural course because, to 

establish a water right, a user had to divert or withdraw 

water. Only recently have state laws recognized rights to 

use water beneficially as it flows naturally. Determining 

the optimal allocation would necessitate establishing the 

value of those environmental benefits. But they are difficult to quantify. Although most western states now recognize in-stream water rights in some form, water-rights 

purchases and leases for in-stream flows represent only a 

small fraction of water-rights transactions in the West.32

The power of the market to reallocate the resource to instream flows is limited because in most states a public entity must hold the rights to instream flows and private citizens cannot purchase such rights.33

Population Shifts to Arid States

The five U.S. states with the fastest-growing populations 

in percentage terms from 1990 to 2000 were all in the 

West. Ranked first was Nevada (at 66.3 percent), followed by Arizona (40.0), Colorado (30.6), Utah (29.6), 

and Idaho (28.5). California was first in absolute terms 

with more than 4.1 million new residents, but it ranked 

18th in percentage terms.34 There was also notable 

growth in the Southeast. Georgia’s population growth was 

the sixth largest in the nation (26.4 percent), followed by 

Florida’s (23.5).

In some of those states where freshwater withdrawals have 

grown along with the population, the federal government 

has undertaken large-scale ecosystem-restoration initiatives that are linked with the urban demand for water. 

The government has, for example, committed financial 

support to the Comprehensive Everglades Restoration 

Plan (CERP) in Florida and California’s Bay-Delta Restoration Program. When the Congress approved Florida’s 

30-year, $7.8 billion CERP in the Water Resources Development Act of 2000, it authorized $700 million in appropriations for an initial set of projects.35 (Recently, a 

draft progress report for the Congress put the final cost of 

the effort at $10.9 billion.36 The state and the federal 

government are to share funding responsibilities equally.) 

CERP aims to restore natural hydrologic functions while 

meeting water-supply and flood-control objectives for agriculture and a growing urban sector in southern Florida. 

The strategy is to increase the storage of excess water in 

the rainy season to provide more water during the dry 

32. According to the Water Strategist’s February 2003 “Annual Transaction Review,” of the 200 transactions in 2002, only 15 were for 

such purposes. The Water Strategist may not record all of the 

trades in western water, but it is the only comprehensive source of 

information on water trades.

33. In Idaho, Oregon, and Washington, only state agencies can dedicate unappropriated water to in-stream flows. (See Idaho Code 

§42-1503, Or. Rev. Stat. §537.336, and Wash. Rev. Code 

§§90.03.247, 90.22.010.) Furthermore, the prior appropriation 

doctrine limits the prospects for such dedications because water in 

most western streams is already fully appropriated. In Colorado, 

for example, since 1973 the state-run Colorado Water Conservation Board has been allowed to appropriate minimum stream 

flows and lake levels for the preservation of the natural environment “to a reasonable degree.” However, because post-1973 water 

rights are relatively junior in priority, flows are available only in 

years when there is sufficient water to satisfy all of the rights of 

senior appropriators. In 1986, the state authorized the Colorado 

Water Conservation Board to buy or accept the donation of senior 

appropriators’ water rights and use them for in-stream flows (see 

Colo. Rev. Stat. §37-92-102). 

34. U.S. Census Bureau, “States Ranked by Percent Population 

Change: 1990 to 2000,” Census 2000 PHC-T-2 (April 2, 2001), 

Table 3, available at www.census.gov/population/cen2000/phc-t2/

tab03.pdf. 

35. No additional projects have been authorized since 2000. Authorization for $1.6 billion for two projects is included in pending legislation, the Water Resources Development Act. Still, the federal 

government contributes to Everglades restoration through appropriations for CERP and other activities spread among several 

agencies. From fiscal years 1993 through 2005, the combined federal investment in Everglades restoration totaled about $2.5 billion. For fiscal year 2006, the Congress appropriated $223 

million.

36. Army Corps of Engineers, Comprehensive Everglades Restoration 

Plan, 2005 Report to Congress (2005).
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 11

season. Officials plan to direct an estimated 80 percent of 

the captured water to the natural system and 20 percent 

to agriculture and urban consumption.

The CALFED program, established by the federal government and California in 1995, aims to restore fish and 

wildlife habitat, protect levees in the San Francisco Bay/

Sacramento-San Joaquin Delta area in central California, 

and address issues of the reliability and quality of the 

water supply—including drinking water. The California 

Bay-Delta Environmental Enhancement Act of 1996 

authorized a total of $430 million for fiscal years 1998 

through 2000, and the Congress appropriated $220 million for CALFED activities during that period. The Congress provided an additional $68 million for activities 

supporting CALFED goals in fiscal year 2001.37 The 

Water Supply, Reliability, and Environmental Improvement Act, signed by the President in October 2004, 

authorized $389 million in fiscal years 2005 through 

2010 for the federal share of CALFED’s costs; the Congress appropriated $37 million in 2006.

As the population shifts to arid areas, water markets (if 

they are allowed to operate) might play an important role 

in managing the changes in water demand in a way that 

yields the greatest possible net benefits to society. 

Drought and Climate

Currently, the federal government spends an average of 

$1.3 billion per year on drought relief for farmers. That 

relief, which can vary substantially from year to year, is 

mostly in the form of crop insurance and crop disaster 

payments and mostly for nonirrigated land.38

The U.S. Department of Agriculture (USDA) administers three permanently authorized programs that provide 

drought relief: the Federal Crop Insurance Program, the 

Noninsured Crop Disaster Assistance Program, and the 

Emergency Loan Assistance Program. Those programs 

accounted for 56 percent of the estimated net federal outlays for drought relief for agriculture from 1989 through 

2004 (see Figure 1). The Federal Crop Insurance Program protects producers from risks related to adverse 

weather (as well as plant diseases and insect infestations). 

