CBO

A

S T U D Y

Future Investment in

Drinking Water and

Wastewater Infrastructure

1RYHPEHU 

The Congress of the United States ■ Congressional Budget Office 
Notes

Numbers in the text and tables may not add up to totals because of rounding.

Unless otherwise indicated, all costs referred to are in 2001 dollars.

Cover photo shows chlorine contact tanks at a wastewater treatment plant within the Delta

Diablo Sanitation District, Antioch, California. ©Paul Cockrell.
Preface

$ ccording to experts from the Environmental Protection Agency and various nonfederal groups, the nation’s drinking water and wastewater systems face increasing challenges over

the next several decades in maintaining and replacing their pipes, treatment plants, and other

infrastructure. But there is neither consensus on the size and timing of future investment costs

nor agreement on the impact of those costs on households and other water ratepayers.

The Congressional Budget Office (CBO) has analyzed those issues at the request of the Chairmen and Ranking Members of the Subcommittee on Water Resources and Environment of

the House Committee on Transportation and Infrastructure and the Subcommittee on Environment and Hazardous Materials of the House Committee on Energy and Commerce. This

study provides background information on the nation’s water systems, presents CBO’s

estimates of future costs for water infrastructure under two scenarios—a low-cost case and a

high-cost case—and discusses broad policy options for the federal government. In keeping

with CBO’s mandate to provide objective, impartial analysis, this report makes no recommendations.

The study was written by Perry Beider and Natalie Tawil of CBO’s Microeconomic and

Financial Studies Division, under the supervision of David Moore and Roger Hitchner.

Many people within CBO and outside it provided valuable assistance; they are acknowledged

in Appendix D.

Dan L. Crippen

Director

November 2002

This study and other CBO publications

are available at CBO’s Web site:

www.cbo.gov







CONTENTS

Summary ix

Drinking Water and Wastewater Infrastructure 1

An Overview of U.S. Water Systems 1

The Federal Role 6

The Need for Increased Investment 8

Estimates of Future Investment Costs 

and Their Implications 11

Bottom-Up and Top-Down Estimates

of Investment in Water Systems 13

CBO’s Estimates of Future Costs 17

Comparing Current Spending and Future Costs 25

The Impact of Projected Water Costs

on Households’ Budgets 26

Options for Federal Policy 33

Federal Support for Research and Development

and Its Implications 34

Federal Support for Infrastructure Investment

and Its Implications 35

Direct Federal Support for Ratepayers and

Its Implications 42

Concluding Note 43

Appendix A

Assumptions the Congressional Budget Office Used

In Its Low-Cost and High-Cost Cases 45

Appendix B

Major Sources of Efficiency Savings 51

Appendix C

The 4 Percent Benchmark for Affordability 55

Appendix D

Acknowledgments 57
vi FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Tables

S-1. Assumptions Used in CBO’s Low-Cost and High-Cost Cases xi

S-2. Estimates of Average Annual Costs for Investment in 

Water Systems, Including Financing, 2000 to 2019 xiv

S-3. Estimates of Average Annual Costs for Investment in

Water Systems, Measured as Capital Resource Costs,

2000 to 2019 xv

2-1. Summary of Estimates of Investment Costs

for Water Systems 15

2-2. CBO’s Estimates of the Likely Range of Average

Annual Costs for Water Systems, 2000 to 2019 17

2-3. Comparison of CBO’s and WIN’s Estimates of

Average Annual Costs, 2000 to 2019 18

2-4. Assumptions Used in CBO’s and WIN’s Analyses 20

2-5. Contributions of Individual Assumptions to Differences

Between CBO’s and WIN’s Estimates 23

2-6. Estimates of Average Annual Capital Costs for Investment

in Water Systems, 2000 to 2019 24

2-7. Estimates of the Difference Between 1999 Spending and

Future Costs for Investments in Water Systems 26

2-8. Percentage Shares of Households’ Average Expenditures 

in the Late 1990s, by Category 29

Figures

S-1. CBO’s Estimates of Annual Investment Costs

for Water Infrastructure x

S-2. Water Bills as a Share of Household Income xviii

1-1. A Drinking Water Plant 2

1-2. A Wastewater Treatment Plant 3
CONTENTS vii

1-3. Community Water Systems and Population Served

by Size of System, 2001 4

1-4. Wastewater Treatment Facilities and Population Served

by Size of Facility, 1996 5

2-1. Water Bills as a Share of Household Income 30

Boxes

S-1. Estimates of Costs for Water Systems’ Future Operations

and Maintenance xii

S-2. Options to Expand Federal Aid for Private Water Systems xix

2-1. Alternative Measures of Investment Spending 12

2-2. Security Investments for Water Systems 14

2-3. The Water Infrastructure Network’s Published Estimates

of Investment Needs and the “Funding Gap” 19

2-4. CBO’s Analysis of Household Water Bills 27

2-5. Water Bills in Various Industrialized Countries 28

3-1. Federal Support of Privately Owned Water Systems 36
Summary

:ater industry authorities and analysts believe

that maintaining the nation’s high-quality drinking water

and wastewater services will require a substantial increase

in spending over the next two decades. They point to

many types of problems with existing water infrastructure, including the collapsed storm sewers in various

cities, the 1.2 trillion gallons of water that overflows every

year from sewer systems that commingle stormwater and

wastewater, and the estimated 20 percent loss from leakage in many drinking water systems.

But the amount of money needed for future investment

in water infrastructure is a matter of some debate, and

various estimates have been developed. The “needs surveys” of drinking water and wastewater systems conducted periodically by the Environmental Protection

Agency (EPA) provide one measure of potential investment costs. Others are offered by groups such as the

Water Infrastructure Network (WIN) and the American

Water Works Association. The Congressional Budget

Office (CBO) has also analyzed future costs for water

infrastructure and presents its estimates here as low-cost

and high-cost scenarios, illustrating the large amount of

uncertainty surrounding those future costs.

In the debate about future investment in water systems,

both the amount of money that will be needed and the

source of those funds are at issue. Advocates of more

federal spending have argued that estimates of the difference between future costs and some measure of recent

spending —the “funding gap”—justify increased federal

support. However, higher future costs could be funded

from many sources and are not necessarily a federal

responsibility.

The federal government currently supports investment

in water systems through several programs. They include

state revolving funds (SRFs) for wastewater and drinking

water, which receive capitalization grants through appropriations to EPA; loan and grant programs of the Department of Agriculture’s Rural Utilities Service; and the

Community Development Block Grants administered by

the Department of Housing and Urban Development.

Notwithstanding those and various smaller programs, the

large majority of the funding for drinking water and

wastewater services in the United States today comes from

local ratepayers and local taxpayers.

Ultimately, society as a whole pays 100 percent of the

costs of water services, whether through ratepayers’ bills

or through federal, state, or local taxes. Federal subsidies

for investment in water infrastructure can redistribute the

burden of water costs from some households to others.

However, subsidies run the risk of undermining the incentives that managers and consumers have to make costeffective decisions, thereby retarding beneficial change in

the water industry and raising total costs to the nation as

a whole.

CBO’s Estimates of Future Costs

for Water Infrastructure

CBO estimates that for the years 2000 to 2019, annual

costs for investment will average between $11.6 billion

and $20.1 billion for drinking water systems and between

$13.0 billion and $20.9 billion for wastewater systems

(see Summary Figure 1).
x FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Drinking Water Wastewater Total

0

10

20

30

40

50

 1999 Low-Cost Case High-Cost Case a a

6XPPDU\ )LJXUH 

CBO’s Estimates of Annual 

Investment Costs for Water

Infrastructure

(Billions of 2001 dollars)

Source: Congressional Budget Office.

a. Average annual costs for the 2000 to 2019 period.

CBO also projects that annual costs over the period for

operations and maintenance (O&M), which are not eligible for aid under current federal programs, will average

between $25.7 billion and $31.8 billion for drinking

water systems and between $20.3 billion and $25.2 billion for wastewater systems. (Unless otherwise noted, all

costs in this study are in 2001 dollars.) For its estimates,

CBO chose the 2000 to 2019 period to simplify comparisons with earlier estimates developed by the Water Infrastructure Network, a coalition of groups representing service providers, elected officials, engineers, construction

companies, and environmentalists. Data on actual spending in 2000 and 2001 are not yet available.

CBO’s estimates of future investment and O&M spending under two different scenarios—a low-cost case and

a high-cost case—are intended to span the most likely

possibilities that could occur. The range of estimates reflects the limited information available at the national

level about existing water infrastructure. For example,

there is no accessible inventory of the age and condition

of pipes, even for the relatively few large systems that

serve most of the country’s households. That lack of

adequate system-specific data compounds the uncertainty

inherent in projecting costs two decades into the future.

Indeed, given the limitations of the data and the uncertainty about how future technological, regulatory, and

economic factors might affect water systems, CBO does

not rule out the possibility that the actual level of investment required could lie outside of the range it has estimated.

Under each scenario, the estimates are intended to represent the minimum amount that water systems must spend

(given the scenario’s specific assumptions) to maintain

desired levels of service to customers, meet standards for

water quality, and maintain and replace their assets costeffectively. However, the estimates exclude certain categories of investment. Because water systems are still developing estimates of the costs for increasing security in the

wake of the September 11 attacks, the estimates do not

include those expenses—but preliminary reports suggest

that security costs will be relatively small compared with

the other costs for investment in infrastructure. Also excluded from the estimates is investment by drinking water

systems to serve new or future customers. Such projects

are generally not eligible for assistance from the SRFs and,

hence, are not covered in EPA’s needs survey.

CBO’s estimates measure investment spending in costs

as financed rather than in current resource costs, the

yardstick that economists typically use. Costs as financed

comprise the full capital costs of investments made out

of funds on hand—that is, on a pay-as-you-go basis—

during the time period being analyzed and the debt service (principal and interest) paid in those years on new

and prior investments that were financed through borrowing. In contrast, current resource costs include the

investments’ capital costs, regardless of how they are paid

for, and exclude payments on past investments. Current

resource costs are more suitable than other measures of

investment for analyzing whether society is allocating

resources efficiently—for example, in assessing the costs

and benefits of water-quality regulations. But CBO’s

present analysis takes goals for water quality and services

as a given and focuses on the financial impact of meeting

those goals. For that purpose, measuring costs as financed

is more useful than measuring current resource costs

because the former better indicates the burden facing

water systems and their ratepayers at a given time.
SUMMARY xi

6XPPDU\ 7DEOH 

Assumptions Used in CBO’s Low-Cost and High-Cost Cases

Low-Cost Case High-Cost Case

Capital Factors

Savings from Increased Efficiency by Drinking Water and Wastewater Systems (Percent) 15.0 5.0

Drinking Water Systems

Annual percentage of pipes replaced 0.6 1.0

Average annual cost for regulations not yet proposed (Billions of 2001 dollars) 0 0.53

Wastewater Systems

Annual percentage depreciation 2.7 3.3

Share of investments in EPA’s needs survey for replacing existing capital (Percent) 25.0 15.0

Average annual cost for abating combined sewer overflows (Billions of 2001 dollars) 2.6 5.4

Financing Factors

Real (Inflation-Adjusted) Interest Rate (Percent) 3.0 4.0

Repayment Period 30 years 25 years

Pay-As-You-Go Share of Total Investment (Percent) 15.0 30.0

Source: Congressional Budget Office.

How CBO Derived Its Estimates

CBO derived its estimates of investment following the

basic approach—including the major sources of data and

supplementary models—used by WIN, which projected

costs for both physical capital and interest on loans and

bonds. Within that approach, CBO’s two cases differ in

the values for six assumptions about physical capital requirements and for three assumptions about financing

costs (see Summary Table 1). The assumptions most

responsible for the difference in the two scenarios’ estimated costs are those about the rate at which drinking

water pipes are replaced, the savings associated with improved efficiency, the costs of controlling what are termed

combined sewer overflows (CSOs), and the repayment

period.1

 (Summary Box 1 discusses how CBO derived its

estimates of O&M costs and compares them with WIN’s

estimates.)

To estimate physical capital requirements for drinking

water and wastewater systems, CBO started with data collected by EPA in its needs surveys and—because the surveys do not adequately cover the full 20-year period—

supplemented them with estimates derived from simple

models. According to EPA, many drinking water systems

have responded to the surveys on the basis of planning

documents covering just one to five years, and many

wastewater systems plan their investments over a time

span of five or 10 years.

The methods CBO used to supplement EPA’s survey data

differed for drinking water and wastewater systems. For

drinking water systems, CBO replaced EPA’s data on investments in pipe networks with larger estimates based

on a study by Stratus Consulting for the American Water

Works Association (AWWA). The Stratus study estimated the need for replacing pipes on the basis of some

national-level data and assumptions about the number

of drinking water systems nationwide (classified by size

and region), the miles of pipe per system, the distribution

of pipe mileage by pipe size, the replacement cost of pipes

of each size, and the replacement rate.

1. A “combined” sewer system is one that commingles stormwater

with household and industrial wastewater. About 5 percent of

publicly owned wastewater systems have combined sewers; the

rest have separate “sanitary” sewers. Both types of systems can

overflow, particularly during a period of heavy rainfall, discharging the excess flow directly into receiving waters.
xii FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

6XPPDU\ %R[ 

Estimates of Costs for Water Systems’ Future Operations and Maintenance

The Congressional Budget Office (CBO) used relatively simple methods to estimate water systems’ future

spending on operations and maintenance (O&M). For

both drinking water and wastewater systems’ O&M in

the high-cost case, CBO extrapolated a linear trend

from real (inflation-adjusted) spending on O&M over

the 1980-1998 period. For the low-cost case, it started

with that same linear trend but adjusted it downward

to reflect savings from improved efficiency phased in

over 10 years, beginning at 2 percent in 1995 and

reaching 20 percent by 2004. Thus, only one factor distinguishes the estimates under the two scenarios—

which, as a result, probably do not capture as much of

the uncertainty surrounding future O&M costs as do

CBO’s more-detailed models of capital investment.

Estimates of annual O&M costs by the Water Infrastructure Network (WIN)—$29 billion for drinking

water and $24 billion for wastewater—are roughly in

the middle of the ranges spanned by CBO’s two cases.

Because CBO and WIN used the same basic approach

of extrapolating a future trend from existing data on

O&M spending, and both WIN’s analysis and CBO’s

low-cost case assume savings of 20 percent from efficiency gains, one might expect the two sets of estimates

to be similar. However, WIN used different spans of

data for extrapolation than CBO did (from 1985 to

1994 for drinking water and from 1972 to 1996 for

wastewater); used a construction cost index (which

might not correspond well to the types of expenditures

associated with O&M) to convert the data to real

dollars instead of the more general price index for gross

domestic product that CBO used; and phased in the

efficiency savings two years later. Moreover, for wastewater, WIN extrapolated its trend not from data on

O&M spending itself but rather from data on O&M

spending per dollar of net capital stock. Although a

water system’s capital stock is plausibly related to its

O&M costs, there is no clear reason for associating

each additional dollar of capital stock with an increasing (rather than a steady) amount of additional O&M

spending.

In analyzing capital costs for wastewater systems, CBO

distinguished between projects to replace existing infrastructure and other investments. It estimated replacement

costs for each year of the 2000-2019 period by multiplying the estimated net capital stock in that year by a

constant rate of depreciation. CBO assumed that the cost

of other investments in each year equals the average annual amount reported in EPA’s needs survey, with two

adjustments. One adjustment substituted EPA’s more

recent estimate of the costs of correcting sanitary sewer

overflows (SSOs) for the survey’s reported needs for repairing and replacing sewers. Because some unidentified

portion of the needs reported in the survey and in the

later analysis of SSO costs represented amounts to replace

existing infrastructure, the second adjustment reduced the

sum of those needs to avoid double-counting.

CBO calculated interest costs for investments made during the 2000-2019 period using assumptions about interest rates, borrowing terms, and the share of investments

paid for through borrowing rather than on a pay-as-yougo basis. However, much of the principal and interest on

investments financed during the period will not be paid

until after 2019. To measure investments from 2000 to

2019 in costs as financed, CBO focused only on the debt

service paid during the period, whether on newly built

projects or on those built before 2000. (As discussed later,

that approach differs from WIN’s.)

Within the basic approach, CBO selected contrasting

assumptions for its low-cost and high-cost cases (shown

in Summary Table 1 on page xi) by examining analyses

by other estimators and consulting with industry experts.

For example, the assumptions used for the costs of controlling CSOs reflect views from EPA and the CSO Partnership, a coalition of communities that have such overflows and firms that design such controls. In particular,

the low-cost case uses EPA’s estimate of the cost of controlling 85 percent of rainwater and snowmelt, whereas

the high-cost case reflects the CSO Partnership’s belief
SUMMARY xiii

that costs will be roughly twice as high unless states revise

standards addressing water quality to allow less expensive

controls. Similarly, the values assumed in the two scenarios for the pay-as-you-go share of investment are based

on CBO’s expectation that systems will increase their use

of borrowing as they try to restrain rates in the face of

rising investment costs, but they reflect different views

among experts about how much and how quickly the use

of pay-as-you-go financing will decline.

Comparing Current Spending 

and Future Costs

As noted earlier, part of the policy debate on investment

in water infrastructure has focused on the difference between current spending and future costs and on how that

difference could affect household ratepayers. However,

the available data on current spending, collected for the

Census Bureau’s Survey of State and Local Government

Finances, shed limited light on the issue because they do

not measure spending in costs as financed. The census

data identify the current interest payments only of drinking water systems and not of wastewater systems. Further,

the data include the capital costs of all investment in a

given year—whether the burden of those projects falls on

ratepayers in that year or is being deferred through borrowing—and exclude the principal being repaid on previous borrowing.

For 1999, the latest year for which information is available, CBO’s best estimates of investment spending are

$11.8 billion for drinking water and $9.8 billion for

wastewater, measured in costs as financed. To develop

those estimates, CBO had to make many assumptions—

for example, about the extent to which water systems had

borrowed to finance investments over the previous 20

years. Different assumptions could have increased or decreased the results, perhaps by 20 percent.

The difference between those estimates of 1999 investment spending and projected average annual investment

from 2000 to 2019 under the low-cost case is close to

zero for drinking water systems and is $3.2 billion for

wastewater systems. Together, the future costs for both

types of systems represent growth of 14 percent from the

1999 levels. That result contradicts the conventional

wisdom that the nation’s water systems will soon be

straining to fund a large increase in investment. Nevertheless, CBO considers that result reasonable, given the

uncertainty about the condition of the existing infrastructure, the prospects for cost savings from improved efficiency, and the possibility that water systems will fund

more of their investment through borrowing and will

borrow for longer terms. Under the high-cost case, the

estimated increases average $8.3 billion per year for

drinking water and $11.1 billion for wastewater, together

representing growth of about 90 percent over the estimated levels for 1999.

Comparing CBO’s Estimates

with Those of Others

When measured in comparable terms, WIN’s estimates

are similar to those of CBO’s high-cost case. In contrast,

estimates obtained from “bottom-up” studies (those that

derive national totals from data on individual systems)

are even lower than the ones CBO projects in its low-cost

case.

Comparing CBO’s and WIN’s Estimates

CBO’s estimates of future investment in water infrastructure are not directly comparable with those of the coalition because the latter are not measured in costs as financed. WIN’s published estimates comprise total capital

costs associated with all investments—whether funded

on a pay-as-you-go basis or through debt—during the

2000-2019 period and all interest paid over time on those

investments. Thus, they differ from costs-as-financed

estimates because they include debt service (principal and

interest) paid after 2019 on investments during the two

decades instead of debt service paid during that time on

pre-2000 investments. That difference is important

because the amounts of investment that were financed

yearly from 1980 through 1999, and that continue to be

paid off from 2000 to 2019, are smaller than the new

amounts that the analyses project will be financed during

the latter period.