Private companies sell and service the policies and are 

reinsured by USDA. The government absorbs a large percentage of the program’s losses, subsidizes a portion of the 

premiums paid by participating producers, compensates 

the companies for some of their operating and administrative expenses, and pays the program’s federal administrative costs. Under the Noninsured Crop Disaster Assistance Program, producers of a crop that is ineligible for 

insurance may be paid for any shortfall in yield under 50 

percent of normal yield at 55 percent of the expected 

price. Producers must apply for coverage before planting 

and pay a fee of $100 per crop per county. The Emergency Loan Assistance Program offers favorable loan 

terms to help producers recover from production and 

physical losses.

The federal government determines when to provide 

emergency drought assistance by using a drought index 

that combines data on various indicators of water supply. 

Supplemental appropriations for crop-loss disaster programs and other assistance programs authorized as 

droughts occur accounted for 44 percent of the estimated 

net federal outlays for drought relief for agriculture from 

1989 through 2004. Generally, with the disaster programs, producers with yields of less than 65 percent of 

normal received compensation for 65 percent of the expected crop price. (In some years, the Congress reduced 

payments because of funding caps or because it limited 

eligibility to one of several crop years.) 

Other assistance programs authorized as events occur are 

ones for livestock assistance, disaster reserve assistance, 

pasture recovery, dairy production assistance, livestock 

indemnity, tree assistance, and emergency conservation.

Nonagricultural sectors are also affected by drought. 

While there are federal programs that provide targeted 

relief, they have had a comparatively limited impact on 

the federal budget. Communities that meet certain 

thresholds of drought-related job losses may apply to the 

Department of Commerce’s Economic Development 

37. The Congress used the Water and Related Resources appropriation within various programs of the Central Valley Project because 

it lacked specific authorizing legislation.

38. In estimating the proportion of federal expenditures associated 

with crop loss that can be attributed to drought (as opposed to 

flood, hail, freezing, wind, insects, disease, and so forth), the Congressional Budget Office used cause-of-loss data provided by the 

Federal Crop Insurance Program.
12 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Figure 1.

Drought Relief: Net Federal Outlays for Agriculture

(Millions of nominal dollars, by fiscal year) 

Source: Congressional Budget Office based on data from the Department of Agriculture.

Notes: The federal government paid $1.48 billion to farmers under the Disaster Assistance Act of 1989, but it was not recorded directly as an 

outlay for crop disaster because farmers were paid in generic certificates. That payment is not included here, nor are outlays for 

administrative expenses. 

Other programs include ones for emergency conservation and for livestock, dairy, tree, and pasture assistance.

Administration for grants to help organize and carry out 

planning processes and support activities—such as the 

creation and expansion of targeted business development 

and the construction of infrastructure improvements. Rural communities can receive federal drought assistance 

through Emergency Community Water Assistance grants 

if they have a significant decline in the quantity or quality 

of their drinking water. The Army Corps of Engineers 

can provide emergency water supplies for human consumption when an inadequate supply is likely to cause a 

substantial threat to public health and welfare. Small 

businesses that have suffered substantial economic injury 

(becoming unable to meet obligations as they mature and 

to pay ordinary and necessary operating expenses) because of a designated drought and are unable to obtain 

credit elsewhere may be eligible for the Small Business 

Administration’s Economic Injury Disaster Loan Program.

Federal costs for drought response could be affected by 

the prospective impacts of climate change. Although 

those impacts are uncertain, researchers anticipate that 

the frequency and intensity of droughts (and floods) will 

change across the nation (reliable projections for specific 

areas are not available).39

Markets could allocate water more flexibly and thereby 

mitigate the potential costs of adapting to changing conditions for drought and to potential climate-related 

changes in water demand (associated with higher temperatures and the loss of water to the atmosphere through 

evaporation and plants’ release of water vapor) and supply 

(because of shifting patterns in the amount, timing, and 

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Crop Insurance

Noninsured Assistance Program

Emergency Loan Assistance

Crop Disaster Payments 

Other Programs

39. See Congressional Budget Office, Uncertainty in Analyzing Climate Change: Policy Implications (January 2005).
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 13

location of precipitation as well as saltwater’s intrusion in 

coastal areas).

Policy Options to Facilitate

Reallocations

The federal government has a role in determining how 

the nation allocates and uses its water resources, despite 

the extent of the states’ jurisdiction over water. To encourage a greater role for market mechanisms that might 

improve on the largely administrative allocation that has 

emerged under state law, the federal government could 

facilitate water marketing in the contexts of the commerce clause of the Constitution and federally reserved 

water rights. The federal government could also increase 

its efforts to promote water banks, which facilitate the 

legal transfer and market exchange of various types of 

entitlements for surface water, groundwater, and storage.

To encourage efficient water use, the government could 

reconsider existing subsidies for water delivery and for 

agricultural products. By distorting price signals, such 

subsidies impede the transfer of water resources to highervalue uses. The government could also evaluate refinements or expansions of programs that address water 

demand directly—such as conservation plans and costsharing programs for improvements to irrigation systems.

To encourage the efficient provision of water, the government could examine whether federal support for supplyaugmenting research and development is appropriate to 

correct for the market failures associated with less-thanoptimal levels of investment.

Facilitating Water Markets

The federal government could clarify the potential for 

broader geographic water marketing using its jurisdiction 

under the commerce clause of the Constitution and federally reserved water rights. The commerce clause gives 

the Congress the authority to allocate interstate waters to 

serve the national interest—even if doing so means overriding state law. Clarification of legal uncertainties about 

the rights of Indian tribes to lease water to different intrastate and interstate users could increase opportunities for 

tribes to transfer water. The government could also facilitate a greater role for water banks, which have emerged to 

address allocation issues in the context of the Endangered 

Species Act but have the potential for broader use.40

The Commerce Clause. Key to understanding how the 

commerce clause of the Constitution governs the interstate sale of water is the Supreme Court’s 1982 decision 

in Sporhase v. Nebraska (see Box 4). With that decision, 

the Court opened the door to interstate water sales and 

federal control of those sales. States have pursued ways to 

try to close the door again.

In response to the Sporhase decision, states have essentially taken two approaches to limit out-of-state transfers 

of water. Some states, such as Colorado and Arizona, have 

laws intended to take advantage of the Supreme Court’s 

acknowledgment that states may protect the health and 

safety of their own citizens by extending a “limited preference” to their citizens to preserve water “in time of severe 

shortage.” There have been no cases testing the application of those statutes.41 Other states, such as Montana 

and New Mexico, have appropriated water and given 

themselves the authority to lease it to those wishing to use 

it. That approach is intended to take advantage of an 

exception to the commerce clause under which states are

40. The geographic scope of water markets is limited by the impact of 

conveyance costs on the viability of transfers. In the West, markets 

have developed in some locations where they are supported by the 

relative economic value of water in different uses and the costs of 

conveyance—which can be significant. A 2002 transaction 

between a northern California irrigation district and the Metropolitan Water District serving Los Angeles, for example, carried an 

option purchase price for water of $100 per acre-foot, while the 

cost of the 300-mile transport (including pumping fees and a 

mandatory 20 percent environmental mitigation charge) was 

about $143 per acre-foot. 

41. In El Paso v. Reynolds, 597 F. Supp. 694 (D.N.M. 1984), the court 

held that a statute similar to the constitutional portions of the 

statute addressed in Sporhase (for example, one restricting export if 

it would be “detrimental to the public welfare of the state”) was on 

its face constitutional. The impact of the commerce clause in such 

cases has yet to be challenged in court. 
14 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Box 4.

Interstate Commerce in Water

In the case of Sporhase v. Nebraska, the Supreme 

Court held for the first time that water was covered 

by the commerce clause of the Constitution.

1

 The 

case involved ownership of contiguous tracts of land 

in Nebraska and Colorado. A well on the Nebraska 

tract pumped groundwater to irrigate both tracts, 

thereby exporting water to Colorado. Nebraska law 

required a permit to export groundwater. For the 

landowners to obtain a permit, the withdrawal of 

groundwater had to be reasonable, not contrary to 

the conservation and use of groundwater, and not 

otherwise detrimental to the public welfare; and the 

state in which the water would be used had to grant 

reciprocal rights for its groundwater to be used in 

Nebraska. Because Colorado prohibited any export

of its water, the landowners did not have a permit. 

Nebraska sued them to prevent the transfer of water 

across the border.

Water was clearly an article of commerce under 

some state law—which permitted groundwater to be 

extracted, bought, and sold—but not in Nebraska, 

where landowners could only extract groundwater 

needed for their land. Noting that the federal government had a significant interest in conservation and 

fair allocation of this resource, the Supreme Court 

concluded that the power of the Congress to legislate 

in the area could not be limited depending on 

whether a particular state considered water to be an 

article of commerce.

Even though the federal government may regulate 

interstate commerce in water, Nebraska is not without power to regulate its own water resources. Regarding state laws that do not directly impede interstate commerce, the Supreme Court had written: 

“Where the statute regulates evenhandedly to effectuate a legitimate local public interest, and its effects on 

interstate commerce are only incidental, it will be 

upheld unless the burden imposed on such commerce 

is clearly excessive in relation to the putative local 

benefits. If a legitimate local purpose is found, then 

the question becomes one of degree. And the extent 

of the burden that will be tolerated will of course depend on the nature of the local interest involved, and 

on whether it could be promoted as well with a lesser 

impact on interstate activities.”2

Under that standard, the Supreme Court concluded 

that the first three conditions necessary for Nebraska 

to grant an export permit did not impermissibly burden interstate commerce. The Court described a 

“limited preference” that a state may grant its own 

citizens in the use of groundwater. Moreover, the 

Court observed that the expectation that each state 

may restrict water within its borders in certain circumstances has been fostered by equitable apportionment decrees and by interstate compacts. However, 

the fourth condition for obtaining an export permit 

(state reciprocity) represented an explicit barrier to 

interstate commerce and failed the “strictest scrutiny” 

tests of “significantly advancing” the goal of preserving and conserving groundwater, there being no adequate nondiscriminatory alternatives.

1. 458 U.S. 941 (1982). The decision overruled an earlier one, 

Hudson County Water Co. v. McCarter (209 U.S. 349 

(1908)), in which the Court upheld a 1905 New Jersey statute prohibiting the export of water to any other state, ruling 

that water was not subject to the commerce clause because it 

was owned in trust for the public. In the decades that followed, many state legislatures—particularly in the West—

enacted statutes prohibiting or significantly restricting the 

interstate export of water.