An additional factor complicates comparing CBO’s and

WIN’s estimates. WIN’s measure of current spending

differs from its measure of future costs, so its estimates

of the increased costs are inconsistent. In particular,
xiv FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

6XPPDU\ 7DEOH 

Estimates of Average Annual Costs for Investment in Water Systems,

Including Financing, 2000 to 2019

(In billions of 2001 dollars)

Drinking Water Wastewater Total

CBOa 11.6 to 20.1 13.0 to 20.9 24.6 to 41.0

Water Infrastructure Network

As published 26.3 24.2 50.5

In costs as financed 21.4 18.9 40.3

Increase in Investment Above Recent Level

CBO (Using a 1999 baseline)a -0.2 to 8.3 3.2 to 11.1 3.0 to 19.4

Water Infrastructure Network

As publishedb 12.2 13.5 25.7

In costs as financedc 9.4 9.2 18.6

Sources: Congressional Budget Office; Water Infrastructure Network, Clean and Safe Water for the 21st Century: A Renewed National Commitment to Water and

Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).

a. Ranges are defined by CBO’s low-cost and high-cost scenarios.

b. Relative to a 1996 baseline.

c. CBO’s approximation of WIN’s results using a 1999 baseline.

WIN’s measure of current spending includes the interest

paid in the current year on past investments in drinking

water infrastructure and does not include interest on investments in wastewater infrastructure. Again, however,

its measure of costs for future years includes all subsequent interest payments on investments made in each

such year.

Using more-detailed results provided by WIN’s analysts,

CBO found that measuring future investment in costs as

financed reduces WIN’s estimates of average annual needs

from $26.3 billion to $21.4 billion for drinking water

and from $24.2 billion to $18.9 billion for wastewater—

an overall reduction of 20 percent (see Summary Table

2).2

 CBO also recalculated the coalition’s estimates of the

difference between current spending and average annual

future needs—the so-called funding gap—in costs as

financed. (To do so, however, CBO had to approximate

WIN’s estimate of current debt service, a key component

of current spending in costs as financed, because not

enough information was available to calculate it directly.)

Again, the revised estimates are lower—$9.4 billion instead of $12.2 billion for drinking water and $9.2 billion

instead of $13.5 billion for wastewater, for a combined

reduction of 25 percent.

The reductions that result from measuring investment

volume in costs as financed bring WIN’s estimates close

to those of CBO’s high-cost case: the coalition’s figures

are somewhat higher for drinking water and a little lower

for wastewater. The similarity in the two sets of estimates

is not surprising, given that CBO and WIN used the

same basic modeling approach and that the specific assumptions used in CBO’s high-cost scenario either duplicate those in WIN’s analysis—both assume that 1 percent

of drinking water pipes and 3.3 percent of wastewater

capital will be replaced annually—or differ in ways that

tend to offset each other. Thus, CBO’s high-cost case

does not provide independent support for WIN’s esti2. Those comparisons express all costs in 2001 dollars. As originally published, WIN’s annual estimates of future spending

were in 1997 dollars and totaled $24 billion for drinking water

systems and $22 billion for wastewater systems. See Water Infrastructure Network, Clean and Safe Water for the 21st Century:

A Renewed National Commitment to Water and Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).
SUMMARY xv

6XPPDU\ 7DEOH 

Estimates of Average Annual Costs for Investment in Water Systems,

Measured as Capital Resource Costs, 2000 to 2019

(In billions of 2001 dollars)

Drinking Water Wastewater Total

CBOa 12.0 to 20.5 14.9 to 22.3 26.9 to 42.7

Water Infrastructure Network 20.9 19.2 40.1

Environmental Protection Agency

Clean Water Needs Surveyb

As published n.a. 7.3 n.a.

Adjusted for more recent estimate of costs to control 

sanitary sewer overflows n.a. 11.4 n.a.

Drinking Water Infrastructure Needs Surveyc

As published 8.0 n.a. n.a.

Adjusted for underreporting 11.1 n.a. n.a.

American Water Works Associationd 8.5 n.a. n.a.

Sources: Congressional Budget Office; Environmental Protection Agency, Office of Water, 1996 Clean Water Needs Survey: Report to Congress, EPA 832-R-97-003

(September 1997); Environmental Protection Agency, Office of Water, Drinking Water Infrastructure Needs Survey: Second Report to Congress, EPA 816-R01-004 (February 2001); American Water Works Association, Reinvesting in Drinking Water Infrastructure: Dawn of the Replacement Era (Denver,

Colo.: AWWA, May 2001); Water Infrastructure Network, Clean and Safe Water for the 21st Century: A Renewed National Commitment to Water and

Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).

Note: n.a. = not applicable.

a. Ranges reflect CBO’s low-cost and high-cost cases.

b. Estimate for 1996 through 2015.

c. Estimate for 1999 through 2018.

d. Estimate for 2000 through 2029.

mates but instead suggests that to obtain estimates of that

magnitude requires making relatively pessimistic assumptions.

Comparing CBO’s Estimates and 

Estimates from Bottom-Up Studies

Support for lower estimates of investment costs comes

from bottom-up studies by EPA and the AWWA. Those

studies measure investment in current resource costs—

again, total capital costs regardless of financing but

without including interest costs. So comparing their

estimates with CBO’s and WIN’s projections requires

that those projections also be expressed in terms of resource costs.

When the results are measured comparably, the estimates

from CBO’s low-cost case are above those from EPA’s

and AWWA’s studies, even after some (perhaps incomplete) adjustments to EPA’s estimates to try to correct for

the surveys’ limitations in capturing investments over the

full 20-year horizon (see Summary Table 3).

• EPA’s latest available wastewater survey, conducted in

1996 and published in 1997, estimated that average

annual needs were $7.3 billion per year.3

 Substituting

EPA’s later projection of costs for controlling sanitary

sewer overflows raises the estimate to $11.4 billion.

• For drinking water, EPA’s 1999 needs survey (published in 2001) estimated average annual needs of $8.0

3. Environmental Protection Agency, Office of Water, 1996 Clean

Water Needs Survey: Report to Congress, EPA 832-R-97-003

(September 1997).
xvi FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

billion; if the amount of underreporting in that survey

equals the amount that EPA found in follow-up visits

to 200 medium-sized and large systems after the

initial 1995 needs survey, then the estimate of $8.0

billion can be scaled up to $11.1 billion.4

• The AWWA conducted a detailed engineering analysis of the needs of 20 medium-sized and large drinking water systems; extrapolating from that admittedly

small base to national totals, the association estimated

that average annual needs cost $8.5 billion.5

Water Costs in Household Budgets

How might future costs of investment in water infrastructure and of operations and maintenance affect household

budgets? CBO estimates that in the late 1990s, total

household bills for drinking water and wastewater services

combined represented 0.5 percent of household income

nationwide. By 2019, CBO projects, household water

bills will account for 0.6 percent of national household

income under the low-cost scenario and 0.9 percent

under the high-cost scenario. According to the best available international data, such shares would not be high

compared with the income shares devoted to household

water bills in many other industrialized countries.6

CBO’s estimates assume steady levels of support financed

by taxpayers and constant shares of water costs paid by

household and nonhousehold ratepayers. Any changes in

those levels or shares would shift the form of the impact

on household budgets but would not change the average

impact nationwide, since households ultimately pay 100

percent of water costs, whether through water bills, taxes,

or the costs of other goods and services produced using

water.

National shares, however, can obscure important differences among households; thus, they shed only limited

light on the argument, made by advocates of boosting

federal aid for water infrastructure, that water bills will

otherwise become “unaffordable” for many households.

Accordingly, CBO went beyond national averages to

examine the current distribution of household water bills

relative to income and to project future distributions.

Specifically, CBO analyzed the current distribution using

a national sample of annualized water bills reported by

approximately 2,800 households; those households participated for a year in the Consumer Expenditure Interview

Survey some time between the third quarter of 1997 and

the first quarter of 1999. CBO’s analysis of the data

included imputing expenditures for the 39 percent of

respondents who did not report their own bills by using

data from households with comparable incomes.7

 To

project the distributions forward to 2019, CBO scaled

up the individual water bills to reflect estimated costs in

the two scenarios and extrapolated household income to

reflect growth in real income and population.

The results of CBO’s analysis can be characterized in several ways, with different measures highlighting different

features of the distributions. One summary measure that

has received significant attention in discussions of future

water costs is the proportion of households whose water

bills exceed 4 percent of their income. But 4 percent has

no economic significance as the point at which household

water bills become “unaffordable,” so the measure is no

better (or worse) than many others.

In terms of that particular measure, CBO estimates that

in the late 1990s, 7 percent of U.S. households spent

more than 4 percent of their income on water bills. An

4. Environmental Protection Agency, Office of Water, Drinking

Water Infrastructure Needs Survey: Second Report to Congress,

EPA 816-R-01-004 (February 2001).

5. American Water Works Association, Reinvesting in Drinking

Water Infrastructure: Dawn of the Replacement Era (Denver,

Colo.: AWWA, May 2001).

6. International data are limited to average direct billing costs for

typical levels of water use. See Organization for Economic Cooperation and Development, Environment Directorate, Environment Policy Committee, Household Water Pricing in OECD

Countries, ENV/EPOC/GEEI(98)12/FINAL (Paris: OECD,

1999).

7. That imputation may overstate water costs since most nonreporting households are likely to be apartment dwellers (who

do not receive separate water bills), and water use per capita is

generally lower in multifamily units than in single-family

homes.
SUMMARY xvii

additional 16 percent of U.S. households had expenditures greater than 2 percent of their income; 25 percent

were spending less than 2 percent but more than 1 percent, and 51 percent were spending no more than 1 percent (see Summary Figure 2). If the additional burdens

associated with CBO’s low-cost and high-cost estimates

led to uniform percentage increases in ratepayers’ bills,

10 percent to 20 percent of U.S. households might be

spending more than 4 percent of their income on water

bills in 2019; an additional 19 percent to 23 percent

might be spending more than 2 percent.

In the WIN coalition’s estimates, water bills account for

a much larger share of household budgets, both now and

in the future. In 1997, WIN estimates, 18 percent of

households spent more than 4 percent of their income on

water services; it foresees 22 percent of households having

bills at that level by 2009 (halfway through the 2000-

2019 period) and a third or more of the population experiencing such costs as rates continue to rise.8

Apparently, the discrepancy between WIN’s estimate of

18 percent for 1997 and CBO’s estimate of 7 percent for

the late 1990s derives primarily from the use of different

data on household water costs. CBO analyzed actual bills

based on water use by households; WIN, however, calculated household water bills using data on charges in 1997

among systems in Ohio for 250 gallons per day. WIN

chose to use those charges because, according to the 1990

census, Ohio households’ drinking water bills relative to

their income matched well those for U.S. households as

a whole. (The 1990 census did not have data on household wastewater expenditures.) However, if household

water bills nationally cannot be accurately characterized

on that basis, then WIN’s results may not be representative. If, for example, low-income households tend to use

less than 250 gallons per day, then, other things being

equal, WIN’s estimates overstate the number of households with water bills claiming more than 4 percent of

their income.

Rationales for Federal Involvement

in Water Services

Economic principles suggest that the federal government’s intervention in drinking water and wastewater

markets may be able to increase the cost-effectiveness of

providing and using water when state and local governments and water systems do not have adequate incentives

to account for effects that their practices may have on

third parties. This CBO study focuses on federal financial

support; of course, the federal government also intervenes

in water markets through its role in establishing waterquality standards under the Clean Water and Safe Drinking Water Acts. Whether current standards promote the

economically efficient use of society’s resources is an important question but is not addressed here.

One opportunity for federal funding to improve costeffectiveness may be by supporting research and development (R&D). Nonfederal entities measure potential

R&D expenditures only against the benefits that they

themselves could realize, ignoring gains that might accrue

to others. Without federal involvement, therefore, funding for the development of new technologies is likely to

be lower than is optimal. But determining the right level

of federal support in practice is a challenge. It depends

on the returns to investment in R&D, which are typically

difficult to predict, and the extent to which nonfederal

entities reduce their R&D expenditures in response to

federal funding.

A similar case might also be made in favor of federal support for disseminating “best management practices.” The

argument is not simply that such practices can help water

systems reduce their costs, although that appears to be

true. (On the basis of 136 assessments of water systems

since 1997, the consulting firm EMA Associates found

that adherence to best practices could reduce operational

costs by an average of 18 percent.) Rather, the crux of the

argument is the possibility that federal costs for gathering

and disseminating information about widely applicable

practices would be lower than the total costs that individual system managers would incur in seeking out relevant

information. If so, then taxpayer-funded support might

yield cost savings.

8. Water Infrastructure Network, Clean and Safe Water for the 21st

Century, pp. 3-4 and 3-5.
xviii FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills in the Late 1990s

Percentage of Income

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills Under the Low-Cost Case, 2019

Percentage of Income

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills Under the High-Cost Case, 2019

Percentage of Income

than 10

than 10

than 10

6XPPDU\ )LJXUH 

Water Bills as a Share of Household Income

(Percentage of U.S. households)

Source: Congressional Budget Office.
SUMMARY xix

6XPPDU\ %R[ 

Options to Expand Federal Aid for Private Water Systems

Half of all community drinking water systems in the

United States are privately owned, as are roughly 20

percent of the wastewater systems that treat household

sewage. However, those systems serve only a small share

of households: private drinking water systems reach

only about 15 percent of households—excluding those

using individual wells—and private wastewater systems

reach only about 3 percent of sewered households.

Giving private systems access to federal funds on equal

footing with public systems may or may not improve

cost-effectiveness because of two opposing effects. On

the one hand, balanced treatment could result in some

cost savings if private ownership can reduce a system’s

costs in some cases and local decisionmakers can correctly identify those cases. On the other hand, increasing federal aid tends to increase investment costs.

To help equalize federal support, the Congress could

modify the Clean Water Act to make private systems

eligible for loans from the state revolving funds. On the

tax preference side, it could alter policies related to taxexempt private activity bonds (PABs). Specific options

publicized by the Environmental Protection Agency’s

Environmental Financial Advisory Board include:

• Exempting bonds issued for water systems from

the federal limits on the amount of PABs issued in

each state;

• Exempting interest earned on those PABs from the

individual alternative minimum tax (AMT) and

partially exempt it from the corporate AMT;

• Increasing opportunities for PAB issuers to benefit

from arbitrage profits—those earned by investing

PAB proceeds at a rate above the bond’s own yield

—by allowing issuers a full two years to spend their

bond proceeds; and

• Allowing one-time refinancing of PABs up to 90

days before redemption of the original debt.1

One argument for providing private water systems with

equal access to federal aid is that it would treat customers of private and public systems equally. Conversely, one argument against equal access is that it

would give private water systems unique advantages

relative to other types of privately owned firms. Under

current law, privately managed enterprises such as

airports and solid-waste facilities can be exempt from

the PAB limits, but only if they are publicly owned.

1. Environmental Protection Agency, Environmental Financial

Advisory Board, Incentives for Environmental Investment:

Changing Behavior and Building Capital (August 1991).

However, other types of federal support for water services

(such as the current spending programs and tax preferences that help fund investment) distort prices and thus

undermine incentives for cost-effective actions by water

systems and ratepayers. Eliminating those distortions

could lower total national costs: for example, system managers might reduce investment costs by undertaking more

preventive maintenance and improving the design of their

pipe networks, and households might cut water use by

fixing leaks and watering lawns less often.

The clearest argument for current policies to subsidize

investment in water infrastructure is to shift the costs of

water services from ratepayers served by high-cost systems

(such as those in small and rural communities) to those

served by low-cost systems, or from low-income to highincome households. (Most federal support goes to publicly owned systems, but some goes to privately owned

ones; see Summary Box 2 for options to expand aid to private systems.)
xx FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

In evaluating the case for subsidizing water services, it is

important to recognize that the level and form of the

subsidies influence not only the distributional effects but

also the extent to which support undermines incentives

for cost-effective actions. To preserve those incentives for

both water systems and users, the Congress could pursue

policies that redistribute income rather than those that

distort the price of water.

Implications of Federal Support

for Infrastructure Investment

Federal support for water systems can have unintended

consequences. For example, an analysis of the federal

wastewater construction grants program under the Clean

Water Act concluded that it reduced other contributions

to capital spending. Thus, total investment in water infrastructure increased only 33 cents for each dollar of federal

support; the other 67 cents effectively reduced state and

local taxes or was spent on other uses.9

Federal support for investment projects also undermines

the cost-effective provision of water services by distorting

the price signals that systems face and thus affecting

managers’ choices in many areas, such as preventive maintenance, construction methods, treatment technology,

pipe materials, and excess capacity. The resulting losses

can be significant, particularly if the subsidies are large.

For example, a statistical analysis done for a 1985 CBO

study of the wastewater construction grants program estimated that setting the federal cost share at 75 percent

initially rather than 55 percent (the reduced level that

went into effect that year) raised plant construction costs

about 40 percent, on average.10

One way to reduce the distorting effects of federal subsidies might be to target increased aid to fewer systems—

those judged most deserving, whether because of high

costs associated with declining customer bases, federal

regulations, or simply high levels of anticipated investment (or investment and O&M spending) in general.

However, defining the target group in a way that does not

reward systems for poor management and past underinvestment might be difficult. Targeting could even

undermine cost-effective practices if it encouraged system

managers to let infrastructure deteriorate in hopes of

qualifying for aid in the future.

A variety of spending mechanisms—grants, loan subsidies, and credit assistance—are available to deliver and

annually readjust a desired level and pattern of aid for

water systems, but the design of such programs would

influence total costs. For example, federal support such

as partial grants, partial loans, or credit assistance would

leave investment projects relying on private funds as well,

and thus could help keep costs down by subjecting water

systems to more market discipline from lenders and ratepayers. Another approach to help system and state authorities make cost-effective choices would be to allow

them more flexibility in using the SRFs. That strategy

might include eliminating floors and ceilings on funding

for eligible activities in the drinking water program,

easing restrictions on transferring federal money between

drinking water and wastewater revolving funds, and

broadening the funds’ range of uses to address issues such

as nonpoint source pollution.

The federal government can also use tax preferences to

aid water systems, but doing so limits its discretion in

delivering certain levels and patterns of aid. Public water

systems and the interest paid on municipal bonds issued

on their behalf are already generally exempt from federal

taxes. Options for enhancing the tax preferences include

increasing the span of time during which issuers may keep

arbitrage profits (earned by investing the proceeds from

a bond at a rate above the bond’s own yield) and eliminating the partial taxation of interest earned on municipal

bonds held by corporations that pay the alternative

minimum tax. Such enhancements would aid mediumsized and large water systems; small systems that did not

have independent access to the municipal bond market

9. James Jondrow and Robert A. Levy, “The Displacement of

Local Spending for Pollution Control by Federal Construction

Grants,” American Economic Review, vol. 74, no. 2 (May 1984),

pp. 174-178. The displacement of state and local spending per

dollar of federal funds might have been less had the federal share

been smaller than 75 percent, its statutory level during the period the authors studied.

10. Congressional Budget Office, Efficient Investments in Wastewater Treatment Plants (June 1985).
SUMMARY xxi

could benefit indirectly, through cheaper or more plentiful SRF loans. The greater year-to-year stability of tax

preferences (compared to spending programs with annual

appropriations) would make planning easier for system

managers, but enhancing the preferences for water systems and not for other issuers of municipal bonds would

make the tax code more complex.

Implications of Direct Federal

Support for Ratepayers

An alternative to subsidizing investment in water systems

would be to assist low-income households facing high

water bills. The federal government does not currently

provide such assistance, but it aids low-income households through more general transfer programs and tax

provisions; it also subsidizes bills for some other utilities.

Compared with support for investment by water systems,

support for ratepayers could address concerns about the

impact of water bills on household budgets more precisely

and with less loss of efficiency. Unlike investment subsidies, support for ratepayers would not distort the

choices confronting system managers; nor would it reduce

the water prices faced by households not receiving the

direct subsidies.
CHAPTER



Drinking Water and Wastewater Infrastructure

'rinking water and wastewater services in the

United States are very decentralized; there is a strong history of local control, and the large majority of funding

for water services comes from local ratepayers and taxpayers. But over the past three decades, the federal government has taken the lead in regulating such systems and

has provided some funding for investment in water infrastructure. Concern over rising needs for such investment

has led to calls for increased federal funding and for systematic reforms to encourage cost-effectiveness in the provision of water services.