2. Quoting Pike v. Bruce Church, Inc., 397 U.S. 137, 142 

(1970).
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 15

themselves market participants rather than regulators.42

Again, no neighboring state or other party has brought 

suit testing those post-Sporhase export restrictions.43

Federally Reserved Water Rights. Policymakers could act 

to make more water resources available to markets as 

claims for federally reserved water rights continue to be 

settled. Many water-rights settlements include provisions 

that authorize the sale or lease of water for off-reservation 

use (see the appendix to this paper). For example, the 

Arizona Water Settlements Act, approved by the Congress in December 2004, resolves the water-rights claims 

of the Gila River Indian Community and the Tohono 

O’odham Nation, allotting about half of the 1.5 million 

acre-feet of water flowing through the Central Arizona 

Project to Indian tribes. Although the settlement explicitly prohibits the out-of-state marketing of water newly 

reallocated to the tribes, it allows the tribes to transfer water to in-state non-Indian water users.44

Whether tribes can lease surface water to different users 

within and beyond state boundaries is an open question. 

Neither Supreme Court decisions nor federal laws have 

recognized a general tribal authority to convey water offreservation. Also, many observers argue that the NonIntercourse Act limits the ability of non-Indians to obtain 

rights to Indian water without Congressional approval 

and would operate to prohibit a lease of water offreservation.45 Still, legislative action might be taken in 

specific federally reserved water-rights settlements to authorize market transactions that move the water involved 

to higher-value uses, generating greater economic benefits 

for both nontribal and tribal communities.

Water Banks. Water banks are institutional mechanisms 

through which water-rights holders (typically irrigators) 

can receive compensation for letting others use their 

rights for a specified period. Most water banks are relatively new—few were established before 1990—and were 

set up primarily to aid compliance with the Endangered 

Species Act.46 Most banks restrict the number and type 

of participants. The level of market activity varies widely

42. Only Montana may appropriate water for consumption in excess 

of 4,000 acre-feet per year and 5.5 cubic feet per second or from 

six river basins for transport outside those basins, and the state 

leases that water to those wishing to use it. (See Mont. Code Ann. 

§§85-2-141(10), -301(2).) New Mexico has legislation authorizing a long-term state appropriation and leasing program. It does 

not bar private water appropriations but allows state appropriations to exist unexercised for up to a century. Significant state 

appropriations in various regions would leave little unappropriated water for private appropriation, while state-appropriated 

water would be available for leasing. (See N.M. Stat. Ann. §§72-

14-43, -44.)

43. Some observers have argued that Congressionally approved interstate compacts that explicitly or implicitly authorize export restrictions are insulated from the Sporhase decision. (See, for example, 

Sharon P. Gross, “The Galloway Project and the Colorado River 

Compacts: Will the Compacts Bar Transbasin Water Diversions?” 

Natural Resources Journal, vol. 25 (1985), p. 935.) However, the 

Supreme Court stated in Sporhase that where it has found a Congressional “intent and policy” to sustain state legislation in the face 

of the commerce clause, that intent was “expressly stated.” That 

would be the case with the Yellowstone River Compact, which 

expressly prohibits interbasin export without the consent of all 

state parties to the compact. (See consent to the Yellowstone River 

Compact, ch. 629, 65 Stat. 663, 669 (1951).) However, it is not 

at all clear that export restrictions that are only implicitly based on 

interstate compacts will withstand scrutiny by the Supreme Court. 

(See Chris Seldin, “Comment: Interstate Marketing of Indian 

Water Rights: The Impact of the Commerce Clause,” California 

Law Review, vol. 87 (1999), pp. 1555-1556.)

44. Some observers argue that this provision simply ensures that some 

of the water is sold back to the non-Indian irrigators who, under 

the terms of the settlement, relinquished their water use (to satisfy 

federally reserved rights) in exchange for federal forgiveness of a 

portion of their debt for the construction of the Central Arizona 

Project. In negotiating settlements, non-Indian entities and state 

governments have an incentive to prevent significant losses of 

water available for non-Indian users and to keep tribal water 

within state boundaries so as not to lose the state’s share of water 

resources.

45. 25 U.S.C. §177. Note that tribal water is charged against a state’s 

allocated share of interstate surface water resources established by 

interstate compacts, so the export of water by tribes presents a 

threat to the entitlements provided under the compacts. See Chris 

Selden, “Comment: Interstate Marketing of Indian Water 

Rights.”

46. Requirements under the Endangered Species Act were the major 

catalyst for the formation of the Edwards Aquifer Bank in Texas, 

the Environmental Water Account in California, and the Klamath 

Basin bank in Oregon and California, among others.
16 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

among banks, but most generally have fewer than five 

trades a year.47

The Arizona Water Bank, created by the state legislature 

in 1996, illustrates the potential for banks to facilitate 

water markets, in this case between states. Water from the 

Colorado River conveyed through the Central Arizona 

Project recharges groundwater aquifers, generating future 

recovery rights that users can draw on at a later time. The 

bank gives California and Nevada access to as much as 

100,000 acre-feet per year of Arizona’s Colorado River 

allotment. In years when there is a surplus, the states can 

pay for the bank to store water that would otherwise go 

unused; in years when there is a shortage, California and 

Nevada can draw on banked supplies.48

In 1999, the Department of the Interior issued regulations for the broad implementation of that interstate 

water banking in the Lower Colorado River Basin.49 The 

regulations operate within the limits of the “Law of the 

River”—the body of law governing the allocation of 

water from the Colorado River, which encompasses at 

least four different legal regimes (U.S. federal and state 

laws, Mexican domestic law, and international law). A 

water bank customer in California, Nevada, or Arizona (if 

empowered by state law) can develop an “intentionally 

created unused apportionment” (ICUA) and store it in 

another Lower Basin state’s bank. That bank can release 

stored water for parties that have banked ICUAs. The 

bank can also release water on credit, in anticipation of an 

equal amount of subsequent water stored in the same 

year. Parties can sell banked water if they have state 

authorization and the approval of all parties to the 

agreement.

An interstate water-banking model like that one might 

facilitate future water transfers in the broader Colorado 

River Basin. Arranging for Upper Basin states, which 

have never used their full apportionment, to bank Colorado River water for potential use by Lower Basin states 

might direct resources to higher-value uses.50

Encouraging the Efficient Use of Water

The federal government influences the demand for water 

through various subsidies and programs. Subsidies for 

water infrastructure and agricultural production encourage the use of water resources, whereas programs that target agricultural and municipal reductions in water use 

reduce demand. Policymakers could reconsider subsidies 

for water infrastructure to promote pricing that better 

reflects the opportunity costs associated with agricultural 

use of water provided through federal facilities and with 

municipal and industrial uses of water for which the costs 

may exceed the benefits. 

Policymakers could also reconsider agricultural marketing 

loans and support programs for the sugar and dairy industries. Those three programs, by increasing the value of 

water maintained in agriculture through their impact on 

production, make transferring water to nonagricultural 

uses more difficult and expensive for prospective purchasers. In the West, where irrigation accounts for such a large 

share of freshwater withdrawals, such programs may significantly reduce the amount of water available for nonagricultural use. 

47. Arizona, California, Colorado, Idaho, Nevada, New Mexico, 

Oregon, Texas, and Washington have all made use of water banks. 

For a summary table of water-banking programs in the West and 

their features, see Peggy Clifford, Caly Landry, and Andrea 

Larsen-Hayden, “Analysis of Water Banks in the Western United 

States,” Publication No. 04-11-011 (Washington State Department of Ecology and WestWater Research Analysis, July 2004).

48. The Arizona Water Bank restricts California’s access to Arizona’s 

unused Colorado River water. A 1930s-era pact gave California 1 

million acre-feet more than the state’s allotment of Colorado River 

water under the federal law that primarily governs water allocation 

within the Lower Colorado River Basin. That additional water 

would come from the unused apportionments of the other states 

as well as the occasional “surplus” flows. With the operation of the 

Arizona Water Bank, however, both Arizona and Nevada used 

nearly their full apportionments in 1996, and California had to 

rely on the Secretary of the Interior’s annual designations of surpluses to avoid losing a significant portion of its water. As a result, 

in 1999, an agreement was reached in which California took a 

major step toward gradually reducing its annual use of Colorado 

River water to 4.4 million acre-feet.

49. 43 C.F.R. § 414.

50. Under the Challenge Grant Program of the Department of the 

Interior’s Water 2025 Initiative (funded at $4 million, $11 million, and $5 million in fiscal years 2004, 2005, and 2006, respectively), the Bureau of Reclamation provides half of the costs of 

projects (initiated by irrigation and water districts or states) that 

focus on water conservation, efficiency, and water marketing and 

can be completed in two years. Thus far, only one of the projects 

(which the bureau selects through a competitive process) directly 

addresses promoting markets. A 2004 grant of nearly $250,000 

was awarded to the Central Oregon Irrigation District in Bend for 

a project to establish a pilot water bank involving many partners—seven irrigation districts, six cities, three tribes, and the 

Deschutes Resource Conservancy.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 17

To further explore potential gains to the economy from 

the use of water resources, the federal government might 

also assess the impact of refining or expanding its costsharing program for improvements to irrigation systems, 

its conservation plans for irrigation districts supplied by 

the Bureau of Reclamation, and its water-efficiency standards for plumbing applications.

Subsidies for Water Infrastructure. Water infrastructure 

is the physical structures used to store and distribute 

water. One option for encouraging efficient water use 

would be to phase out infrastructure subsidies that support the delivery of water to agricultural and municipal 

users at rates that generally do not cover costs. Changes 

that move water prices toward levels that correspond 

more closely to opportunity costs encourage more beneficial use of water resources economywide.

The less one pays for water, the more water one is likely 

to use. Studies gauging the price responsiveness of 

demand for irrigation water have found a wide range of 

effects: for a 10 percent increase in the price of water, estimated declines in use have ranged from 1 percent to 20.3 

percent.51 The differences may reflect assumptions about 

the effect of changes in water prices on new distribution 

capacity, the effect of changes in the prices of agricultural 

products on the demand for them, and the extent to 

which irrigators are informed about the price of each 

additional unit of water.

Studies gauging the price responsiveness of residential demand for water have generally been seen as suggesting 

that changes in price have little effect on use. However, 

existing estimates do not indicate the potential responsiveness of water use to price changes outside the narrow 

range seen in those studies. A 1997 review of 24 such 

studies of residential water demand found that a 10 percent increase in the price of water corresponded to 

estimated declines in use ranging from 0.2 percent to 

33.3 percent, with an average decline of 5.1 percent. 