An Overview of U.S. Water Systems

Most U.S. residents are served by drinking water and

wastewater systems that are eligible for federal support

through state revolving funds (SRFs). In 1999, roughly

54,000 publicly or privately owned community drinking

water systems (defined as those with at least 15 service connections used by year-round residents or otherwise serving

at least 25 year-round residents) provided drinking water

to some 250 million people.1

 As of 1996, 16,000 publicly

owned treatment works collected and processed the wastewater from about 190 million people.

Though the details vary, water systems generally provide

the same basic functions: drinking water systems take in,

treat (in most cases), monitor, and distribute water to

households and other customers, while wastewater systems

collect, treat, and typically discharge water after use.

Roughly one-third of the households served by community

water systems use groundwater, which in some cases does

not require treatment. Otherwise, drinking water undergoes one or more of the following processes: flocculation

and sedimentation (to coagulate small particles into larger

groups and have them settle out of the water stream),

filtration (to remove additional particles), ion exchange

(to treat hard water and remove a variety of inorganic contaminants), and disinfection by chlorine or ozone (to kill

microbes). Ultimately, the water is distributed through

a network of pipes; the necessary pressure is supplied by

gravity, when the water has been pumped up into a storage

tower, or by direct pumping, when the water is from a

ground-level storage facility (see Figure 1-1).

Publicly owned treatment works collect wastewater

through a network of sewers, then process it using various

physical, biological, and chemical treatments. So-called

“primary treatment” uses screens, settling tanks, and other

physical methods to remove sand, grit, and larger solids;

it can remove up to 50 percent of the suspended solids

and biochemical oxygen demand (a measure of organic

matter, defined by the amount of oxygen that bacteria

would consume in decomposing it). In 1972, the Clean

Water Act required publicly owned treatment works to

adopt “secondary treatment” (which stimulates the growth

of bacteria to consume the waste materials prior to discharge) in order to reduce the levels of key pollutants by

85 percent (see Figure 1-2). In some cases, various types

of “advanced treatment” may be required to, for example,

reduce the unconventional pollutants like nitrogen and

phosphorus (which can promote excessive growth of algae)

in order to meet quality goals set for specific bodies of

water.

1. “Noncommunity” systems that are not-for-profit, such as those

of schools and hospitals, are also eligible for assistance from the

revolving funds.
2 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

)LJXUH 

A Drinking Water Plant

Source: Adapted by permission. Copyright American Water Works Association.
CHAPTER ONE DRINKING WATER AND WASTEWATER INFRASTRUCTURE 3

)LJXUH 

A Wastewater Treatment Plant

Source: Congressional Budget Office based on Water Environment Federation, Clean Water for Today: What Is Wastewater Treatment? (Alexandria, Va.: WEF, November

1999).

Assisted by federal funding provided since 1972, public

wastewater systems have nearly reached the goal of universal secondary treatment: as of 1996, only 176 of the

14,000 public treatment facilities that discharged effluent

streams were not meeting the requirement—and some of

those were exempt from it because they discharged to

sufficiently deep ocean waters or to other facilities that

in turn provided secondary treatment. As a result, although

the amount of biochemical oxygen demand arriving at

treatment facilities rose by more than 25 percent between

1972 and 1996 (which was consistent with population

and economic growth), the amount discharged fell about

40 percent.

Most water systems are small. For example, 58 percent

of community drinking water systems serve 500 people

or fewer, and 85 percent reach no more than 3,300 people

(see Figure 1-3). Many small wastewater facilities (such

as household septic units) are privately owned and thus

excluded from statistics on publicly owned treatment

works. Even so, 81 percent of the public facilities in operation in 1996 handled no more than 1 million gallons

per day (MGD), enough to serve roughly 8,000 people,

and 41 percent processed no more than 0.1 MGD (see Figure 1-4).2

Though outnumbered by the small systems, the relative

handful of large systems serve the great majority of people.

Just 7 percent of community drinking water systems serve

more than 10,000 people each, but they supply 81 percent

of those served by such systems; indeed, “very large”sys2. The data in million gallons per day are from Environmental

Protection Agency, Office of Water, 1996 Clean Water Needs

Survey: Report to Congress, EPA 832-R-97-003 (September

1997), p. C-4. The conversion from MGD to persons assumes

125 gallons per person-day, the low end of a range provided in

a personal communication from John Flowers of EPA.
4 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Up to 500 501 to 3,300 3,301 to 10,000 10,001 to 100,000 More than 100,000

0

10

20

30

40

50

60

70

80

58

26

8 6

1 2

8 10

37

44

Percentage of Systems

Percentage of People Served

Size of System, in Number of People Served

)LJXUH 

Community Water Systems and Population Served by Size of System, 2001

(Percentage)

Source: Environmental Protection Agency, “Factoids: Drinking Water and Ground Water Statistics for 2001” (January 2002).

Note: The total number of water systems is 53,783. The total number of people served is 264,145,129.

tems, defined by the Environmental Protection Agency

(EPA) as ones with more than 100,000 customers, represent 1 percent of systems but 44 percent of all people

served. Similarly, the largest 3 percent of wastewater plants

handled 68 percent of the total flow processed by all such

plants nationwide.

For both drinking water and wastewater, systems owned

by the public sector—by local governments or special local

or regional government authorities—serve the large majority of households. Although community drinking water

systems owned by the private sector account for over half

of all such systems, they serve only about 15 percent of

households; private wastewater systems that treat household sewage account for roughly 20 percent of the total,

but serve few households—perhaps 3 percent.3

 In a hybrid

arrangement, a small but growing number of publicly

owned systems have contracted with private firms to

operate and maintain them.

The U.S. pattern of decentralized, local control of water

systems is also common abroad, but an increasing number

of industrialized countries have moved to consolidate

operations or ownership, and some are emphasizing the

role of the private sector. In Great Britain, for example,

just 10 regional private companies provide almost all

wastewater services and most of the drinking water in

England and Wales, and fewer than 20 smaller companies

3. EPA’s data show that roughly 4,200 private facilities have permits to discharge treated household sewage (by comparison,

there are about 16,000 publicly owned treatment works). Private wastewater systems are not eligible for assistance from SRFs

(unlike their drinking water counterparts), so they are not included in some of EPA’s data-collection efforts, such as the

Clean Water Needs Survey. Consequently, precise data on the

percentage of the population that they serve are not readily

available; the estimate of 3 percent reflects common thinking in

the industry.
CHAPTER ONE DRINKING WATER AND WASTEWATER INFRASTRUCTURE 5

Up to 0.100 0.101 to 1.000 1.001 to 10.000 10.001 to 100 More than 100

0

10

20

30

40

50

60

41 41

16

3

1 0.5

7

24

36

31

Percentage of Facilities

Percentage of Flow

Size of Facility, in Millions of Gallons of Wastewater Treated Daily

Less than

)LJXUH 

Wastewater Treatment Facilities and Population Served by Size of Facility, 1996

(Percentage)

Source: Congressional Budget Office based on Environmental Protection Agency, Office of Water, 1996 Clean Water Needs Survey: Report to Congress, EPA 832-R-97-003

(September 1997).

Note: The total number of facilities is 15,986; the total daily flow is 32,175 million gallons per day. Totals exclude 38 facilities for which data were unavailable.

supply most of the remaining drinking water4; three public

authorities provide the water and sewer services in Scotland.5

 Australia, Canada, and Ireland also have regional

systems that provide both drinking water and wastewater

services.6

 France has 15,500 municipally owned water systems, but most of those systems contract out their operations to one of a handful of private companies.7

The costs of providing water services can vary widely, depending on the size of the system, the proximity and

quality of the local water sources, and other factors.

Treatment costs in particular are subject to economies of

scale. For example, EPA’s data on the costs of monitoring

and treatment to comply with the Safe Drinking Water

Act standards in force as of September 1994 suggest that

the average cost per household was on the order of $4 per

year in systems serving more than 500,000 people, but

4. Organization for Economic Cooperation and Development,

Environment Directorate, Working Party on Economic and

Environmental Policy Integration, Industrial Water Pricing in

OECD Countries, ENV/EPOC/GEEI(98)10/FINAL (Paris:

OECD, 1999), pp. 9, 192, 197. 

5. Web site of the North of Scotland Water Authority, www.

noswa.co.uk.

6. Organization for Economic Cooperation and Development,

Industrial Water Pricing, pp. 9 and 27.

7. Organization for Economic Cooperation and Development,

Industrial Water Pricing, p. 91; and Liana Moraru-de Loe, “Privatizing Water Supply and Sewage Treatment Services in Ontario,” Water News, vol. 16, no. 1 (March 1997), available at

www.cwra.org/news/arts/privatisation.html.
6 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

$300 per year for systems serving no more than 100

people.8

The large majority of funding for water services comes

from local sources, as can be seen in the detailed data

reported by the Association of Metropolitan Sewerage

Agencies in its AMSA Financial Survey, 1999. Of the

revenues reported by 112 medium-sized and large wastewater systems, 55 percent came from user charges or hookup fees, 15 percent from reserves and interest, 15 percent

from bond proceeds, 4 percent from property taxes, 3 percent from SRF loans, 2 percent from federal and state

grants, and the remainder from various smaller categories.9

Excluding reserves, interest, and bond and loan proceeds,

all of which derive or must be repaid from other sources,

the local funding provided by user charges, hookup fees,

and property taxes made up 88 percent of the “underlying”

revenues, while federal and state grants contributed just

3 percent.10 However, federal aid plays a larger role in the

financing of small and rural systems not included in the

AMSA survey, as discussed below.

The AMSA’s data do not categorize user charges by type

of customer, but EPA has some information on that subject for drinking water systems. Results from the agency’s

1995 Community Water System Survey indicate that residential customers accounted for three times the sales volume of commercial and industrial customers—55 percent

versus 18 percent. Another 4 percent of sales were to

wholesale customers (who in turn sold to final users), and

23 percent were described as “other,” including sales to

governmental and agricultural customers and sales by systems that did not disaggregate by customer type.11

The Federal Role

Except as a builder of dams and other major public works

used to supply water, the federal government played a

relatively minor role in funding or regulating local water

systems before 1972.12 The Public Health Service had published drinking water standards as early as 1914 and updated them in 1925, 1946, and 1962, but those standards

were federally enforced only for the water supplies of interstate carriers. Matching grants for 30 percent to 50 percent

of the cost of constructing wastewater treatment facilities

became available in 1956, but initially the amount of

funding was small and there were no federal requirements

for such facilities.

With the passage of the Federal Water Pollution Control

Act Amendments of 1972, later designated the Clean

Water Act, the Congress adopted the goal of restoring and

maintaining the chemical, physical, and biological integrity

of the nation’s waters, thereby ensuring that they would

be fishable and swimmable. Toward that goal, the legislation established a requirement that municipal wastewater

discharged to surface waters be given secondary treatment,

increased the federal matching share to 75 percent for constructing publicly owned treatment works, and greatly expanded the amount of the available funding. Consequently, federal outlays for wastewater treatment grants

rose tenfold in real (inflation-adjusted) terms during the

1970s, reaching a high of $9.1 billion (in 2001 dollars)

in 1980.13

The expansion of aid was seen as a temporary infusion

of capital to allow publicly owned wastewater systems to

construct secondary treatment facilities—and, indeed,

funding has declined sharply since its real peak in 1980.

In 1981, amendments to the Clean Water Act cut the

authorization for wastewater grants in half and reduced

the federal matching share to 55 percent for facilities built

after 1984. Then in 1987, legislation was enacted to phase

out the construction grant program by 1991 and replace

8. New calculation based on data in Congressional Budget Office,

The Safe Drinking Water Act: A Case Study of an Unfunded Federal Mandate (September 1995), pp. 16-17.

9. Association of Metropolitan Sewerage Agencies, The AMSA

Financial Survey, 1999 (Washington, D.C.: AMSA), p. 36.

10. Those percentages do not account for the federal and state contributions through subsidized interest rates on SRF loans.

11. Environmental Protection Agency, Office of Water, Community

Water System Survey, Volume 1, EPA 815-R-97-001a (January

1997), pp. 13-14.

12. Issues involving federal water projects and the adequacy of water

supplies are outside the scope of this study. But see Congressional Budget Office, Water Use Conflicts in the West: Implications

of Reforming the Bureau of Reclamation’s Water Supply Policies

(August 1997).

13. Congressional Budget Office, Trends in Public Infrastructure

Spending, CBO Paper (May 1999), pp. 102-104.
CHAPTER ONE DRINKING WATER AND WASTEWATER INFRASTRUCTURE 7

it with a period of grants to capitalize state revolving

funds, with the states matching 20 percent of each federal

dollar. The SRFs provide several types of financial support

—including loans at or below market interest rates, purchase of existing local debt obligations (bonds), and guarantees for new debt —but they do not make grants. The

1987 law envisioned that loan repayments would allow

the SRFs to operate without ongoing federal support and

authorized contributions only through 1994; however,

the Congress has continued to appropriate funds each year

since then, including $1.35 billion for 2002.14 In nominal

dollars, appropriations from 1973 through 2002 have

totaled $73 billion.

The federal government’s primary involvement with

drinking water began with the Safe Drinking Water Act

in 1974. Among the factors leading to its passage were

concerns that the Public Health Service’s drinking water

standards were based on inadequate and obsolete data,

that state and local officials were not adequately monitoring water systems, and that pollutants found in drinking

water were carcinogenic. EPA issued few standards for

drinking water contaminants in the law’s first decade, and

the Congress amended it in 1986 to require the agency

to develop standards for 83 specified contaminants and

for 25 others every three years. As amended, the law called

for the standards, deemed “maximum contaminant levels,”

to be set as close as feasible to levels at which no adverse

health effects were known or anticipated—taking cost into

consideration in defining feasibility. EPA considers a

standard feasible if the cost of meeting it is “reasonable”

for large water systems.15

Neither the original Safe Drinking Water Act nor the

1986 amendments authorized federal funding, but as the

number of standards and the costs of meeting them grew,

so did support for providing drinking water systems with

financial assistance. Thus, a key provision of the law’s

1996 amendments created a program of drinking water

SRFs modeled after the existing wastewater program and

authorized $9.6 billion through fiscal year 2003 in capitalization grants, again requiring a 20 percent state match.

(Appropriations through fiscal year 2002 for the drinking

water funds have totaled $5.3 billion.) Other major provisions revoked the requirement that EPA regulate an additional 25 contaminants every three years, authorized the

agency to adopt less stringent contaminant standards if

necessary to keep costs from exceeding benefits, and required it to identify “variance technologies” that could

be approved for use by small systems judged unable to afford to comply with the relevant standards. The amendments also called on states to establish programs to certify

and develop the technical, financial, and managerial capacity of drinking water systems to comply with all federal

requirements.

Federal spending programs outside of EPA also provide

financial support for investments in water infrastructure.

The Rural Utilities Service of the Department of Agriculture provides a mix of loans and grants for water and waste

disposal projects in communities with fewer than 10,000

people; the program received $647 million in 2002.

Drinking water and wastewater projects may also receive

funding through the Public Works and Development

Facilities Program (administered by the Economic Development Administration in the Commerce Department)

or the Community Development Block Grants program

(administered by the Department of Housing and Urban

Development) if they meet the relevant criteria: the former

program focuses on job creation and the latter on community development that benefits low- and moderateincome people. Still other programs focus on assistance

to specific groups or locations, such as Indian tribes, native

Alaskan villages, Appalachia, and unincorporated colonias

on the U.S.-Mexico border.

The federal government also supports water infrastructure

indirectly, through tax preferences. Because the interest

paid on state and local bonds is generally excludable from

taxable income, municipalities and other public water

authorities can issue bonds at lower rates than they would

otherwise have to pay. Also, bonds issued for privately

owned drinking water and wastewater systems are considered “qualified private activity bonds” eligible for taxexempt status; however, the federal government limits the

14. In addition, for 2002 the Congress earmarked $344 million in

grants for wastewater and drinking water projects. 

15. See, for example, Environmental Protection Agency, “National

Primary Drinking Water Regulations: Arsenic and Clarifications

to Compliance and New Source Contaminants Monitoring,

Final Rule,” Federal Register, vol. 66, no. 14 (January 22, 2001),

p. 6981.
8 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

volume of tax-exempt private bonds that each state can

issue annually. Issues of municipal and tax-exempt private

bonds for municipal utilities—primarily drinking water

and wastewater systems but also some solid and hazardous

waste facilities—totaled $14.0 billion in 2000 and $29.3

billion in 2001.16 The Joint Committee on Taxation estimates that the exemption will save bondholders $0.6 billion in fiscal year 2002.17

The Need for Increased Investment

Dramatic incidents in recent years have called attention

to the importance of water infrastructure. In 1993, contamination of the Milwaukee water supply by cryptosporidium caused 400,000 cases of gastrointestinal illness

and an estimated 50 to 100 deaths. That same year, two

people in Atlanta were killed by falling into a sinkhole

created by the collapse of a storm sewer. Baltimore had

two sinkholes of 30 feet or more in 1997, and a Manhattan sinkhole caused millions of dollars in damage in 1998.

Less catastrophic failures demonstrate the widespread

nature of the problems. According to EPA’s data, 880

publicly owned treatment works receive flows from “combined sewer systems” which commingle stormwater with

household and industrial wastewater and frequently overload during heavy rain or snowmelt. EPA estimates that

such overflows discharge 1.2 trillion gallons of stormwater

and untreated sewage every year. Even “sanitary” systems

with separate sewers for wastewater can overflow or leak

because of pipe blockages, pump failures, inadequate

maintenance, or excessive demands. According to a draft

EPA report, overflows from sanitary sewers alone result

in a million illnesses each year.18 Moreover, according

to industry experts, many urban and rural drinking water

systems lose 20 percent or more of the water they produce

through leaks in their pipe networks.19

In part, those problems result from the aging of the nation’s water infrastructure, particularly its pipes. Though

less visible than treatment facilities, pipes actually account

for the majority of both drinking water and wastewater

systems’ assets.20 According to estimates, drinking water

systems have 800,000 miles of pipes, and sewer lines cover

more than 500,000 miles.21 The rule of thumb is that a

sewer pipe lasts 50 years (although actual useful lifetimes

can be significantly longer, depending on maintenance

and local conditions), and a 1998 survey of 42 municipal

sewer systems found that existing pipes averaged 33 years

old, suggesting that many are, or soon will be, in need of

replacement.22 Similarly, a study by the American Water

Works Association that analyzed 20 medium-sized and

large drinking water systems concluded that the need to

16. Personal communication from Amy Resnick, editor, The Bond

Buyer, citing data from Thomson Financial.

17. Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2002-2006, JCS-1-02 (January 17, 2002),

p. 21.

18. Environomics, Inc., and Parsons Engineering Science, Inc.,

Economic Analysis of Proposed Regulations Addressing NPDES

Permit Requirements for Municipal Sanitary Sewer Collection

Systems and Sanitary Sewer Overflows (draft prepared for the

Environmental Protection Agency, March 24, 2000), p. 3-1.

19. Personal communications from John Young, Vice President for

Engineering, American Water Works Services Company, and

Buzz Teter, Research and Development Specialist, American

Leak Detection.

20. For example, a recent study of 20 medium-sized and large

drinking water systems found that water mains accounted for

more than 60 percent of the current value of the systems’ capital

stock. American Water Works Association, Reinvesting in

Drinking Water Infrastructure: Dawn of the Replacement Era

(May 2001), p. 11, available at www.awwa.org/govtaff/infrastructure.pdf.

21. American Society of Civil Engineers, Drinking Water, Issue

Brief (no date); Parsons Engineering Science, Inc., Metcalf and

Eddy, and Limno-Tech, Inc., Sanitary Sewer Overflow (SSO)

Needs Report (prepared for the Environmental Protection

Agency, Office of Wastewater Management, May 2000), p. 2-2.

The estimate for sewer lines is for systems with separate sanitary

sewers; given the same assumptions, systems that combine sanitary wastewater and stormwater add roughly 140,000 more

miles to the overall total.

22. American Society of Civil Engineers, Optimization of Collection

System Maintenance Frequencies and System Performance (prepared for the Environmental Protection Agency, November

1998).
CHAPTER ONE DRINKING WATER AND WASTEWATER INFRASTRUCTURE 9

replace pipes will rise sharply over the next 30 years as previous generations wear out.23

Although treatment plants represent a smaller share of

water systems’ assets than pipes do, they too are aging.