(About three-quarters of the estimates were between 0.2 

percent and 7.5 percent.)52 Notably, the mean price for 

water (in 2000 dollars) in various locations in the United 

States used for empirical studies is about $0.0022 per 

gallon, and it ranges from $0.0001 to $0.0035. At such 

prices, a user’s cost for daily 10-minute showers over the 

course of a month (using a 7.5-gallon-per-minute 

showerhead) totals only $5.00.53

Subsidies for Agricultural Production. The federal government subsidizes the production of crops through its 

marketing loan system. Marketing loan provisions allow 

farmers to repay commodity loans (nine- or 10-month 

government loans for which farmers pledge production as 

collateral) at less than the original loan rate (plus interest) 

when market prices are lower. Loan rates affect producers’ 

decisions about how much to plant, and thus their demand for water, because the income support provided 

through marketing loans is based on current production 

and prices. 

The marketing loan system increased production of 

wheat by an estimated 2.5 percent, corn and soybeans by 

an estimated 1.5 percent, and cotton by an estimated 10 

percent in 2000.54 One analysis of adjustments in the 

2002 farm bill estimated that they would prompt a 1 percent increase in the acreage that producers planted with 

major field crops.55

Marketing loans for rice and upland cotton began with 

the provisions of the 1985 farm bill; subsequent legislation made them available for soybeans and other oilseeds 

starting in 1991, and they became available for wheat and 

feed grains beginning with the 1993 crop year. The 2002 

farm bill, which governs programs through 2007, removed the Department of Agriculture’s discretionary 

authority to reduce payment rates for marketing loan 

price supports when market prices fall. It raised rates for 

most crops (lowering them only for soybeans and holding 

51. Mark Kanazawa, “Pricing Subsidies and Economic Efficiency: 

The U.S. Bureau of Reclamation,” Journal of Law and Economics, 

vol. 36 (April 1993), pp. 205-234.

52. M. Espey, J. Espey, and D. Shaw, “Price Elasticity of Residential 

Demand for Water: A Meta-Analysis,” Water Resources Research,

vol. 33, no. 6 (1997), pp. 1369-1374. Also see Sylvestre Gaudin, 

“Effect of Price Information on Residential Water Demand,” 

Applied Economics, vol. 38, no. 4, (2006), pp. 383-393.

53. David S. Brookshire and others, “Western Urban Water 

Demand,” Natural Resources Journal, vol. 42, no. 4 (Fall 2002), 

pp. 873-898.

54. See P.C. Westcott and J.M. Price, “Analysis of the U.S. Commodity Loan Program with Marketing Loan Provisions,” Department 

of Agriculture, Economics Research Service, Agricultural Economics Report No. 801 (April 2001); and B.L. Gardener, “Agricultural Policy: Pre- and Post-FAIR Act Comparisons,” Policy 

Analysis Report 01-02 (College Park, Md.: University of Maryland, Center for Agriculture and Natural Resource Policy, 2002). 

55. Paul Westcott, “Marketing Loan Rates and Acreage Response,” 

Choices (Fourth Quarter 2003), pp. 31-34.
18 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

them constant for rice) and extended marketing loans to 

six new crops. Producers can receive the payments on all 

current production.

Federal support for the production of sugar also encourages agricultural water use. Sugar beets are one of the 

most water-intensive crops grown in the West—approximately 75 percent of the typical sugar beet root consists 

of water. The farm bills of the early 1980s reinstated 

mandatory price supports for the sugar industry (after the 

initial sugar program expired in 1974), and later bills 

extended the supports through 2007.56 The federal government protects the price of sugar by restricting imports, 

making below-market-rate loans available to processors, 

and limiting the amount of sugar that processors can sell 

domestically. Because of that support, domestic growers’ 

supply for the national sugar market increased from 

roughly 55 percent of the total prior to the early 1980s to 

86 percent in 2005.57 One recent analysis of the prices 

supported by federal import restrictions estimated that 

they generate a 5 percent to 6 percent increase in the 

nation’s acreage devoted to sugar beet production, with 

corresponding needs for agricultural water use.58

Federal support for dairy producers also encourages agricultural water use by promoting the production of alfalfa 

for feed. Alfalfa is another water-intensive crop, accounting for nearly 20 percent of the irrigation water applied in 

western states.59 Dairy price supports take the form of 

federal purchases of surplus dairy products when market 

prices are low, federal milk-marketing orders that regulate 

the farm price of milk for roughly two-thirds of national 

production by requiring processors to pay minimum 

prices, and countercyclical payments under “milk-income 

loss contracts” when prices fall below a certain target.60

Conservation Programs. Federal cost-sharing programs 

for improvements to irrigation systems provide payments 

to offset agricultural producers’ costs of adopting moreadvanced irrigation technology. Those programs might 

be more effective if they targeted larger farms. Nearly 75 

percent of the farms that did not participate in public 

cost-sharing programs between 1994 and 1998 accounted for over 80 percent of irrigated farms in the 

West. Of those, the larger farms (those with annual sales 

of over $250,000) accounted for more than 60 percent of 

the irrigated acreage and more than 65 percent of the 

farm water applied. Moreover, the largest 10 percent of 

irrigated farms (those with annual sales in excess of 

$500,000) accounted for almost half of the total farm 

water applied.61

Federally required conservation plans for irrigation districts that have their water supplied by the Bureau of Reclamation improve the reliability of existing water supplies, postpone the need for new or expanded water 

supplies, and reduce the impact of drought. Those plans 

might have a greater impact on farm water conservation if 

requirements and enforcement were more stringent. Under the Reclamation Reform Act of 1982, for instance, irrigation districts select their own conservation goals—

which can be broadly defined and even inconsistent with 

the original intent of the requirements. Furthermore, although conservation plans were originally due by early 

1987, by 1996 fewer than half of the nearly 500 affected 

districts had submitted a plan, and the Congress provided 

neither specific enforcement authority, nor an enforcement mechanism, to use with districts that did not 

56. The government provided mandatory price support in 1977 and 

1978 and discretionary support in 1979.

57. Congressional Research Service, Sugar Policy Issues, CRS Issue 

Brief for Congress IB95117 (February 16, 2006).

58. J.C. Beghin and others, The Cost of the U.S. Sugar Program Revisited, Working Paper 01-WP 273 (Ames, Iowa: Iowa State University, Center for Agriculture and Rural Development, 2001).

59. Department of Agriculture, National Agricultural Statistics Service, 1997 Census of Agriculture, vol. 3, Special Studies, 1998 Farm 

and Ranch Irrigation Survey, Report AC97-SP-1 (1999).

60. The Deficit Reduction Act of 2005 (Public Law 109-171) 

includes a two-year extension of the program that provides milkincome loss contracts. See Congressional Research Service, Dairy 

Policy Issues, CRS Issue Brief for Congress IB97001 (January 10, 

2006).

61. Department of Agriculture, Economic Research Service, “Briefing 

Room: Irrigation and Water Use - Questions and Answers” (May 

28, 2004), available at www.ers.usda.gov/Briefing/WaterUse/

Questions.

Improved irrigation efficiency may not translate into water savings 

if it reduces the amount of reusable water (reusable runoff and 

excess deep percolation) that represents an important source of 

water for downstream withdrawals and environmental purposes. 

Potential conservation programs could focus on assessing salvage 

amounts and costs associated with technologies to target water 

that is not reusable—reducing evaporation losses from sprinklers, 

water surfaces, and excessively wet soil; reducing transpiration 

from unwanted plants; and reducing runoff that is of impaired 

quality.
HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER 19

comply.62 With the Central Valley Project Improvement 

Act of 1992, the Congress did introduce narrower requirements for plans and an enforcement mechanism. 

That law generally requires that irrigation districts’ plans 

include some form of conservation pricing, and districts 

without a federally approved plan are subject to an increase in their water costs. Applied more widely, such 

price-based compliance incentives might yield greater net 

benefits from the use of water resources.

Some analysts have suggested that the federal waterefficiency standards enacted with the Energy Policy Act of 

1992 (which mandated the use of water-efficient plumbing fixtures) increased society’s net benefits and that standards for additional plumbing applications could do the 

same.63 More broadly, water prices that were more closely 

aligned with costs could encourage conservation and efficient water use by broad classes of consumers.

Encouraging the Efficient Provision of Water

The government has directed budgetary resources to the 

creation of additional water supplies through research 

and development (R&D) of technologies to desalinate 

and to purify water.64 The United States spent more than 

$1 billion (in 1999 dollars) on such R&D, beginning 

with the Saline Water Act of 1952 and continuing until 

1982, when most federal funding for that activity was 

discontinued. Since the 1990s, additional nominal 

appropriations have amounted to about $330 million.65

In addition, to support decisionmaking for long-term 

water management, the federal government has funded 

the collection of data on streamflow and groundwater 

levels specifically to enhance the reliability of predictive 

models. The U.S. Geological Survey (USGS) has collected streamflow information since 1889. The agency 

operates a national network of about 7,200 stream 

gauges, which measure and record the quantity and variability of water flows. The number of gauges has remained relatively constant, but there have been fewer and 

fewer gauges with 30 or more years of records. From 

1990 to 2001, the agency discontinued 690 gauges 

because of funding constraints. 

Efforts to collect data on groundwater levels present other 

difficulties. There is no comprehensive groundwater-level 

monitoring network with uniform coverage of major 

aquifers. Researchers do not use standardized approaches 

at similar spatial or temporal scales in gathering data on 

levels and rates of change, threatening the long-term viability of current efforts. A recent poll of USGS district 

offices and state and local water agencies indicated that 

there were about 42,000 observation wells (the principal 

source of information about groundwater systems) in the 

United States with five years (a relatively short period) or 

more data on water levels. Many of those long-term monitoring wells are clustered in certain areas; since the 

1980s, the number monitored by the USGS has declined 

by about half because of limitations in funding and personnel.

In general, when multiple and separate public- and 

private-sector entities face a similar problem, they tend to 

invest too little in R&D, because each balances the potential cost of research against only its own expected benefits, rather than the benefits that can accrue to all parties. 

Federal investment in research and development of desalination and water-purification technologies and in the 

collection of information addresses such a market failure. 

Determining the level of federal support merited by such 

considerations is a challenge, however. It depends on the 

typically difficult-to-predict results from the investment

62. Department of the Interior, Bureau of Reclamation, Final Environmental Impact Statement: Proposed Acreage Limitation and Water 

Conservation Rules and Regulations, Pub. No. FES 96-7 (Denver, 

Colo., February 2, 1996); and Department of the Interior, Bureau 

of Reclamation, Reclamation Policy for Administering Water Conservation Plans Pursuant to Statutory and Contractual Requirements

(Denver, Colo., 1996).

63. Peter Gleick and others, Waste Not, Want Not: The Potential for 

Urban Water Conservation in California (Oakland, Calif.: Pacific 

Institute for Studies in Development, Environment, and Security, 

November 2003).