Equipment in many plants built under the Clean Water

Act and Safe Drinking Water Act will need to be replaced

in the next decade or two. Moreover, many drinking water

systems will have to make additional investments in treatment equipment to satisfy forthcoming regulations under

the Safe Drinking Water Act.

In short, costs to construct, operate, and maintain the

nation’s water infrastructure can be expected to rise significantly in the future. Less clear, however, are the

amount and timing of the increases. Estimates of future

costs and the uncertainties surrounding them are discussed

in Chapter 2; sources of funding to pay those costs are

considered in Chapter 3. 23. American Water Works Association, Reinvesting in Drinking

Water Infrastructure.
CHAPTER



Estimates of Future Investment Costs

and Their Implications

$ny estimate of costs for future investment in

water systems reflects not only the current state and future

depreciation of the existing infrastructure but also the

goals—such as the regulatory requirements and the levels

of customer satisfaction—that water systems seek to

achieve and the efficiency with which they pursue those

goals. An underlying assumption, about which there appears to be general consensus, is that customers will continue to expect high-quality service. Less consensus exists,

however, regarding the future costs of regulatory requirements and potential efficiency savings.

Given the limitations of the available data, which begin

with uncertainties about even the amount and condition

of the current infrastructure, in this study the Congressional Budget Office (CBO) does not provide a single

point estimate of 20-year investment costs. Instead, it

discusses estimates for two scenarios—a low-cost case and

a high-cost case—that it believes span the most likely possibilities. CBO derived those estimates by applying specific

new assumptions to the same modeling framework that

the Water Infrastructure Network (WIN)—a coalition

of groups representing water systems, elected officials,

engineers, construction companies, and environmentalists

—used to develop its own estimates. Like WIN’s analysis,

CBO’s scenarios cover the years 2000 to 2019; data on

actual investment in 2000 and 2001 are not yet available.

The two scenarios yield estimates of average annual investment costs ranging from $11.6 billion to $20.1 billion

for drinking water systems and from $13.0 billion to

$20.9 billion for wastewater systems.1

 Those estimates

measure investment volume in 2001 dollars (as do all other

dollar figures in this chapter not identified otherwise) and

in terms of costs as financed, taking into account the use

of borrowing to spread the investment burden over time.

In particular, the estimates reflect the full capital costs of

investments made each year on a pay-as-you-go basis and

the debt service (principal and interest) paid on prior

financed investments. Costs as financed are particularly

relevant to policy debates about affordability because they

reflect the current burden on water systems. (One could

also measure investment volume in terms of economic

resource costs; see Box 2-1.)

By comparison, spending on investment in states’ 1998-

1999 fiscal year (calculated using similar assumptions to

the ones underlying the projections of future investment)

was $11.8 billion for drinking water and $9.8 billion for

wastewater. Thus, the projected overall shortfall between

current spending and future costs is $3.0 billion per year

in the low-cost case (-$0.2 billion for drinking water and

$3.2 billion for wastewater) and $19.4 billion in the highcost case ($8.3 billion for drinking water and $11.1 billion

for wastewater).

1. The estimates for drinking water and wastewater are not strictly

comparable because the methods CBO used to derive them

were not identical, as discussed below. 
12 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

CBO has also analyzed the impact of those projected

increases on household budgets. Assuming for simplicity

that both the level of taxpayer-financed support and the

distribution of costs between household and other water

ratepayers remained constant, CBO estimates that by

2019, average bills for drinking water and wastewater

services combined would account for 0.6 percent of

average household income under the low-cost case and

0.9 percent under the high-cost case, up from 0.5 percent

in the late 1990s. Of course, many households would pay

%R[ 

Alternative Measures of Investment Spending

This study measures investments in water systems in

terms of costs as financed because that measure best

reflects the impact on water rates and hence on the

affordability of household water bills. The alternative

and more common measure is economic costs—the

quantity of real economic resources required by the

investments.

In particular, economic costs reflect the capital costs of

all investments, whether financed by bonds or loans or

paid for from funds on hand; that measure omits interest payments on bonds and loans, which represent mere

transfers of funds. Thus, it differs in two ways from the

measure describing costs as financed: by excluding

interest costs and by focusing on the full capital costs

of new financed investments rather than the current

principal payments on previous financed investments

(see the table). Although less relevant than costs as financed for judging the affordability of water services,

economic costs are the preferred measure for policy

questions that focus on the efficient use of society’s

resources, such as questions about the costs and benefits

of water-quality regulations.

The Water Infrastructure Network’s (WIN’s) estimates

reflect neither economic costs nor costs as financed. For

each of the 20 years analyzed, the estimates combine

the capital costs for all investments made that year—

that is, the economic costs—and the sum (in real dollars) of all future interest costs for the portion of the

investments financed by borrowing. In other words,

each year’s estimate adds the cost of that year’s pay-asyou-go investments and the total debt service (principal

plus interest) to be paid in later years for the new financed investments. Thus, whereas costs as financed

include the current debt service paid on past investments, WIN’s estimates include future debt service on

current investments. The impact of that difference is

discussed in Box 2-3 on page 19.

Note that the distinction between the two measures of

cost does not apply to spending on operations and

maintenance (O&M). Since O&M is paid for from

current funds, the real resource costs to the economy

are the same as the immediate burden on water systems

and their ratepayers.

Costs Included in Measures of Investment Spending

Costs as Financed Economic Costs WIN’s Estimatesa

Capital Costs of Current Pay-As-You-Go Investments yes yes yes

Current Principal for Old Financed Investments yes no no

Total Future Principal for Current Financed Investments no yes yes

Current Interest on Old Financed Investments yes no no

Total Future Interest on Current Financed Investments no no yes

Source: Congressional Budget Office.

a. As published. Elsewhere in this study, CBO has converted WIN’s estimates to costs as financed, using detailed results from WIN’s analysis to include and

exclude component costs, as needed.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 13

less than those averages, and many others would pay

more. For example, in CBO’s two cases an estimated 10

percent to 20 percent of households would be paying

more than 4 percent of their income for water services by

2019, compared with 7 percent doing so in the late

1990s.

CBO’s estimates of future investment costs appear to be

significantly below those published in the WIN report;

however, the two are not directly comparable because

WIN’s estimates do not reflect costs as financed. When

expressed in comparable terms, the estimates from CBO’s

high-cost case and WIN’s analysis are similar. That similarity is not surprising because CBO used WIN’s basic

modeling approach and, in the high-cost case, similar

assumptions. Thus, CBO’s high-cost case does not lend

independent support for WIN’s estimates; rather it suggests that estimates of that magnitude require relatively

pessimistic assumptions. Studies that project national investment costs by aggregating data from individual water

systems have yielded estimates that are lower than those

of CBO’s low-cost case.

CBO’s estimates do not include the costs of additional

investments in infrastructure security prompted by the

September 2001 attacks on the World Trade Center and

the Pentagon. As this report was written, the drinking

water and wastewater industries were in the early stages

of assessing their vulnerabilities (see Box 2-2). Preliminary

indications are that capital costs for security will not add

much to the investment costs described here. CBO’s estimates also exclude investments in drinking water systems

that serve only future growth; such investments are not

eligible for funding under the state revolving fund program.

Bottom-Up and Top-Down Estimates

of Investment in Water Systems

To interpret CBO’s scenarios and estimates, it is useful

to understand the basic approaches underlying previous

estimates of investment in water systems—particularly

those used in WIN’s analysis, which CBO adapted. The

approaches can be divided into two categories: bottom-up

estimates reflect assessments of the needs of individual

systems—either all systems nationwide or a sample of systems—whereas top-down estimates are based on analyses

of aggregate national data. Top-down studies are simpler

and less expensive, but their results are sensitive to a number of assumptions required because of the limitations of

the aggregate data—particularly the lack of a national inventory of pipes’ age and condition.

Bottom-Up Estimates

EPA’s periodic needs surveys provide the most comprehensive bottom-up estimates.2

 The 1999 drinking water

survey, published in February 2001, estimates total investment costs from 1999 to 2018 to be $159.5 billion

(see Table 2-1).3

 The agency’s latest available wastewater

survey estimates 20-year costs to be $147.0 billion, if

$13.2 billion for projects not involving infrastructure per

se is excluded.4

 Expressed as average annual costs, those

estimates are $8.0 billion for drinking water systems and

$7.3 billion for wastewater systems; both estimates reflect

capital costs alone, excluding financing.

One key limitation of both surveys, acknowledged in

EPA’s reports, is that many respondents may have been

unable to supply adequate documentation for investments

later in the 20-year survey period because they relied on

2. Some of the estimates identified here as “bottom-up” contain

minor top-down components and vice versa.

3. Environmental Protection Agency, Office of Water, Drinking

Water Infrastructure Needs Survey: Second Report to Congress,

EPA 816-R-01-004 (February 2001), p. 12. The report expressed the estimate as $150.9 billion in January 1999 dollars.

The survey included on-site analyses at 599 small systems (serving up to 3,300 people) randomly selected from the roughly

45,000 such systems and questionnaires mailed to all of the

1,111 systems serving more than 40,000 people and a random

sample of 2,556 of the 7,759 systems serving 3,301 to 40,000

people. The return rate on the questionnaires was 96 percent.

Ibid., pp. 18-19.

4. The original figures, in January 1996 dollars, were $128.0 billion and $11.5 billion; EPA derived the national totals after reviewing documentation submitted by the states. Environmental

Protection Agency, Office of Water, 1996 Clean Water Needs

Survey: Report to Congress, EPA 832-R-97-003 (September

1997), pp. 1-2, 20. The excluded categories cover projects addressing nonpoint source pollution involving agriculture and

silviculture; urban runoff; and groundwater, estuaries, and wetlands.
14 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

%R[ 

Security Investments for Water Systems

Although utility, government, and academic experts

can identify generally what measures are needed to safeguard water services, a reliable assessment of the total

potential costs of addressing those needs is not yet

available.

Environmental Protection Agency officials and outside

security experts generally view a terrorist attack on physical infrastructure (dams, treatment plants, pipes, and

computer systems) as the scenario warranting the most

attention. In some cases, successful attacks, such as one

that would destroy any of the 93,000 “high hazard”

dams, could not only disrupt service but also immediately cause human deaths. Contamination of drinking

water at a reservoir or treatment plant is considered

relatively unlikely to cause a large-scale health problem

because of the volume of contaminants needed and because of the screening involved in treatment.1

 Contamination of the water once it was in the distribution

system would be more direct but would affect fewer

people.

In the short term, water systems are focusing on securing or eliminating toxic chemical stockpiles at treatment plants; installing basic surveillance and security

equipment such as fencing, lighting, motion sensors,

closed-circuit television, locks, and alarms; and conducting background checks and security training programs. Also, the water industry’s Information Sharing

1. For a contrary view, see www.amsa-cleanwater.org/advocacy/

security/articles.cfm, which cites an article from the November

17, 2001, St. Louis Post Dispatch quoting two government officials who believe that the potential risk from bacterial contamination is high.

and Analysis Center (ISAC)—a Web-based tool providing threat alerts, a mechanism for systems to report

incidents, and training resources—is scheduled to be

launched in December 2002. The ISAC will help water

systems, law enforcement agencies, and emergency response organizations share information.

For longer-term improvements in security, the nation’s

water systems are working to finish vulnerability assessments and to adapt their emergency response plans to

include terrorist acts. Moreover, research and development is under way to identify ways to combat physical

vulnerabilities and contamination (chemical, biological,

or radiological) and to identify the interconnections

with other critical services such as those of the energy,

telecommunications, and transportation sectors and

emergency services.

As the vulnerability assessments and research projects

are completed, investment needs will become clearer,

and perhaps much larger than those identified today.

Nonetheless, on the basis of conversations with industry experts, CBO anticipates that those needs will be

small compared with the widespread needs to replace

and improve the water infrastructure. For example, the

American Water Works Association has estimated national costs of $450 million to complete vulnerability

assessments for all systems serving more than 3,300

people and $1.6 billion for initial security improvements (access controls such as fences, lighting, cameras,

and alarms). Combined, those one-time amounts represent less than 1 percent of CBO’s estimates of the 20-

year capital costs of investment in drinking water

systems.

planning documents covering one to 10 years.5

 The report on wastewater also argues that the survey underreports future investments to correct problems with sanitary sewer overflows (SSOs).6 Indeed, a subsequent topdown report placed the investment costs of controlling

SSOs at $92.4 billion, well above the figures found in the

5. Environmental Protection Agency, Drinking Water Infrastructure Needs Survey, p. 43; and 1996 Clean Water Needs Survey,

p. 7.

6. Environmental Protection Agency, 1996 Clean Water Needs

Survey, p. 7.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 15

7DEOH 

Summary of Estimates of Investment Costs for Water Systems

(In billions of 2001 dollars)

Drinking Water Wastewater Total

As

Published

Per

Year

As

Published

 Per

Year

As

Published

 Per

Year

Bottom-Up Estimates

Environmental Protection Agency

Clean Water Needs Survey n.a. n.a. 147.0 over 20 years 7.3 n.a. n.a.

Drinking Water Infrastructure

Needs Survey 159.5 over 20 years 8.0 n.a. n.a. n.a. n.a.

American Water Works Association 255 over 30 years 8.5 n.a. n.a. n.a. n.a.

Top-Down Estimates

Stratus Consulting (Investments

in distribution systems only) 348.3 over 20 years 17.4 n.a. n.a. n.a. n.a.

Water Infrastructure Network

 Capital only 20.9 per year 20.9 19.2 per year 19.2 40.1 per year 40.1

Capital and financing 26.3 per year 26.3 24.2 per year 24.2 50.5 per year 50.5

Source: Congressional Budget Office based on Environmental Protection Agency, Office of Water, 1996 Clean Water Needs Survey: Report to Congress, EPA 832-R-97-003

(September 1997); Environmental Protection Agency, Office of Water, Drinking Water Infrastructure Needs Survey: Second Report to Congress, EPA 816-R-01-

004 (February 2001); American Water Works Association, Reinvesting in Drinking Water Infrastructure: Dawn of the Replacement Era (Denver, Colo.:

AWWA, May 2001); Stratus Consulting, Inc., Infrastructure Needs for the Public Water Supply Sector (unpublished report for the American Water Works

Association, December 22, 1998); and Water Infrastructure Network, Clean and Safe Water for the 21st Century: A Renewed National Commitment to

Water and Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).

Note: n.a. = not applicable.

corresponding categories of the survey.7 Replacing those

figures reported in the survey with the top-down estimate

raises total costs from $147.0 billion to $198.2 billion.

The perceived shortcomings of EPA’s surveys helped spur

the American Water Works Association (AWWA) to conduct an in-depth analysis of 20 large and medium-sized

drinking water systems. On the basis of the actual age

and estimated lifetimes of the pipes, treatment plants, and

other assets, the analysis found that the 20 systems would

need to spend about $6 billion (in 2000 dollars) above

their current levels over the next 30 years.8

 The corresponding annual costs per household ranged from about

$18 to $77. On the basis of those 20 systems, the report

extrapolated a national total of $255 billion over 30 years,

implying an annual average of $8.5 billion (in 2001 dollars)—very similar to the $8.0 billion average reported

in EPA’s drinking water survey.

Top-Down Estimates

The top-down estimates reviewed for this study are larger

than the bottom-up estimates (see Table 2-1). The differences could reflect incomplete coverage of costs over

the 20-year period and other limitations of the existing

bottom-up studies, inaccurate assumptions in the topdown studies, or both. 7. Parsons Engineering Science, Inc., Metcalf and Eddy, and

Limno-Tech, Inc., Sanitary Sewer Overflow (SSO) Needs Report

(prepared for the Environmental Protection Agency, Office of

Wastewater Management, May 2000), pp. 1-7, 5-3. As presented in the report, the estimate was $87.3 billion in December 1998 dollars.

8. American Water Works Association, Reinvesting in Drinking

Water Infrastructure: Dawn of the Replacement Era (Washington,

D.C.: AWWA, May 2001), p. 18.
16 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

A top-down study done by Stratus Consulting for the

AWWA (not to be confused with the association’s recent

20-system study) estimated 20-year costs for investments

in drinking water distribution systems to be $348.3

billion, roughly four times the amount reported in EPA’s

survey.9

 The total from the Stratus study translates to

average annual costs of $5.1 billion for large systems and

$9.9 billion for medium-sized systems, reflecting point

estimates or probability distributions for five factors: the

number of systems nationwide (classified by size and

region), the miles of pipe per system, the distribution of

pipe mileage by size category, the replacement cost of

pipes in each size category, and the average annual rate

of replacement.10 Many uncertainties surround those factors. For example, two databases cited in the study

yielded estimates of 828 miles and 713 miles of pipe in

the average large system.11 Simply using the lower figure

instead of the higher would have reduced estimated investment costs for large systems by 14 percent, or $15

billion over 20 years. And major uncertainty accompanied the assumptions regarding future replacement rates,

as discussed in the next section.

WIN’s April 2000 report combined data and estimates

from existing sources with a new top-down analysis.12 For

drinking water, WIN borrowed estimates related to water

distribution from the Stratus study and estimates for all

other categories (treatment, storage, water sources, and

“other”) from EPA’s 1995 needs survey for drinking

water, the predecessor to the 1999 survey discussed above.

For wastewater, WIN’s approach distinguished investments to replace existing infrastructure from all other

investments, such as those to build new treatment plants

or new structures to contain stormwater runoff. The

analysis calculated the cost each year for replacing infrastructure as the product of net capital stock in that year

and a fixed depreciation rate.13 WIN estimated other investment costs on the basis of EPA’s needs survey, adjusted using the agency’s revised estimate for controlling

sanitary sewer overflows. However, because the survey

captured some replacement projects also, WIN’s analysts

subtracted a percentage to avoid double-counting. Again,

some key assumptions, such as those about the depreciation rate and the correction factor for double-counting,

were accompanied by significant uncertainty.

The WIN report went beyond the studies discussed above

by also estimating financing costs and operation and

maintenance (O&M) costs. To estimate financing costs,

WIN’s analysts assumed that water systems would pay for

25 percent of investment costs from internal funds, with

the rest financed for 20 years at a real interest rate of

3 percent. They estimated O&M costs by extrapolating

a linear trend through data on actual spending: for drinking water, they used 1985-1994 data on O&M spending

itself; for wastewater, they used 1972-1996 data on

O&M spending per dollar of estimated net capital stock.

Both estimates apparently subtract 20 percent for efficiency savings, phased in over 10 years. Those approaches

are discussed in more detail in Appendix A.

9. Stratus Consulting, Inc., Infrastructure Needs for the Public Water Supply Sector (unpublished report for the American Water

Works Association, December 22, 1998). The study estimated

costs only for large and medium-sized systems; for small systems, it adopted the estimate from EPA’s 1997 needs survey.

10. The report provided 80 percent confidence intervals—that is,

the ranges that cover the central 80 percent of the possible outcomes, omitting only the bottom 10 percent and the top 10

percent. For large systems, the 80 percent confidence interval

(in 1998 dollars) covered $0.9 billion to $9.7 billion. For

medium-sized systems, the distribution was somewhat less diffuse, spanning $5.8 billion to $13.6 billion. Ibid., p. 3-10.

11. Ibid., p. 3-2.

12. Water Infrastructure Network, Clean and Safe Water for the 21st

Century: A Renewed National Commitment to Water and Wastewater Infrastructure (Washington, D.C.: WIN, April 2000),

available at www.win-water.org. The following description of

WIN’s methods comes from an unpublished appendix to the

report and from several sets of oral or written statements from

Kenneth Rubin, PA Consulting, who served as lead analyst

developing the model for WIN.