64. Desalination and water-recycling technologies currently make a 

very small contribution to water supplies in the United States. At 

the end of the 1990s, nearly 800 desalination plants (many for 

industrial use) in 46 states provided about 1.4 percent of residential and industrial water, and the nearly 2 million acre-feet of 

water recycled annually in the early 2000s was not significant on a 

national scale. 

65. See Congressional Research Service, Desalination R&D: The New 

Federal Program, CRS Report for Congress RS20069 (February 

18, 1999); statement of Maryanne Bach, Director of Research and 

Development for the Bureau of Reclamation, before the Subcommittee on Water and Power of the House Committee on 

Resources, Bureau of Reclamation Activities Related to Desalination 

Research and Development for Informational Purposes in Connection 

with H.R. 1071 (May 24, 2005); and statement of Betsy A. Cody, 

Congressional Research Service, before the Subcommittee on 

Water and Power of the House Committee on Resources, Federal 

Role in Reclamation Water Reuse and Recycling: Developments in 

Implementation of Title XVI (March 27, 2003).
20 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

and on the extent to which nonfederal entities change 

their R&D expenditures in response to increased federal 

funding.66

More traditionally, the federal government has relied on 

building dams and conveyance systems to develop additional water supplies. However, the economic justification for such federal investments depends on resolving 

several issues, including identifying the federal interest 

(which may be limited if the benefits of proposed projects 

accrue primarily within an individual location or state), 

avoiding distortionary subsidies for agriculture, charging 

prices for water that reflect its value, and accounting for 

uncertainties associated with the supply of freshwater. 

66. The historically low price of water in the United States has probably also impeded the evolution of water treatment technologies 

(and thus their suitability for widespread use) because distorted 

price signals fail to communicate to private firms the benefits 

available to all parties from research and development.
Appendix:

Marketing Features of

Indian Water-Rights Settlements

It is an open question whether tribes can lease surface 

water to other users, either within the same state or in another state. There is no formal federal recognition of a 

general tribal authority to convey water off-reservation. 

Furthermore, many observers argue that federal laws limit 

the ability of non-Indians to obtain rights to Indian water 

without Congressional approval and that such laws would 

prohibit a lease of water off-reservation. Many waterrights settlements, however, include provisions that 

authorize the sale or lease of water for off-reservation use. 

This appendix lists the Indian water-rights settlements 

approved by the Congress that have water marketing features and describes the features allowed under the terms 

of each settlement (see Table A-1).
22 HOW FEDERAL POLICIES AFFECT THE ALLOCATION OF WATER

Table A-1.

Selected Indian Water-Rights Settlements

Source: Congressional Budget Office based on information provided by Craig Bell, Western States Water Council, “Settlements Approved by 

Congress” (March 23, 2005), and Public Law 108-451, December 10, 2004. 

Settlement State

Original 

Settlement Date Water-Marketing Features

Arizona Water Settlements Act Arizona 2004 Out-of-state marketing prohibited, but tribes may 

transfer water to in-state non-Indian users.

Shivwits Band of the Paiute Indian Tribe 

of Utah Water Rights Settlement Act

Utah 2000 Use or lease of water rights allowed for any 

beneficial use of the water off-reservation.

Chippewa Cree Tribe of the Rocky Boy’s 

Reservation Indian Reserved Water 

Rights Settlement Act

Montana 1999 Transfer of any portion of water rights allowed for 

use of water off-reservation by service contract, 

lease, exchange, or other agreement, subject to the 

approval of the Secretary of the Interior and the 

state.

Yavapai-Prescott Indian Tribe Water 

Rights Settlement Act

Arizona 1994 Marketing of effluent generated on-reservation 

allowed.

Jicarilla Apache Tribe Water 

Settlement Act

New Mexico 1992 Subcontracting allowed on- or off-reservation with 

the Secretary of the Interior’s approval and subject 

to state law. 

Northern Cheyenne Indian Reserved 

Water Rights Settlement Act

Montana 1992 Transfers allowed on- and off-reservation, with most 

off-reservation marketing subject to state law.

Ute Indian Rights Settlement Act Utah 1992 Future water sales possibly allowed by neutral 

marketing provisions, subject to the body of law 

governing the allocation of Colorado River water. 

Tribal water made subject to state law by the offreservation leasing provision.

Fallon Paiute Shoshone Indian Tribes 

Water Rights Settlement Act

Nevada 1990 Limited transactions allowed, subject to state law.

Fort Hall Indian Water Right Act Idaho 1990 Off-reservation leasing to local users allowed.

Fort McDowell Indian Community 

Water Rights Settlement Act

Arizona 1990 Off-reservation leasing of Central Arizona Project 

water limited to 99-year lease with the city of 

Phoenix.

Truckee-Carson-Pyramid Lake Water 

Right Act

Nevada/

California

1990 Limited transactions allowed, subject to state law.

Salt River Pima-Maricopa Indian 

Community Water Rights Settlement 

Act

Arizona 1988 Marketing limited to a lease-exchange agreement 

with the city of Phoenix.

San Luis Rey Indian Water Rights 

Settlement Act

California 1988 Intertribal entity established to market water.

Southern Arizona Water Rights 

Settlement Act

Arizona 1982 Limited off-reservation leasing allowed in Tucson 

Active Management Area.

Ak-Chin Indian Water Rights 

Settlement Act

Arizona 1978 Off-reservation leasing in certain nearby counties 

allowed by 1992 amendments.