13. WIN constructed its estimate of the capital stock of wastewater

infrastructure that existed in 1999 from a 1990 estimate prepared for the Federal Infrastructure Strategy Program of the

Army Corps of Engineers, information on annual investments

for 1990 to 1999 obtained or extrapolated from census data,

and the assumed depreciation rate. That depreciation refers to

the annual reduction in the useful economic life of an asset, not

to the related accounting concept of the credit allowed for tax or

regulatory purposes.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 17

7DEOH 

CBO’s Estimates of the Likely Range of Average Annual Costs

for Water Systems, 2000 to 2019

(In billions of 2001 dollars)

Drinking Water Wastewater Total

Debt Service on Pre-2000 Investments 4.4 to 4.4 4.3 to 4.3 8.7 to 8.7

Capital Costs (Paygo + Financed Principal) on New Investments 5.3 to 12.1 6.5 to 12.9 11.8 to 25.0

Interest on New Financed Investments 1.9 to 3.6 2.3 to 3.7 4.1 to 7.3 

Total Investment 11.6 to 20.1 13.0 to 20.9 24.6 to 41.0

Operations and Maintenance 25.7 to 31.8 20.3 to 25.2 46.1 to 57.0

Source: Congressional Budget Office.

Note: Ranges reflect CBO’s low-cost and high-cost cases.

CBO’s Estimates of Future Costs

CBO’s two sets of projections of 20-year costs for water

systems differ significantly. Under its low-cost case, the

estimate for average annual investment costs for both

drinking water and wastewater is $24.6 billion ($11.6 billion for drinking water and $13.0 billion for wastewater

—see Table 2-2), 40 percent less than its estimate of

$41.0 billion under the high-cost case ($20.1 billion for

drinking water and $20.9 billion for wastewater). Again,

the estimates are measured in terms of costs as financed,

reflecting the average annual capital costs for pay-as-yougo (or more briefly, paygo) investments and the debt service (principal and interest) paid on prior financed investments.14 The divergent estimates reflect nine differences

in the assumptions used in the two scenarios and illustrate

the uncertainty inherent in top-down analyses of 20-year

investment needs.

For operations and maintenance, the range of estimates

between the two cases is narrower—the smaller total of

$46.1 billion is just 19 percent below the larger figure of

$57.0 billion. Those estimates reflect a relatively narrow

range of modeling assumptions and may understate the

true range of uncertainty.

CBO’s estimates of future investment under its high-cost

scenario are similar to those from WIN’s analysis, when

the latter are measured in terms of costs as financed (see

Table 2-3). (WIN’s report does not provide costs-asfinanced estimates, but CBO was able to calculate such

estimates using more-detailed results provided by WIN’s

analysts; see Box 2-3.) WIN’s operations and maintenance estimates are directly comparable to CBO’s and fall

within the upper half of the range between the two cases.

Note that because of the nature of the underlying data

sources, CBO’s estimates of future costs, like WIN’s, exclude some investments associated with new customers

and expansion, at least for drinking water. The estimates

for investments in drinking water distribution, which are

based on the analysis by Stratus Consulting, cover only

the cost of replacing the existing infrastructure and exclude the effects of any increases (or decreases) in capacity. The estimates for other categories of investments in

drinking water systems reflect the eligibility criteria used

in EPA’s needs survey and thus include investments to

serve new customers only if those investments are necessary to respond to a public health problem (for example,

bringing service to homes served by contaminated wells)

or if they represent components of projects triggered by

the needs of existing customers (such as increased capacity

14. As Table 2-2 shows, debt service on pre-2000 projects accounts

for roughly one-third of total investment costs in the low-cost

case and one-fifth in the high-cost case.
18 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

7DEOH 

Comparison of CBO’s and WIN’s Estimates of Average Annual Costs, 2000 to 2019

(In billions of 2001 dollars)

Drinking Water Wastewater Total

Investment (Costs as financed)

CBOa 11.6 to 20.1 13.0 to 20.9 24.6 to 41.0

WIN (Calculated by CBO) 21.4 18.9 40.3

Operations and Maintenance

CBOa 25.7 to 31.8 20.3 to 25.2 46.1 to 57.0

WIN 29 24 53

Source: Congressional Budget Office based in part on data from the Water Infrastructure Network.

Note: CBO recalculated WIN’s estimates for investment to convert them to costs as financed.

a. Ranges reflect CBO’s low-cost and high-cost cases.

of a treatment plant due for replacement anyway).15

Those exclusions tend to bias estimated future costs

downward; however, both CBO’s and WIN’s analyses of

the impact of future costs on water systems and ratepayers

also neglect related factors that could increase revenues,

such as population growth and increased reliance on

hookup fees and developers’ contributions.

The Low-Cost and High-Cost Scenarios

CBO’s goal in assembling the assumptions for each

scenario was to choose sets of plausibly (not extremely)

low and high values that have a reasonable chance of

occurring together. The resulting low and high estimates

are thus intended to span most of the distribution of

possible outcomes but not its extreme tails.

In total, 11 assumptions distinguish the low-cost and

high-cost cases from each other or from WIN’s analysis

(see Table 2-4). The three assumptions most responsible

for the difference in estimates of investment costs in

CBO’s scenarios are those concerning the rate at which

drinking water pipes will need to be replaced, the costs

associated with addressing combined sewer overflows

(CSOs), and the potential savings in investment costs

from gains in efficiency. Those assumptions are outlined

here; a more comprehensive discussion of all 11 assumptions is available in Appendix A.

Replacement Rate for Drinking Water Pipes. The aging of

existing water infrastructure is the single largest factor

driving projected increases in investment spending.16 But

how much of the infrastructure will need to be replaced

over the next 20 years is a difficult question. Again, for

purposes of this analysis, CBO assumes that managers

maintain service standards and make efficient choices in

trading off investment and maintenance; clearly, one

could reduce replacement costs over a span of 20 years

by delaying appropriate investments, at the cost of lower

standards of service, excessive maintenance expenditures

in the meantime, or both.

15. The estimates of investment costs for wastewater systems are

probably also incomplete, though in a less systematic way. The

estimates of costs for replacement do not directly include the

incremental costs of any increases in capacity or capability. In

principle, those incremental costs could be reflected in the needs

survey data that underpin the estimates of other costs (because

wastewater projects to serve new customers are eligible for SRF

assistance and are thus covered in the needs survey); as explained, however, it is doubtful that the survey data capture

such costs for the full 20-year period.

16. Of course, such investments cannot always be assigned a unique

cause. For example, some replacements of deteriorated sewer

pipes can be viewed either as triggered by a need to comply with

regulations on sewer overflows or as ordinary replacements of

depreciated capital stock.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 19

%R[ 

The Water Infrastructure Network’s Published Estimates of

Investment Needs and the “Funding Gap”

The Water Infrastructure Network’s (WIN’s) published estimates of total investment needs (capital plus

financing) do not reflect costs as financed: they include

total debt service on new investments from 2000 to

2019, regardless of when those payments occur, rather

than the debt service (on both pre-2000 and new investments) actually paid during the period. The difference is important because the investments financed

from 1980 to 1999 and still being paid off from 2000

to 2019 are smaller than the investments projected to

be financed during the latter period. Therefore, as the

table shows, recalculated to express the costs of investment as financed—the true burden facing water systems and ratepayers during the 20-year period—

WIN’s results drop by 20 percent: from the published

annual average of $50.5 billion (in 2001 dollars) for

both drinking water and wastewater to $40.3 billion.

Not only do WIN’s published estimates not represent

costs as financed, they also do not measure the same

things covered by the Census Bureau’s data on water

systems’ current spending (discussed below in the text).

Thus, subtracting the census data from WIN’s estimates, which WIN did to derive what it termed the

“funding gap,” does not yield an internally consistent

estimate of the difference between current spending

and future needs. In particular, whereas WIN’s projections of needs in any year include all interest paid over

time on that year’s investments, the census data for a

given year include interest payments made in that year

on preexisting debt for drinking water systems and exclude interest on debt for wastewater systems. When

both future investment needs and current spending are

measured in terms of costs as financed, the estimated

funding gap that WIN refers to averages $18.6 billion

per year for drinking water and wastewater combined.1

1. That estimate uses 1999 as the base year for “current” spending,

whereas WIN’s published estimate used 1996. CBO has not

pursued the data far enough to estimate 1996 spending in terms

of costs as financed; doing so would require estimating 1996

debt-service payments on investments going back to 1976 (assuming 20-year borrowing). Nonetheless, it is safe to say that

the funding gap measured in costs as financed would be similar

with 1996 as the base year: costs as financed reflect debt service

on many previous years of investment and thus are a kind of

moving average that smooths out year-to-year changes in

investment volume.

WIN’s Estimates, as Published and in Costs as Financed

(In billions of 2001 dollars)

Drinking Water Wastewater Total

WIN’s Estimates as Published

Total investment 26.3 24.2 50.5

Increase above 1996 level 12.2 13.5 25.7

WIN’s Estimates in Costs as Financed

(Calculated by CBO)

Total investment 21.4 18.9 40.3

Increase above 1999 level 9.4 9.2 18.6

Memorandum:

CBO’s Range of Estimates

Total investment 11.6 to 20.1 13.0 to 20.9 24.6 to 41.0

Increase above 1999 level -0.2 to 8.3 3.2 to 11.1 3.0 to 19.4

Source: Congressional Budget Office based in part on Water Infrastructure Network, Clean and Safe Water for the 21st Century: A Renewed Commitment to

Water and Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).
20 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

7DEOH 

Assumptions Used in CBO’s and WIN’s Analyses

CBO’s Assumptions

 Low-Cost Case High-Cost Case WIN’s Assumptions

Capital Factors

Savings from Increased Efficiency in

Investment by Drinking Water and

Wastewater Systems (Percent) 15.0 5.0 0

Drinking Water Systems

Annual percentage of pipes replaced 0.6 1.0 1.0

Average annual cost for regulations

not yet proposed

(Billions of 2001 dollars) 0 0.53 0

Wastewater Systems

Annual percentage depreciation 2.7 3.3 3.3

Share of investments in EPA’s needs 

survey for replacing existing capital 

(Percent) 25.0 15.0 20.5

Average annual cost for abating

combined sewer overflows

(Billions of 2001 dollars) 2.6 5.4 2.6

Financing Factors

Real Interest Rate (Percent) 3.0 4.0 3.0

Repayment Period 30 years 25 years 20 years

Pay-As-You-Go Share of Total Investment

(Percent) 15.0 30.0 25.0

Average Annual Debt Service on Pre-2000

Investments (Billions of 2001 dollars) 8.7 8.7 9.5

Operations and Maintenance Linear extrapolation

of 1980-1998 trend,

less 20 percent 

efficiency savings

phased in from 

1995 to 2004

Linear extrapolation

of 1980-1998 trend

Drinking water: Linear 

extrapolation of 1985-

1994 trend, apparently

less 20 percent 

efficiency savings 

phased in from 

1997 to 2006

Wastewater: Linear 

extrapolation of 1972-

1996 trend per unit of

net capital stock, less 

20 percent efficiency 

savings phased in from

1997 to 2006

Source: Congressional Budget Office based in part on data from the Water Infrastructure Network.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 21

In the case of drinking water pipes, both of CBO’s

scenarios assume replacement rates drawn from the aforementioned study by Stratus Consulting, whose findings

were later incorporated in the WIN coalition’s analysis.

The Stratus study assumed that 1 percent of pipe mileage

is replaced each year on average, and CBO adopted that

assumption in its high-cost case.17 However, that study

also presented a plausible alternative approach in which

a pipe is replaced when its age reaches its service life, and

growth in pipe mileage since 1880 has been proportional

to growth in the U.S. population. On the basis of that

approach, CBO’s low-cost case adopted an average annual replacement rate of 0.6 percent.18

Abatement of Combined Sewer Overflows. After the deterioration of existing infrastructure, regulatory requirements

are probably the second largest factor driving investments

in water systems. Wastewater systems in particular face

major investments to reduce the incidence of sewer overflows—from both combined sewers, which commingle

stormwater with domestic sewage and industrial wastewater, and separate sanitary sewers.19 As noted in Chapter 1, combined sewer systems—found in roughly 900

wastewater systems nationwide, about 4 percent of the

total—frequently exceed their collection and treatment

capacity during periods of heavy rain or snowmelt, discharging the excess flow directly into receiving waters. 

The low-cost case assumes that investments to control

CSOs will total $51.3 billion nationally, as estimated in

EPA’s 1996 Clean Water Needs Survey. That estimate

comes from a top-down statistical analysis, supplemented

by communities’ documentation of specific plans when

available. The analysis assumed that communities would

need to capture and treat 85 percent of their rain and

snowmelt and calculated the cost of constructing basins

and disinfection facilities to do so.

For many communities, however, 85 percent will not be

enough, given their state’s designated uses for water

bodies and associated quality standards. Thus, analysts

generally regard EPA’s estimate of CSO control costs as

too low under current standards.20 For example, the CSO

Partnership—a coalition of communities with combined

sewer systems and firms expert in designing controls—believes that EPA’s estimate is a reasonable one only if states

make wide use of their legal option to revise the standards

but that meeting current standards could cost on the

order of $100 billion.21 CBO adopted that figure in its

high-cost scenario.

17. More precisely, the study assumed a range of annual replacement rates from 0.5 percent to 1.5 percent, averaging 1.0 percent. The study used repeated random sampling from that range

and ranges for other uncertain factors to calculate a probability

distribution for investment costs. Stratus Consulting, Infrastructure Needs for the Public Water Supply Sector, p. 3-9.

18. Under that simple historical approach, annual replacement rates

between 2000 and 2019 would average 0.9 percent if pipes last

50 years, just 0.3 percent if they last 75 years (because it assumes that relatively few pipes were laid during the Depression

and World War II, when the population grew slowly), and

about 0.6 percent if they last 100 years (ibid., p. 3-5). CBO

averaged those three rates to obtain the 0.6 percent rate assumed

in its low-cost case. Each of the three rates is well below the

long-run average set by the inverse of the lifetime (that is, 2.0

percent for 50 years, 1.3 percent for 75 years, and 1.0 percent

for 100 years), indicating that pipe networks remain relatively

young until after 2019. Thus, the approach does not support

the perception of an imminent crisis in drinking water pipes.

19. Although investment costs to address sanitary sewer overflows

are also uncertain, CBO’s two scenarios both use EPA’s estimate

of those costs, largely for lack of information to underpin an

alternative estimate.

20. In some cases, however, emerging innovative approaches that

remove stormwater from the centralized sewer system—such as

decentralized wastewater treatment (which emphasizes reusing

treated flows where practical) and restorative redevelopment

(which reintroduces stormwater to the soil and vegetation)—

might result in costs lower than those reflected in EPA’s estimates.

21. States are authorized to modify the designated uses of and quality standards for their water bodies if they demonstrate that

meeting the old standards is technically infeasible or would have

“substantial and widespread economic and social impacts.” Examples of changes that could reduce costs for addressing CSOs

include allowing a higher number of days that swimming may

be suspended because of elevated bacteria levels; allowing less

stringent standards in the winter when swimming is less popular; and applying water quality standards at the site of human

contact, rather than the site of the discharge from the combined

sewer system.
22 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Efficiency Savings. Many water systems are realizing significant savings in operational and capital costs per unit of

service by focusing on such things as demand management, labor productivity, system consolidation, asset

management, and innovative construction contracting (see

Appendix B).22 However, the amount that systems will

save from efficiency gains over the next 20 years—or

could save, if given the right incentives—is uncertain.

CBO’s low-cost and high-cost cases assume that efficiency

savings reduce future investment by 15 percent and 5 percent, respectively. Those assumptions reflect several types

of indirect or anecdotal evidence—data on potential and

observed savings in O&M costs, estimates of investment

savings from studies of water systems abroad, and individual case studies of domestic systems—and are within the

range cited by some industry experts.23

Evidence that water systems are already reaping savings

in O&M costs and could continue to do so comes from

comparing a consulting firm’s assessments of 97 mediumsized and large water utilities conducted through 1997

with 136 later assessments. In the initial group, potential

savings in operational costs through the use of six types

of best practices averaged 25 percent; for the later group,

the distance from the efficiencies of best practices had

narrowed, averaging only 18 percent.24 Similarly, a 1996

report from the Association of Metropolitan Sewerage

Agencies said that it is “not unusual” for systems that

undertake efficiency initiatives to reap savings of 20 percent to 25 percent in operational costs.25

Fewer data are available on the potential impact of efficiency savings on investment costs. Some of the best evidence comes from overseas. One study of urban water

systems in New South Wales, Australia, estimated potential investment savings of 12 percent to 14 percent within

five years; also, executives from two Australian systems

report anecdotally that they have already realized savings

of 30 percent.26 In the United Kingdom, the latest rates

from the government regulator of water companies assume capital savings averaging 13 percent over five years,

on top of savings already achieved in the past decade.27

Here in the United States, two well-documented examples of innovative contracts giving a single firm the responsibility to design, build, and operate a treatment

plant have yielded estimated savings of about 20 percent

and 40 percent, the latter including discounted O&M

costs (see Appendix B). 

Comparing CBO’s Estimates with Those of Others

One measure of the importance of the above assumptions

is the impact each one would have had on the estimate

of investment costs for drinking water and wastewater

22. For examples of the methods systems are using to identify potential savings, see Terry L. Atherton, “Success Through Mock

Competition,” and Mark Premo, “Rebuilding a Utility with

Employee Involvement and Peer Input,” both in Association of

Metropolitan Water Agencies, Making Waves: Competitiveness

Strategies for Public Water Utilities, vol. 1 (Washington, D.C.:

AMWA, undated).

23. For example, one expert has testified to the Congress that “The

cost profiles of the water and wastewater industries suggest the

potential for cost reductions in the range of five percent or more

in each of the following areas: efficiency practices (planning,

management, and operations), integrated resource management

(supply side and demand side), technological innovation (capital

and operating), and industry restructuring (consolidation, privatization, and market-based approaches)” (emphasis in original). Supplemental answers from Dr. Janice A. Beecher, Beecher

Policy Research, Inc., in Senate Committee on Environment

and Public Works, Subcommittee on Fisheries, Wildlife, and

Water, Water and Wastewater Infrastructure Needs, Committee

Print 107-316 (March 27, 2001), p. 95. Of course, some of

those categories would apply more to operational costs than to

capital costs.

24. Personal communication with Alan Manning, EMA Associates.

25. Association of Metropolitan Sewerage Agencies, in collaboration

with Apogee Research, Inc., Evaluating Privatization: An AMSA

Checklist (Washington, D.C.: AMSA, 1996), p. 11.

26. Halcrow Management Sciences Limited, New South Wales Water Agencies’ Review: Summary (December 1999), p. 53, available from the Independent Pricing and Regulatory Tribunal at

www.ipart.nsw.gov.au under “What’s New–Updates,” January

28, 2000; and personal communication with Claude Piccinin,

Deputy Executive Director, Water Services Association of Australia, July 26, 2001.

27. Office of Water Services, Final Determinations: Future Water

and Sewerage Charges 2000-05 (undated), p. 98, available at

www.ofwat.gov.uk/final_determinations.htm.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 23

systems if it had been used individually in WIN’s analysis.

For example, if that analysis had used 0.6 percent instead

of 1.0 percent for the average annual rate of replacement

for drinking water pipes, as in CBO’s low-cost case,

WIN’s estimate in costs as financed would have been

reduced by $5.4 billion per year (see Table 2-5). Thus,

that factor alone accounts for more than one-third of the

total difference between the estimates from WIN’s

analysis and CBO’s low-cost case. Conversely, the higher

costs for abating combined sewer overflows assumed in

CBO’s high-cost case would have raised WIN’s estimate

of average annual costs by $2.2 billion. CBO’s assumptions about efficiency would also have had significant

impacts: the assumed savings of 5 percent to 15 percent

would have reduced estimated annual costs by $1.5 billion to $4.6 billion.

Despite some different assumptions, CBO’s estimate

from its high-cost case is very close to WIN’s because savings from a longer borrowing term, on old debt service,

and from efficiency are almost entirely offset by larger

costs to address combined sewer overflows, to fund to in7DEOH 

Contributions of Individual Assumptions to Differences Between

CBO’s and WIN’s Estimates

(In billions of 2001 dollars per year)

Low-Cost Case High-Cost Case

WIN’s Estimate (one case) 40.3 40.3

CBO’s Estimate 24.6 41.0

Difference to Be Explained (WIN minus CBO) 15.7 -0.7

Capital Factors

Savings from Increased Efficiency by Drinking Water and Wastewater Systems 4.6 1.5

Drinking Water Systems

Annual percentage of pipes replaced 5.4 n.a.

Average annual cost for regulations not yet proposed n.a. -0.4

Wastewater Systems

Depreciation rate 0.8 n.a.

Share of investments in EPA’s needs survey for replacing existing capital 0.5 -0.6

Average annual cost to control combined sewer overflows n.a. -2.2

Total Savings from Capital Factors 11.4 -1.7

Total Capital Savings, Including Interactions 10.4 -1.7

Financing Factors

Real Interest Rate n.a. -2.0

Repayment Period 5.0 3.0

Pay-As-You-Go Share of Total Investment 1.2 -0.6

Average Annual Debt Service on Pre-2000 Investments 0.8 0.8

Total Savings from Financing Factors 7.1 1.3

Total Financing Savings, Including Interactions 7.8 1.1

Source: Congressional Budget Office.

Notes: n.a. = not applicable (when assumptions do not differ from WIN’s).

Because of interaction effects, the sum of the dollar impacts from each assumption individually—or from all capital factors and all financing factors—does

not equal the overall difference between CBO’s and WIN’s estimates. For example, the impact of investment efficiencies is smaller when the rate of investment

is reduced by lower rates of depreciation and replacement.
24 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

7DEOH 

Estimates of Average Annual Capital Costs for Investment in Water Systems,

2000 to 2019

(In billions of 2001 dollars)

Drinking Water Wastewater

CBOa 12.0 to 20.5 14.9 to 22.3

Water Infrastructure Network 20.9 19.2

Environmental Protection Agency

Clean Water Needs Surveyb

As published n.a. 7.3

Adjusted for more recent estimate of costs to control sanitary sewer overflows n.a. 11.4

Drinking Water Infrastructure Needs Surveyc

As published 8.0 n.a.

Adjusted for estimated underreporting 11.1 n.a.

American Water Works Associationd 8.5 n.a.

Sources: Congressional Budget Office; Environmental Protection Agency, Office of Water, 1996 Clean Water Needs Survey: Report to Congress, EPA 832-R-97-003

(September 1997); Environmental Protection Agency, Office of Water, Drinking Water Infrastructure Needs Survey: Second Report to Congress, EPA 816-R97-003 (February 2001); American Water Works Association, Reinvesting in Drinking Water Infrastructure: Dawn of the Replacement Era (Denver,

Colo.: AWWA, May 2001); Water Infrastructure Network, Clean and Safe Water for the 21st Century: A Renewed National Commitment to Water and

Wastewater Infrastructure (Washington, D.C.: WIN, April 2000).

Note: n.a. = not applicable.

a. Ranges reflect CBO’s low-cost and high-cost cases.

b. Estimate for 1996 through 2015.

c. Estimate for 1999 through 2018.

d. Estimate for 2000 through 2029.

vestments in wastewater systems for purposes other than

replacing existing infrastructure, and to meet drinking

water standards, along with a higher interest rate and

larger paygo share. In contrast, CBO’s low-cost case differs sharply from WIN’s largely because of the replacement rate assumed for drinking water pipes, the assumed

savings from efficiency, and the longer borrowing term;

other assumptions, such as a smaller paygo share and

lower estimate of old debt service, have smaller but still

significant effects.

Evidence from the available bottom-up studies—EPA’s

needs surveys and the American Water Works Association’s study of 20 systems—does not support estimates

of the magnitude produced by CBO’s high-cost case and

WIN’s analysis. Indeed, estimates from the bottom-up

studies are well below those from CBO’s low-cost case

(when expressed in comparable terms). Specifically, EPA’s

survey estimated average annual capital (that is, real resource) costs of $8.0 billion for drinking water, and

AWWA’s study put that figure at $8.5 billion. For wastewater, EPA’s figure was $7.3 billion. By comparison,

CBO’s estimates of real resource costs in the low-cost case

are $12.0 billion for drinking water and $14.9 billion for

wastewater (see Table 2-6). The estimates based on EPA’s

surveys remain somewhat lower even after (perhaps incomplete) adjustments to better capture investment needs

over the full 20-year horizon, which raise the figure for

drinking water to $11.1 billion and the figure for wastewater to $11.4 billion.28

28. The adjustment for drinking water systems applies the percentage amount of underreporting that EPA found in follow-up

visits to 200 medium-sized and large systems after the 1995

needs survey. The adjustment for wastewater systems substitutes

EPA’s later model-based estimate of costs to address SSOs for

the estimates from the survey—specifically, those for projects to

prevent inflows and infiltration and to replace or rehabilitate

sewers.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 25

For O&M costs, the differences between CBO’s and

WIN’s estimates involve fewer factors. The approach that

CBO used in its low-cost case to estimate O&M costs for

drinking water systems is essentially the same as WIN’s,

differing only in extrapolating from 19 years of data

instead of 10 and phasing in the assumed 20 percent

efficiency savings two years sooner. Those factors account

for a minor part of the difference in the two estimates;

most appears to reflect differences in data sources.29 For

wastewater systems, one additional difference between

CBO’s low-cost case and WIN’s analysis is that the latter

extrapolates the trend in the ratio of O&M to capital

stock, not in O&M itself (see the discussion in Appendix A). For both drinking water and wastewater, CBO’s

high-cost case estimates exceed WIN’s because they assume no efficiency savings (beyond those already reflected

in the 1980-1999 trend).

Comparing Current Spending

and Future Costs

Large future investment costs are relevant to policymakers

primarily because of the prospect that they will require

large increases above current investment levels and hence

large increases in the rates charged to households and

other water users. WIN’s report, EPA officials, and water

industry representatives have referred to the difference

between current (or recent) spending and future costs as

a “funding gap.” But the difference does not reflect the

ability of local water systems to generate additional resources on their own to pay for increased future investment, so it does not reflect a gap that can only be filled

by federal funds.

CBO estimates that investment spending in 1999 was

$11.8 billion for drinking water and $9.8 billion for

wastewater (in 2001 dollars). Those figures are estimates

because the available data do not measure spending in

terms of costs as financed. The most comprehensive data,

from the Census Bureau’s annual surveys of state and

local government finances, show total capital outlays

(whether financed through borrowing or paid from funds

on hand) for both drinking water and wastewater systems

and interest payments for drinking water systems. Thus,

the census data do not capture costs as financed because

they lack information on interest payments for wastewater

systems (which the survey classifies as municipal departments, not utilities) and because they include the capital

costs for new financed investments rather than the current principal payments made on past investments.

CBO’s estimates of 1999 baseline spending for drinking

water and wastewater combined include estimates of

spending on new paygo investments and on debt service

for earlier investments financed through borrowing. CBO

calculated the former as an assumed share of all investments made in 1999; the latter reflects assumptions regarding interest rates and paygo shares from 1979

through 1998.30 (CBO used the same approach to estimate the future costs of debt service on pre-2000 investments; see Appendix A for details.) The resulting estimates

are necessarily somewhat uncertain, given the large number of assumptions involved.

Those estimates of 1999 spending imply that future investment costs represent an annual average increase for

drinking water and wastewater systems combined of $3.0

billion under the low-cost case and $19.4 billion under

the high-cost case (see Table 2-7). The former figure

represents just 14 percent of the current financial burden

of water investments. That result is contrary to the conventional wisdom that the nation’s water systems will

soon be straining to fund a large increase in investment,

but CBO considers it reasonable, given the uncertainty

about how soon existing infrastructure will need replace29. For example, whereas CBO took the data it used to convert

nominal O&M spending to 2001 dollars from the GDP price

deflator, WIN appears to have used the Engineering NewsRecord’s Construction Cost Index, which both WIN and CBO

used for capital spending.

30. CBO’s analysis also involved scaling up the census data on investments in drinking water systems by 15 percent to capture

spending on privately owned systems. For lack of information,

however, CBO did not adjust the data downward to omit investments to serve future growth. As noted above, growthrelated investments are excluded from EPA’s needs survey and

thus from CBO’s estimates of future investment costs; consequently, their inclusion in the census data lends a downward

bias to CBO’s projections of the difference between current

spending and future costs. WIN’s analysis of baseline spending

made those same choices.
26 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

7DEOH 

Estimates of the Difference Between 1999 Spending and Future Costs

for Investments in Water Systems

(In billions of 2001 dollars per year)

Drinking Water Wastewater Total

CBOa

Future costs 11.6 to 20.1 13.0 to 20.9 24.6 to 41.0

1999 spending 11.8 9.8 21.6 

Difference - 0.2 to 8.3 3.2 to 11.1 3.0 to 19.4

WIN (Costs as financed)

Future costs 21.4 18.9 40.3

1999 spending (Approximate) 12.0 9.7 21.7

Difference 9.4 9.2 18.6

Source: Congressional Budget Office.

Note: The figures for 1999 spending are estimates, reflecting assumptions about debt service payments on investments from earlier years. For the purpose of comparison,

CBO recalculated WIN’s results in terms of costs as financed and approximated WIN’s estimate of 1999 spending. 

a. Ranges reflect CBO’s low-cost and high-cost cases.

ment, the prospects for increased efficiency, and the potential for water systems to fund more of their investment

through borrowing and to borrow for longer terms. In

contrast, the $19.4 billion difference estimated under the

high-cost case, which CBO considers equally possible,

nearly matches the current financial burden of investments in water systems. 

Expressed in costs as financed, WIN’s results show a difference between 1999 spending and average future costs

of $9.4 billion for drinking water and $9.2 billion for

wastewater (see Table 2-7).31 Again, the implied estimates

from WIN’s analysis are close to those from the high-cost

case and much larger than those from the low-cost case

(while significantly below WIN’s published figures,

shown in Box 2-3 on page 19). The main novelty here is

that subtracting baseline spending makes the differences

between WIN’s estimates and CBO’s larger in relative

terms.

The Impact of Projected Water Costs

on Households’ Budgets

Ultimately, individuals bear the costs of investments in

water systems and expenditures for O&M—directly

through households’ drinking water and wastewater bills

and indirectly through the prices they face for goods and

services produced using water and through local, state,

and federal taxes supporting water systems. The distribution of costs among individuals depends on their water

use, their system’s characteristics (including rate structures and external funding), their consumption of waterintensive goods and services, and their tax bills.

Given the availability of data on households’ water bills,

but not on indirect expenditures on water through taxes

and consumption of other goods and services, CBO has

analyzed the impact that projected levels of investment

and O&M spending would have on households’ budgets

in the absence of increased support from taxpayers. For

simplicity, the analysis assumed that all residential, com31. CBO did not obtain enough information to directly calculate

WIN’s estimate of 1999 debt service, a key component of baseline spending in terms of costs as financed. Instead, CBO approximated WIN’s estimate by using a proxy model based on

WIN’s methods and assumptions. To improve the approximation, CBO adjusted the proxy model’s estimate of 1999 debt

service in proportion to the difference between WIN’s known

estimate of average annual debt service from 2000 to 2019 and

the corresponding estimate from the proxy model.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 27

%R[ 

CBO’s Analysis of Household Water Bills

CBO’s data come from the quarterly responses of approximately 2,800 households participating in the

national Consumer Expenditure Interview Survey,

carried out by the Bureau of the Census under contract

with the Bureau of Labor Statistics. Households in

CBO’s sample began their yearlong participation in the

survey no earlier than the third quarter of 1997 and no

later than the second quarter of 1998. To obtain

national-level results, CBO weighted the data to adjust

for the fact that not all surveyed households participated for the full course of a year.

Participants report “cash” income from all sources, including food stamps. To guard against an overly conservative estimate of the proportion of household income spent on water bills, CBO incorporated all

incomes as reported to the Consumer Expenditure

Survey even though 3 percent of households in the

sample have an annual income of less than $5,000 and

a small fraction have large negative incomes. Some

analysts question the reliability of such reported incomes because expenditures by those households often

exceed their pretax income.1

1. Geoffrey D. Paulin and David L. Ferraro, “Imputing Incomes

in the Consumer Expenditure Survey,” Monthly Labor Review,

vol. 117, no. 12 (December 1994), pp. 23-31.

Participants also report water expenditures on the basis

of bills received exclusively for drinking water and

sewer services. For the 39 percent of respondents not

reporting their own water bills, CBO imputed their

expenditures by using the average values of water bills

from reporting households in comparable income

classes. Those income classes covered $10,000 segments

up to $100,000; the last income class consisted of

households earning at least $100,000. Again, that

imputation errs on the side of overstating the share of

household income spent on water since most nonreporting households are probably apartment dwellers

who do not receive separate water bills. Water use per

capita is generally lower in multifamily units, which,

compared with single-family homes, tend to have fewer

water-using appliances and to share landscaping and

swimming pools.2

2. Duane D. Baumann, John J. Boland, and W. Michael Haneman,

Urban Water Demand Management and Planning (New York:

McGraw-Hill, Inc., 1998).

mercial, and industrial water customers would face the

same percentage increase in their bills, notwithstanding

the fact that investment and O&M requirements vary

among systems.

CBO’s Estimates

CBO estimates that total household water bills represented 0.5 percent of total household income in the late

1990s, when customers paid about $58 billion directly

to water systems (see Box 2-4). To pay for future infrastructure expenditures and O&M costs without increased

support from taxpayers, direct funding from customers

in 2019 would have to reach $84.7 billion in the low-cost

case and $121.9 billion in the high-cost case, implying

average annual rates of increase between 1999 and 2019

of 1.62 percent and 3.48 percent, respectively. Taking

into account projected growth in income over that time,

water bills in 2019 would equal 0.6 percent of national

household income in the low-cost case and 0.9 percent

in the high-cost case.32 The best available data suggest

that such shares would not be high compared with those

in many other industrialized countries (see Box 2-5).

32. The percentages reflect a projected 19.2 percent increase in real

household income between the late 1990s and 2019 on the

basis of CBO’s July 2001 forecast through 2011 for taxable

personal income for earners age 20 and over (with married couples counting as one earner) and the Social Security trustees’

midrange assumptions for population growth. The simple analysis leaves out several factors, including potential changes in the

spread of the income distribution or in the allocation of water

costs between household and other users.
28 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

%R[ 

Water Bills in Various Industrialized Countries

Compared with households in other countries, U.S.

households typically enjoy relatively low-cost water

bills. Without information on household costs associated with tax-financed subsidies for water systems,

international comparisons of drinking water and wastewater costs at the household level are limited to examining bills that users pay for typical quantities of

water services. By that measure, U.S. households’ water

bills as a share of personal financial resources, on average, currently rank third-lowest among those of 16 industrialized countries of the Organization for Economic Cooperation and Development (see the table).

By 2019, under the Congressional Budget Office’s

high-cost case, U.S. households’ average costs (as a percentage of per capita gross domestic product) would

nearly double if the increases in investment and O&M

expenditures were passed along entirely to customers

in their water bills. If households’ water bills in other

countries rose no faster than per capita GDP, the

United States’ ranking would fall from third- to tenthlowest. Even with those assumptions, direct billing for

water services relative to personal financial resources

would still be lower in the United States, on average,

than in France or England.

Households’ Average Bills for Typical Levels of

Water Consumption in OECD Countries in the Late

1990s (Percentage of per capita GDP)

Korea 0.64

Italy 0.72

United States 1.00

Japan 1.04

Turkey 1.32

Belgium 1.44

Sweden 1.48

Spain 1.52

Denmark 1.60

Australia 1.72

Finland 2.16

France 2.20

England and Wales 2.28

Netherlands 2.52

Czech Republic 3.84

Hungary 6.20

Source: Congressional Budget Office based on Organization for Economic

Cooperation and Development, Environment Directorate, Environment Policy Committee, Household Water Pricing in OECD Countries, ENV/EPOC/GEEI(98)12/FINAL (Paris: OECD, May 1999).

Note: The table reflects the best indicator of households’ water bills that

CBO can construct, given limitations on international data. It draws

on two data sources that incorporate information from different

years. The first reports 1996 data on average drinking water charges

for a household using 200 cubic meters of water per year relative

to per capita GDP; the second reports average drinking water and

sewer charges per cubic meter for a year between 1994 and 1999,

depending on the most recent data available for each country.

However, shares of income nationwide can obscure important differences among households and thus shed only

limited light on the argument, made by advocates of increased federal aid for investment in water systems, that

rising costs will make bills unaffordable for some households.33 Certainly, households at different income levels

1990s was 0.98 percent, meaning that half of all households spent

less than that amount and the other half spent more. Another summary measure—the average of the individual household shares—

cannot be calculated in a nonarbitrary way because of the very

small, zero, and negative incomes reported by some surveyed households (see Box 2-4). One arbitrary approach is to cap all shares at

some maximum level; with a cap of 10.1 percent, the average

household share becomes 1.6 percent. Another way is to ignore the

data from all households reporting zero or negative income; under

that approach, which accepts all small but positive incomes as accurate, the average share is 4.8 percent.

33. Other summary measures of water costs consider the share of

income spent by individual households. For example, the

median share of income spent on water services in the late

 
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 29

7DEOH 

Percentage Shares of Households’ Average Expenditures 

in the Late 1990s, by Category

Annual Household Expenditures (Thousands of dollars)

Under

10 10 to 20 20 to 30 30 to 40 40 to 90

Over

90

Water and Sewer 2.49 1.67 1.27 1.09 0.80 0.56

Other Utilities 10.75 8.62 7.39 6.70 5.24 3.74

Shelter, Household Operations, and Supplies 34.86 35.05 30.63 28.75 26.48 26.68

Food 20.97 17.31 15.50 14.59 12.35 10.13

Health Care 6.70 7.43 5.76 5.52 4.21 3.16

Other Identified Expendituresa 24.41 29.33 35.65 37.24 41.68 40.41

Taxes (Nonproperty) -0.19 0.60 3.80 6.11 9.25 15.33

Total for Identified Expenditures 100 100 100 100 100 100

Source: Congressional Budget Office based on data from Bureau of the Census, Consumer Expenditure Interview Survey, third quarter 1997 through first quarter 1999.

a. Apparel and personal care, transportation, personal insurance and pensions, recreation, entertainment, alcohol, smoking, education and reading, and cash contributions.

devote different proportions of their total spending to

water services—as they do to other utilities, food, medical

care, and housing. For example, households with total expenditures under $10,000 devoted an average of 2.5 percent to water bills in the late 1990s and thus would generally have to adjust more to accommodate rate increases

than would households with expenditures of, say, over

$90,000, which devoted an average of just 0.56 percent

to water bills (see Table 2-8).34 For comparison, the share

of total spending going to everything other than food,

housing, medical care, utilities, and taxes averages 22 percent for the former group and 40 percent for the latter.

Of course, the share of a household’s income spent on

water bills also depends on its water use and local rates.

Sorting individual households specifically by the share of

income going to water bills, CBO found that in the late

1990s, half of all households spent 1 percent of income

or less for water services, while others spent significantly

more (see Figure 2-1).35

Distributions such as those CBO found can be characterized in many ways, emphasizing different features. One

measure that has received significant attention is the fraction of households billed more than 4 percent of income

for their water services—but that is simply one of many

potential summary measures. Four percent has no particular economic significance as the point at which households’ water bills become “unaffordable.” (For the origin

of the 4 percent measure, see Appendix C.)

34. To avoid the problems associated with the very low and negative

income reported by some households in the survey, Table 2-8

compares spending in each category not to income but to total

spending. For households that are net savers, water bills represent a larger share of spending than of income; for households

that are net borrowers, the opposite is true.

Households’ adjustments to higher rates would reflect not only

their income and expenditures but also their potential for reducing water use. A 1984 assessment of 50 peer-reviewed studies

concluded that a 10 percent increase in price, with everything

else unchanged, would prompt a 2 percent to 4 percent decline

in residential water demand. John J. Boland, Benedykt

Dziegielewski, Duane D. Baumann, and Eva M. Opitz, Influence of Price and Rate Structures on Municipal and Industrial

Water Use, Institute for Water Resources Report 84-C-2 (Fort

Belvoir, Va.: U.S. Army Corps of Engineers, 1984).

35. The figure treats households that reported zero or negative income as spending more than 10 percent of their income for

water.
30 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills in the Late 1990s

Percentage of Income

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills Under the Low-Cost Case, 2019

Percentage of Income

1 2 3 4 5 6 7 8 9 10 More 0

10

20

30

40

50

60

Bills Under the High-Cost Case, 2019

Percentage of Income

than 10

than 10

than 10

)LJXUH 

Water Bills as a Share of Household Income

(Percentage of U.S. households)

Source: Congressional Budget Office.
CHAPTER TWO ESTIMATES OF FUTURE INVESTMENT COSTS AND THEIR IMPLICATIONS 31

However, using that particular measure, CBO estimates

that in the late 1990s, 7 percent of U.S. households spent

more than 4 percent of their income on water; an additional 16 percent spent more than 2 percent. Twenty-five

percent spent less than 2 percent but more than 1 percent, and 51 percent spent no more than 1 percent.36

The distribution in the late 1990s represents a modest

shift from the late 1980s, when only 4.7 percent of U.S.

households were spending over 4 percent of their income

on water bills. In 2019, given uniform increases in

charges associated with CBO’s low-cost and high-cost

estimates, 10 percent to 20 percent of U.S. households

might be spending more than 4 percent of their income

on bills for the services they now use; an additional

19 percent to 23 percent might be spending more than

2 percent.

Comparing CBO’s and WIN’s Estimates

Compared with CBO, WIN found water bills accounting

for a much larger share of household budgets, both now

and in the future. The coalition’s estimate that 18 percent

of U.S. households spent more than 4 percent of their

income on water bills in 1997 is more than twice as high

as CBO’s estimate of 7 percent. WIN projected that

22 percent of households would spend over 4 percent of

their income on water bills by 2009 (halfway through the

2000 to 2019 study period) and stated that a third or

more of the population would have bills reaching that

level as costs continued to rise.37

The discrepancy between CBO’s estimate for the late

1990s and WIN’s for 1997 apparently exists because

WIN did not analyze actual bills based on water use by

individual households as CBO did. Instead, WIN calculated households’ water bills using data on Ohio systems’ 1997 charges for the equivalent of 250 gallons per

day.38 (The other possibility would be that WIN’s estimates of household income were lower than CBO’s, but

comparing average income by percentile across WIN’s

and CBO’s data sources suggests that household income

was higher in WIN’s analysis.) The accuracy of WIN’s

results rests on the extent to which households’ water bills

nationally can be characterized using only data on charges

for consumption of 250 gallons per day in Ohio. If, for

example, low-income households tend to use less water

than that, then, other things being equal, WIN’s estimates overstate the number of households with water bills

claiming more than 4 percent of their income.39

36. The distribution appears to be similar for urban and rural areas.

For example, CBO estimates that 7 percent of urban households

and 8 percent of rural households were paying more than 4 percent of their income for water bills. However, the urban-rural

comparison is hampered by the large share (47 percent) of rural

households that did not report water bills. Since CBO imputed

spending for nonreporters using average bills of all rural and

urban households with similar income, estimated bills for rural

households may be too low if actual bills for rural nonreporters

exceeded the imputed averages. Alternatively, estimated bills for

rural households may be too high if the imputed costs exceeded

the actual costs—if, for example, many of the rural nonreporters

used private wells and septic tanks.

37. Water Infrastructure Network, Clean and Safe Water for the 21st

Century, pp. 3-4 and 3-5.

38. Although WIN’s Clean and Safe Water for the 21st Century report states that its analysis is based on “individual fees (not average),” it is actually based on the 1997 rates that Ohio households would have faced if they used the equivalent of 250 gallons per day, according to Ken Rubin of PA Consulting.

39. WIN considered Ohio households’ expenditures for drinking

water and wastewater services (relative to income) as representative of such expenses nationwide because in the 1990 census

such data on spending for drinking water in that state matched

well with the information for the United States as a whole. (The

1990 census data do not include wastewater expenditures.)
CHAPTER



Options for Federal Policy

)ederal intervention in drinking water and wastewater markets may be designed to serve various purposes,

such as protecting the environment or ensuring that

drinking water meets certain standards everywhere in the

country. All such policy objectives can be viewed as efforts

to increase the cost-effectiveness of providing and using

water or to achieve a certain distribution of the benefits

and costs.

Economic principles suggest that federal action may be

able to increase cost-effectiveness when other entities do

not have adequate incentives to account for the extrajurisdictional, or “spillover,” effects that their decisions have

on third parties. For example, standards for wastewater

treatment may improve cost-effectiveness by reducing costs

to downstream users by more than the costs of treatment.

However, whether current standards established under

the Clean Water and Safe Drinking Water Acts are consistent with the economically efficient use of society’s resources is an important question that is outside the scope

of this study.

A main opportunity for federal involvement that may improve cost-effectiveness is sponsoring research and development (R&D). Private firms and state governments that

may fund R&D for water systems have little incentive to

consider the spillover benefits that would accrue to other

parties and thus are likely to forgo some research opportunities that would be worthwhile from the national

perspective.1

Federal intervention in water markets can also be intended

to serve distributional purposes—to shift costs from people

who have low income, use a lot of water, or are served by

high-cost systems to people who have high income, use

relatively little water, or are served by low-cost systems.

The drawback of such interventions through federal

funding and tax preferences, however, is that they generally

distort prices and thereby undermine incentives for costeffective actions by producers and consumers of water

services. Eliminating the distortions could lower total

national costs: without federal support, the prospect of

rising costs and accountability to ratepayers would give

managers of water systems strong incentives to look for

ways to control costs in both their operational and investment choices. Similarly, the increased rates themselves,

better reflecting the true costs of water services, would tend

to encourage water users to adjust their behavior—for example, to use less water or to pretreat industrial wastewater

—in order to cut costs.

Both the distributional effects of subsidies for water services and the extent of their adverse impact on incentives

for cost-effective actions depend on the subsidies’ level

and form. To preserve incentives for cost-effective actions

by water systems and users, the Congress could pursue

policies that redistribute income—such as aid to water

systems based on a predetermined formula not tied to current investments or direct subsidies to needy households

for a basic level of water use—rather than policies that distort the price of water, such as the present subsidies for

investment in infrastructure.

1. See Congressional Budget Office, “Investing in Physical Capital

and Information,” in Budget Options (February 2001). Even

broad-based coalitions may not be able to support the appropriate level of research through coordinated voluntary contributions.
34 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Federal Support for Research and

Development and Its Implications

Technical R&D into new pipe materials, construction and

maintenance methods, and treatment technologies can

lead to significant savings. One of the many successful innovations that could be cited here is pipe bursting, a

method for replacing pipes that does not require trenches

to be cut along the entire length of the replacement. Instead, using a single access point, the construction crew

sends equipment into a section of pipe to burst it from

within and feeds a flexible new pipe in to take its place.

By using pipe bursting, the drinking water system in

Columbus, Georgia, reduced its costs for replacing water

mains by an estimated 25 percent.2

 A less tested but promising technology for wastewater treatment, supercritical

water oxidation, could achieve superior environmental

results and reduce operating costs by one-third, according

to one study. Capital costs could be somewhat higher than

those for existing technologies but might fall as the

method is further developed or used at larger scales.3

Despite the potential for technological progress to provide

cost savings, the level of R&D spending on drinking water

and wastewater currently seems low compared with that

for electrical power according to the limited data available.

The combined budgets of the American Water Works

Association Research Foundation (AWWARF) and the

Water Environment Research Foundation (WERF), the

main research organizations for the drinking water and

wastewater industries, are on the order of $25 million per

year. That amount represents roughly 0.05 percent of current spending for investment in water systems and their

operations and maintenance. In contrast, spending in 2000

by the Electric Power Research Institute was 0.14 percent

of total electricity sales (which roughly corresponds to

spending on investment and O&M). The Environmental

Protection Agency funded an additional $7 million of

R&D in 2002, excluding grants to AWWARF and

WERF.4

To try to speed the development and adoption of less

costly materials and methods, the federal government

could increase its financial support of technical R&D. The

increase could take the form of additional research projects

managed by EPA, larger federal grants to private organizations such as AWWARF and WERF, or both. One

specific proposal, advanced by the Water Infrastructure

Network coalition, calls for federal funding of $250 million per year for a new Institute of Technology and Management Excellence.5

 As the name suggests, that institute

would support not only technical R&D but also the dissemination of good management practices.

While additional federal funding for R&D may have the

potential to lower total national costs for water services,

in practice it may be difficult to determine an appropriate

increase, since the line between a useful response to a

market failure and a wasteful subsidy is not always clear.

Federal funding may be subject to various influences not

related to the cost-effective provision of water services and

may allow others to reduce their own research funding.

Thus, a compelling case for increased appropriations for

water research cannot rest at the theoretical level but must

include the details of the proposed uses of the additional

funds and the capabilities of other funders.

In many cases, the key to improving the cost-effectiveness

of a particular drinking water or wastewater system may

lie not in developing new technologies but in improving

the way system managers deploy existing and emerging

technologies. Notwithstanding important differences in

local conditions that are beyond managerial control, it is

clear that some systems operate less efficiently than others,

whether because of ignorance, system-level problems (such

2. Steve Allbee, Environmental Protection Agency, “The Infrastructure Investment Gap Facing Drinking Water and Wastewater Systems” (speech to the Association of Metropolitan

Water Agencies, St. Pete Beach, Fla., October 24, 2000).

3. “New Wastewater Treatment Good for the Environment,”

WaterTechOnline, October 9, 2001, available at www.water

techonline.com/news.asp?mode=4&N_ID=26205.

4. Personal communication with Terry Grindstaff, EPA, September 27, 2002. The figure includes $6.2 million for research on

drinking water treatment and $0.7 million on wastewater treatment.

5. Water Infrastructure Network, Water Infrastructure Now: Recommendations for Clean and Safe Water in the 21st Century (undated), available at www.win-water.org, p. 12.
CHAPTER THREE OPTIONS FOR FEDERAL POLICY 35

as poor leadership, featherbedding, or operation on a small

scale), or simply a lack of concern over current water costs.

As noted in Chapter 2, according to recent assessments

of 136 systems, the industry is becoming more efficient

but still could reduce operating costs by an average of

18 percent through more widespread use of “best practices.”6

Of course, rising costs for investment and O&M can be

expected to motivate system managers to acquire knowledge and overcome local constraints in order to reduce

the pressure for higher rates. So whether federal support

for the dissemination of information on best practices

could further improve systems’ efficiency is unclear.

Federal Support for Infrastructure

Investment and Its Implications

Through different spending programs, including the state

revolving funds, federal funds paid for about 11 percent

of the nationwide investment in water infrastructure in

1999, and federal tax preferences provided a subsidy equivalent to perhaps 3 percent more. Again, Congressional

action to increase such support would affect both the

national costs for water services and the distribution of

those costs, but the specific effects would depend on

choices about the amount of the increase, the degree of

targeting to particular categories of water systems, and the

mechanisms used to provide the support. Similarly, the

effects of cutting back federal assistance would depend

on the details of the cuts.

Current Federal Support for Water Systems

As noted in Chapter 1, the federal government supports

investment in water infrastructure through a variety of

spending programs and, to a lesser extent, through tax

preferences. Small and disadvantaged communities benefit

disproportionately from the spending, through either explicit targeting at the federal level or states’ allocations of

loans from the revolving funds. In contrast, larger communities (which can access the municipal bond market

more easily) are the primary beneficiaries of the tax preferences. Privately owned water systems have less access to

federal support than their publicly owned counterparts

do (see Box 3-1).

Federal tax law aids investment in water systems primarily

through the general exemption of interest on municipal

bonds, which makes the bonds more attractive to buyers

and thus reduces the interest rates that water systems must

offer. The exemption applies to personal and corporate

income taxes but not to the alternative minimum tax

(AMT) for corporations; firms that pay the AMT must

include interest on the bonds in calculating their “adjusted

current earnings,” which effectively makes 75 percent of

the interest subject to that tax. Two other provisions of

the federal tax code related to municipal bonds also help

water systems: bond issuers can keep some arbitrage profits

(made by reinvesting bond proceeds at a higher interest

rate) and can refinance the bonds up to 90 days before

redeeming the original debt.7

 The Joint Committee on

Taxation estimated that the interest exemption and related

provisions saved bondholders $0.6 billion in 1999 on

bonds issued for both municipal and privately owned

water systems and hazardous waste facilities.8

 That figure,

including the unknown but relatively small share associated with hazardous waste facilities, corresponds to roughly 3 percent of the investment in water systems in 1999,

the latest year for which data are available.

Federal spending programs support water infrastructure

in several ways, including direct grants for investment

projects, capitalization grants to the SRFs, and credit subsidies in the form of loans and loan guarantees. On the

6. Personal communication with Alan Manning, EMA Associates.

7. To keep any arbitrage profits, systems must spend the bond

proceeds within four phased deadlines over two years. Also, they

can use the “advance refunding” option only once for each original bond issue.

8. Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 1999-2003, staff report JCS-7-98 (December 14, 1998), p. 16. This figure covers bonds backed by water

systems’ revenues but not municipal “general obligation” bonds.

Note that the committee’s estimate of the “expenditure” associated with a tax preference is somewhat larger than the corresponding estimate of the increased federal revenue associated

with eliminating it: the former takes the existing level of the

taxed activity as given and thus does not reflect behavioral adjustments that taxpayers would make if the preference was

changed.
36 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

%R[ 

Federal Support of Privately Owned Water Systems

The large majority of households are served by publicly

owned, or municipal, drinking water and wastewater

systems. Although nearly half of all community drinking

water systems are privately owned, they reach only about

15 percent of the households served. Roughly 20 percent

of wastewater systems that treat household sewage are

privately owned, but they serve only about 3 percent

of households.1

 Various federal and state restrictions

limit private systems’ access to federal aid provided

through the state revolving fund (SRF) programs and

to federal tax preferences.

Private wastewater systems are not eligible for loans from

SRFs, and although private drinking water systems are

eligible under federal law, they may be blocked by

provisions in some states’ constitutions. In other states,

private systems’ access to SRF loans can be inhibited

simply because the states leverage their SRF money. If

enough of the proceeds from bonds issued to leverage

SRF money are used to make loans to private systems,

the bonds are considered private activity bonds (PABs),

which are subject to several restrictions.2

The most important of those restrictions is the cap on

each state’s annual volume of tax-exempt PABs. Federal

tax law sets the limits at the greater of $75 per resident

of the state or $225 million in calendar year 2002, after

which those figures will be indexed for inflation. To

date, the limits have restrained the issuance of PABs in

1. The estimate of 3 percent is commonly cited within the industry,

but precise data on the households served by private wastewater

systems are not readily available.

2. See Environmental Protection Agency, Environmental Financial

Advisory Board, Funding Privately Owned Water Providers

Through the Safe Drinking Water Act State Revolving Fund (July

1998). Private activity bonds are those for which 10 percent or

more of the proceeds are used directly or indirectly by a nongovernmental entity and 10 percent or more are secured directly

or indirectly by property used in a trade or business. Formally,

the definition applies to both taxable and tax-exempt bonds;

typically, however, the term “private activity bond” is used to

refer to the latter.

most states.3 And within those limits, water systems’

needs compete for allocations against many other purposes, such as housing, industrial development, student

loans, mass commuting facilities, and local electricity

and gas facilities. Indeed, all “exempt facilities”—the

subset of eligible facilities or purposes that includes

water infrastructure—accounted for less than 10 percent

of PABs in 1999.

Even when private water systems are allocated a share

of a state’s PABs, three other provisions of federal tax

law raise their financing costs relative to those of municipal systems. First, interest on PABs remains subject

to the alternative minimum tax (AMT) for both corporations and individuals, which reduces the demand for

such bonds by potential investors who pay the AMT

and thus raises the interest rate that issuers must offer.4

(As discussed in the body of this report, interest on

municipal bonds can be partially taxed under the corporate AMT.) Second, privately owned systems must

spend bond proceeds within six months, whereas public

systems have four phased deadlines that allow spending

to occur over two years. The shorter spendout period

reduces the time during which private systems can earn

“arbitrage profits” by investing bond proceeds at rates

above the bond’s own yield and may also force them

to incur higher transaction costs for a phased series of

smaller bond issues. Third, private systems have somewhat less flexibility in refinancing bonds to take advantage of favorable interest rates: PABs cannot be refinanced with new tax-exempt bonds unless the proceeds

are used immediately to retire the original debt,

3. States may carry forward allowances under the cap for designated

projects for three years. Frequently, a state that appears to have

not issued PABs up to its limit in a given year will actually be

using that option to save allowances for a large project or to wait

for more favorable market conditions.

4. The impact on PAB rates is estimated to be 15 to 25 basis points

(that is, 0.15 to 0.25 percentage points). See Environmental

Protection Agency, Environmental Financial Advisory Board,

Funding Privately Owned Water Providers.
CHAPTER THREE OPTIONS FOR FEDERAL POLICY 37

%R[ 

Continued

whereas governmental bonds can be “advance refunded”

once, up to 90 days before redemption of the original

debt.

The Congress could eliminate most of those provisions

that place privately owned systems at a disadvantage

relative to municipal systems—the exception being obstacles in states’ constitutions that disallow aid from

SRFs.5

 For example, it could amend the Clean Water

Act to allow SRF loans to private wastewater systems.

It could also reclassify bonds for projects that served

public needs for water services as governmental bonds

rather than PABs (thus sidestepping all of the differences

in tax treatment), or it could partially or fully exempt

bonds for water systems from the annual caps on PABs.

There is no precedent for such tax treatment of privately

owned utilities, however. PABs for airports, docks,

wharves, solid-waste facilities, and environmental enhancements of hydroelectric generating facilities are

exempt from the volume caps, as is 75 percent of the

value of PABs for high-speed intercity rail facilities, but

only if the facilities are publicly owned, with private

parties restricted to serving as operators or lessees.6

A commonly heard argument for equalizing both the

access to funding and the tax treatment of private and

municipal water systems is that water users should not

5. Of course, the Congress could give states incentives to amend

their constitutions. One proposal for doing so calls for modifying

the calculation of each state’s share of the annual federal appropriations for drinking water SRFs, which reflect the findings

of the Environmental Protection Agency’s needs survey, to

exclude the needs for privately owned systems in states that do

not make loans to such systems.

6. Moreover, the contract or lease for such a facility is subject to

several restrictions: it must not allow the private operator to

claim depreciation or investment tax credits, extend beyond

80 percent of the useful life of the assets financed by the bonds,

or allow assets to be sold to the operator for less than fair market

value; and compensation to the operator must be primarily in

the form of a fixed periodic payment. Also excluded from the

volume cap on PABs are bonds for veterans' mortgages and for

certain nonprofit organizations. Bonds for public educational

facilities have their own cap, equal to the greater of $10 per

person or $5 million.

be denied the benefits of federal aid simply because their

service comes from a privately owned system. Opponents of aid to private systems sometimes argue that

the government should not support private profits;

however, state regulation of rates charged by private

utility monopolies such as water systems constrains

profits and can ensure that most of the gains from federal aid flow to customers.7

The overall cost impact of treating publicly and privately

owned systems equally is not clear. On the one hand,

equal treatment could be beneficial to the extent that

private ownership reduces investment or operating costs

in at least some cases and that local decisionmakers can

generally identify the efficient arrangements. On the

other hand, equalizing the treatment would in all likelihood mean increasing federal aid to private systems

rather than reducing aid to public systems; thus, as with

the options to increase aid to water systems in general,

it could contribute to higher total national costs by

distorting water companies’ own choices—such as

choices between equity and bond financing and between

investment and maintenance.

One final argument sometimes made for equalizing

treatment—or more broadly, for encouraging or reducing barriers to direct private investment in water

systems—is that the private sector can tap large additional sources of funding for infrastructure needs. That

argument is flawed, however, since the funds for both

publicly and privately owned systems ultimately come

from the ratepayers (and perhaps taxpayers). A more

compelling version of the argument is that private

owners may have access to cheaper financing in some

cases.

7. Small water systems, such as those owned by small housing developments, homeowners’ associations, resorts, summer camps,

and trailer parks, are not always subject to rate regulation. Even

when not regulated, however, many such systems are likely to

pass the benefits of federal support on to water users, whether

because of their ownership structure (in the case of homeowners’

associations) or because of market competition on overall rates

(in cases such as camps and trailer parks).
38 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

basis of a mix of data on appropriations, obligations, and

outlays, the General Accounting Office reported that federal support in 2000 included $1.5 billion in project

grants, nearly $2.2 billion in SRF grants, and $780 million

in the face value of loans and loan guarantees from the

Department of Agriculture (USDA).9

 Of course, SRF

grants do not flow directly to water systems but rather to

state pools from which loans are made, and only a small

portion of the face value of loans and loan guarantees

represents a subsidy to the recipient water systems. Taking

into account the actual volume of SRF loans, the average

interest rates charged in the SRF program and USDA’s

program, and the market-based rates that borrowers would

otherwise have to pay, the Congressional Budget Office

estimates that federal and federally supported spending

provided a subsidy equivalent to 10.8 percent of the total

investment in drinking water and wastewater systems in

1999.10

Some federal spending on water infrastructure is targeted

to particular categories of systems. The drinking water SRF

program allows states to use up to 30 percent of their capitalization grants to subsidize the loans to systems serving

disadvantaged communities, as defined by state affordability criteria, and requires states to give at least 15 percent of the loan dollars to systems serving no more than

10,000 people, if enough eligible projects are available.

Through 2000, systems of that size had received 39 percent of the loan funds (and 74 percent of the loans).11

USDA’s program exclusively aids communities of no more

than 10,000 people. Under that program, communities

with a lower median household income receive loans

carrying lower interest rates; eligibility for grant assistance

is restricted to projects that would otherwise exceed an

affordability guideline.12 Various smaller federal programs

target aid on the basis of location (as with grants from the

Appalachian Regional Commission), local economic

distress (for example, the Public Works Program of the

Commerce Department), or other factors.

In contrast, neither the clean water SRF program nor the

federal tax preferences draw formal distinctions between

small and large water systems. Nonetheless, a November

2000 report noted that states had given wastewater systems

serving up to 10,000 people 23 percent of the money

loaned under the SRF program (and 58 percent of the

loans) since 1990, whereas systems of that size accounted

for 11 percent of the 20-year needs documented in EPA’s

1996 survey.13 Conversely, because many small communities have no credit rating and cannot issue their own

bonds, drinking water and wastewater systems owned by

such communities cannot directly take advantage of the

tax preferences; instead, they benefit indirectly to the extent that they receive assistance from a state revolving fund

or other pooling mechanism that taps the bond market.

General Implications of Federal Investment

Support for Water Systems

Federal investment support for water systems can have

unintended consequences, such as a reduction in comparable spending by state or local governments. Evidence from

9. General Accounting Office, Water Infrastructure: Information on

Federal and State Financial Assistance, GAO-02-134 (November

2001). The figures are in 2000 dollars.

10. This calculation of the value of the subsidy received by water

systems is partly analogous to the calculation of the subsidy

value under the Federal Credit Reform Act of 1990 for the purpose of determining the impact on the federal budget. The latter would use the federal government’s borrowing rate (instead

of the market rate) and make allowances for default risk. (Neither calculation reflects any illiquidity or undiversifiability associated with the debt.)

11. Mary Tiemann, Safe Drinking Water Act: State Revolving Fund

Program, CRS Short Report for Congress 97-677 (Congressional Research Service, updated January 10, 2002).

12. Subject to additional eligibility requirements, projects may receive grant funding if the ratio of the median household income

(MHI) in the service area to the statewide median for nonmetropolitan areas is no greater than 80 percent and the project’s debt service per household would exceed 0.5 percent of

the local MHI or if the ratio is between 80 percent and 100 percent and the debt service would exceed 1.0 percent of the local

MHI. Because that guideline focuses on the debt service associated with an individual project rather than local costs in total—

and on MHI rather than individual household income—it sheds

little light on the question, discussed in Appendix C, of the fraction of income above which water bills might be considered

unaffordable.

13. Claudia Copeland, Rural Water Supply and Sewer Systems: Background Information, CRS Report for Congress 98-64 ENR

(Congressional Research Service, November 30, 2000).
CHAPTER THREE OPTIONS FOR FEDERAL POLICY 39

the federal wastewater construction grants program under

the Clean Water Act suggests that large increases in federal

aid can lead to significant displacement. Between 1970

and 1980, federal support for wastewater plants rose by

$8.2 billion, but state and local funding fell by $1.9 billion, effectively negating about one-quarter of the federal

increase. A more detailed analysis, taking into account

factors that might otherwise have led to increased state

and local investment, concluded that federal construction

grants reduced other capital spending by 67 cents on the

dollar.14 The exact relationship between federal funding

and displacement of spending by state and local governments is not known; for instance, displacement per dollar

could be smaller at lower levels of federal involvement.

But to the extent that state and local governments cut their

funding for water systems, federal support intended for

water infrastructure benefits state and local taxpayers instead through increased spending on other services or

through lower nonfederal taxes.

A second unintended consequence of federal aid for investment projects is that it distorts price signals for system

managers—and thus affects their decisions about such

things as preventive maintenance, construction methods,

treatment technology, pipe materials, and excess capacity

—and for ratepayers, affecting their decisions about usage.

The overall effect is to undermine the cost-effective provision and use of water services. Evidence from a 1985

CBO study of wastewater treatment plants indicates that

the effects can be significant, at least at high levels of subsidization. Case studies of four plants, financed with

various levels of governmental assistance, showed that

higher subsidies led to the selection of more costly treatment technologies, the construction of significant reserve

capacity, and longer construction periods.15

In that same study, a statistical analysis of cost data on 68

plants indicated that reducing the nonlocal share of

investment funding from 75 percent to 55 percent, as occurred in 1985 under the construction grant program,

would reduce capital costs by an average of roughly 30 percent. That estimate implies that the federal burden for the

same number of projects would be almost twice as high

at 75 percent support as at 55 percent, with more than

four-fifths of the difference going to cover higher costs

and less than one-fifth going to reduce the burden on local

systems.16 Thus, at least for wastewater treatment plants,

high levels of subsidization appear to be a very inefficient

way to reduce local investment costs.

The study was less able to quantify the effects that lower

subsidy levels would have on cost-effectiveness. It is plausible that the impact of an additional dollar of federal aid

depends on the base level of subsidy—for example, that

raising the subsidy from 5 percent to 10 percent, with recipient systems still bearing 90 percent of capital costs,

would lead to a smaller increase in costs than raising it

from 50 percent to 55 percent would. But efforts to map

the relationship between external support and project costs

in more detail were inconclusive, in part because of the

small data set.

One way to reduce the distortions associated with federal

aid to water systems, of course, would be to reduce the

aid itself. Doing so would encourage system managers to

find greater efficiencies in their investment and operations

and prompt ratepayers to reduce low-priority uses. Consequently, total nationwide costs for water services would

be lower than they would if federal support remained

steady or increased. But despite the savings, total costs

would probably still rise, given the projected increases in

replacement and new investment—and a larger share of

those total costs would be paid more visibly through water

bills, rather than taxes. Opponents of cutting federal aid

for water infrastructure also argue that national funding

14. James Jondrow and Robert A. Levy, “The Displacement of

Local Spending for Pollution Control by Federal Construction

Grants,” American Economic Review, vol. 74, no. 2 (May 1984),

pp. 174-178.

15. Congressional Budget Office, Efficient Investments in Wastewater

Treatment Plants (June 1985), pp. xi-xii. According to some

analysts, another factor responsible for raising costs in the construction grant program was the industry’s inability to design

and build treatment plants rapidly enough to accommodate the

sudden, large infusion of additional federal dollars.

16. For example, a treatment plant that cost $10 million to build

with a 75 percent federal subsidy would have a federal share of

$7.5 million and a local share of $2.5 million, while a plant that

cost 30 percent less and had a 55 percent subsidy would entail

federal costs of $3.85 million and local costs of $3.15 million.

So the higher subsidy rate raises federal spending by $3.65 million but reduces local spending by only $0.65 million.
40 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

should continue to help local systems pay for the costs of

meeting water quality standards set or directed by the federal government.

Another way to reduce the distortions would be to deliver

the aid to water systems differently—according to some

formula that does not involve systems’ current investments

or activities and thus does not distort the marginal costs

seen by system managers. Such a formula could include

factors related to systems’ size (such as miles of pipes and

investment spending over some fixed historical period),

investment needs (for example, average age of pipes and

treatment plants), and local financial capacity (such as the

population and average income of the service area). By

leaving marginal costs largely untouched, formula-based

aid reflecting such independent factors would redistribute

revenue to water services without undermining managers’

incentives for cost-effective choices, at least in the short

run.17 However, it would not address the issue of federal

support displacing funding from state and local governments.

Targeting Investment Aid for Water Systems

Still another way to limit the negative incentives of increased federal support for water systems is to target the

aid. All things being equal, the fewer systems eligible for

aid, the smaller the undesired consequences. Aid could

be given to systems facing high costs (relative to the population served or relative to the aggregate income of the

population served) for investment (or investment and

O&M) in general or for narrower categories of costs, such

as those to comply with federal regulations or to maintain

or replace investments “stranded” by shifts in population.

But defining the target group in a way that does not reward systems for poor management and low spending in

the past, and does not encourage such laxness in systems

hoping to qualify for aid in the future, could be difficult.

Implementation would be another challenge. One of the

two main choices would be to establish a formula to

determine the amount of aid to be given to a system with

certain characteristics; the other would be to specify general criteria and then have systems submit funding applications that would be judged against the criteria, allowing

a system to present whatever information supports its case.

On the one hand, case-by-case review avoids the use of

rough proxies and arbitrary thresholds and could allow

for aid to systems with ongoing weaknesses to be tied to

specific requirements for improvement. On the other

hand, the administrative costs of preparing and evaluating

the applications would be higher, and the lower predictability would give more systems reason to defer investing

on their own in hopes of gaining outside funding.

Advocates of maintaining or increasing the current targeting of small systems in any expansion of federal aid point

to a backlog of requests for USDA’s assistance and high

projected per capita investment costs, at least for drinking

water systems.18 Some opponents argue that the states’ emphasis on small systems in allocating SRF money makes

additional federal targeting unnecessary. Moreover, it

could be ineffective: increasing the statutory targeting

within the SRF programs would merely codify what many

states are already doing, and providing increased support

through other programs (such as USDA’s program) might

lead states to readjust their SRF portfolios to maintain the

current distribution of aid between small and large systems. Some opponents also question whether current programs do enough to ensure that small systems do not remain dependent on external funding indefinitely.

Grants, Credit Subsidies, and Tax Preferences

As noted earlier, subsidies to investments in water systems

may be delivered through spending on grants or credit

17. Some factors included in an aid formula could be influenced by

the choices of system managers over a longer period of time. For

example, the level of investment activity in a system would affect the average age of its infrastructure. Even in that case, however, the incentives to invest would be only modestly distorted if

the formula reflected not the current average age of infrastructure but, say, the average age five years earlier.

18. In January 2000, USDA reported a backlog of $3.3 billion in

requests for water loans and grants. EPA’s latest survey of drinking water needs reported that 20-year needs per household averaged $3,000 in systems serving up to 3,300 people, nearly four

times the $790 average for large systems (those serving more

than 50,000 people). Similarly, for wastewater, EPA has stated

that the smallest systems lack economies of scale and are likely

to face the largest percentage increases in user charges and fees;

however, results from the 1996 Clean Water Needs Survey found

that small systems accounted for 11 percent of both needs and

population, implying equal costs per capita.
CHAPTER THREE OPTIONS FOR FEDERAL POLICY 41

subsidies (such as loans with subsidized interest rates, loan

guarantees, and bond insurance) and through tax preferences. Despite the seeming diversity, each of those approaches serves to reduce investment costs to the water

system, and for a given reduction in the cost of a particular

project, each is likely to have the same impact on the recipient. For example, a 10 percent reduction in the local

cost of a $12 million treatment plant that would otherwise

be financed by 30-year bonds paying 5 percent interest

could be accomplished by providing a grant of $1.2 million, a loan for the full cost of the project at 4.1 percent

interest, or bond insurance or tax preferences that reduced

the bond interest rate to that same 4.1 percent.

But some levels and patterns of federal subsidy may not

be easily attained through all of the mechanisms. For example, providing large increases in aid to publicly owned

water systems through tax policy alone would be difficult,

given that such systems and the interest paid on municipal

bonds are generally exempt from federal taxes already.

(Significantly increasing the tax preferences available to

privately owned systems would be easier; see Box 3-1.) 

Where tax preferences and spending programs are viable

alternatives to achieve the desired level and pattern of

support to water systems, the two can be contrasted in several ways. One argument in favor of tax preferences is that

they provide more year-to-year stability, which can facilitate planning by system managers. However, spending

programs are more readily reviewed and adjusted by the

Congress. And changing the tax rules to benefit water

systems alone could raise questions about the treatment

of other users of municipal bonds while adding complexity

to the tax code and increasing administrative costs.

Federal spending programs also differ from tax preferences

in that they make it easier for the Congress to specify

detailed conditions under which the aid is to occur. Such

conditions can have both positive and negative effects on

cost-effectiveness. In some cases, incentives or requirements associated with federal funds—“carrots and sticks”

—may prompt recipients to take cost-effective actions that

they would not otherwise. But conditions on spending

that are truly beneficial may be rare: broad, general provisions may have little impact, and specific, detailed conditions may be cost-effective for some systems but not for

others. Currently, one prominent stick is the requirement

that drinking water systems receiving SRF assistance

demonstrate the technical, managerial, and financial capacity to comply with the Safe Drinking Water Act over the

long term. In keeping with that requirement, some states

give priority to SRF loans that address capacity problems

by consolidating two or more systems.19 Various additional

carrots and sticks have been proposed, such as giving priority to systems that adhere to certain best practices or to

states that have or adopt laws allowing water treatment

plants to be designed and built using integrated contracts

(discussed earlier in Box 2-3 on page 19).

More generally, however, restrictions on the use of federal

dollars can reduce cost-effectiveness by limiting the recipients’ flexibility in addressing their goals for water services.

To increase such flexibility, the Congress could reduce

the amount of money earmarked for special-purpose

projects and provide those funds to the SRFs instead. Also,

the SRFs themselves could be made more flexible by

eliminating floors and ceilings on funding for eligible

activities in the drinking water program, allowing states

to transfer more of their grant money between the drinking water and the wastewater SRFs, and broadening the

range of uses—as in a proposal from EPA’s Environmental

Financial Advisory Board to combine the existing SRFs

into environmental state revolving funds (ESRFs).20

Designed to address a broad set of issues affecting water

quality, the ESRFs could fund a wider range of projects

to control nonpoint source pollution (particularly projects

on private property) and contamination problems associated with landfills, “brownfields,” and air pollution.21

19. Environmental Protection Agency, Office of Water, The Drinking Water State Revolving Fund: Financing America’s Drinking

Water, EPA-816-R-00-023 (November 2000), p. 7.

20. Under current law, states may shift up to one-third of each

year’s drinking water SRF grant to the clean water program or

an equal amount in the other direction. For the proposal to

create ESRFs, see Environmental Protection Agency, Environmental Financial Advisory Board, Environmental State Revolving

Funds: Developing a Model to Expand the Scope of the SRF (June

2001).

21. Of course, allowing greater flexibility in the use of SRF money

might be said to dilute the original Congressional intent to support infrastructure, and some of the gains expected from broadening the SRF programs may not materialize if the state agencies

administering the funds lack the technical expertise to accurately

evaluate new kinds of proposals.
42 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Within the set of spending options, the distinctions among

grants and credit subsidies arguably have less policy significance. Grants are sometimes said to be more appealing

because they are simpler to explain to local ratepayers.

Conversely, it is sometimes argued that in comparison to

grants, credit subsidies have a lower federal cost per dollar

of support seen by the recipient—that argument, however,

holds only under the assumption that the government’s

cost should not be measured using a discount rate reflecting the same risk premiums that private lenders require.22

Finally, investment projects that rely at least in part on

private funding can help keep costs down by subjecting

systems to more market discipline; that argues against

traditional loans covering 100 percent of capital costs and

in favor of grants or partial loans or loan guarantees.

In terms of tax preferences, one approach that could benefit both municipally owned systems and private systems

would be to relax the restrictions on arbitrage profits—the

gains state and local governments make from the difference

between the tax-free rate of interest that they pay bondholders and the higher rates they can earn on taxable bonds

and other assets. To avoid encouraging state and local governments to issue bonds simply to take advantage of the

spread in interest rates, the federal government restricts

such arbitrage profits. In particular, current rules require

that systems rebate to the government arbitrage profits

on bond proceeds not spent on schedule within a two-year

deadline (or for private systems, a six-month deadline).

Extending the deadline or otherwise increasing the arbitrage earnings that water systems could keep would reduce

their net cost of borrowing.23 Another option would be

to eliminate the partial taxation of interest on municipal

bonds held by corporations that pay the alternative minimum tax.

Direct Federal Support for

Ratepayers and Its Implications

The federal government supports low-income households

in various ways, notably through income-based welfare

programs and the earned income tax credit, but does not

currently provide direct funding to assist households with

their water bills. Existing payment assistance programs

for water services are organized locally—some by individual utilities, others by local authorities using tax revenues

for support or by community organizations using donated

funds—and are much less common than those for home

energy and telecommunications services.24 The federal

government does provide some assistance for other utility

bills. In particular, the Low-Income Home Energy Assistance Program (LIHEAP), established in 1981, provides

states with over $1 billion in block grants each year to

subsidize low-income households’ heating and cooling

costs. Also, the Low Income Program of the telecommunications Universal Service Fund, authorized in its current

form in 1996, has used approximately $600 million per

year (from fees charged to firms that provide interstate

telecommunications services) to provide eligible households with discounts on telephone services.

Federal aid to households could address distributional

objectives with more precision and less loss of efficiency

than can be achieved from aid for investment in water

systems. A program that aided households directly could

be more cost-effective in achieving a given distributional

objective because fewer households would face reduced

water prices and water system managers would not face

distorted choices.25 A program designed to defray the

22. The argument is that the federal government has a lower discount rate (based on its lower borrowing cost), which gives the

same loan repayment stream a higher present value for the Treasury than for the local system—and thus that the net federal

cost of making the loan is smaller than the net support it provides. Paul K. Marchetti, The Programmatic and Financial Integration of Grants and Loans Within the State Revolving Funds,

Council of Infrastructure Financing Authorities Monograph no.

11 (September 2001), pp. 11-13. 

23. A variant option would be to maintain the current time limits

during which proceeds on tax-exempt bonds may earn arbitrage

profits but extend the period during which the proceeds must

be spent. That alone could lower investment costs by reducing

the number of cases in which systems would have to use a

phased series of smaller bond issues.

24. For a comprehensive discussion of payment assistance programs

for water services, see American Water Works Association Research Foundation, Water Affordability Programs (Washington,

D.C.: AWWARF, 1998).

25. H.R. 3930 and S. 1961 in the 107th Congress would allow

states to use a certain portion of federal SRF grants to buy down

the interest rate or otherwise increase the subsidy on SRF loans

to local water systems, if the systems in turn directed the bene-
CHAPTER THREE OPTIONS FOR FEDERAL POLICY 43

expense of basic water use—one that provided a dollar

amount determined by the number of members in the

household instead of paying benefits as a proportion of

water bills, for example—would not affect households'

marginal costs of water consumption, thus preserving incentives for consumers to avoid overusing water services.26

A consumption subsidy could also be designed to support

conservation measures—for example, by subsidizing repairs to fix leaky plumbing. However, beneficiaries (and

others allocating funds on their behalf) are likely to prefer

direct assistance over conservation measures with even

moderately long payback periods.27

Delegating most implementation responsibilities to subfederal entities and providing the consumption subsidy

to service providers on behalf of households could minimize the federal government’s administrative costs and

allow more people to be served for a given amount of

funding. For example, delegating to the states would allow

for cost-effective variations, taking advantage of existing

state institutions and programs, in the methods used to

identify, notify, and deliver benefits to eligible households.

But some of the federal costs “saved” would be merely

shifted to nonfederal parties, such as service providers.

State governments shoulder most of the responsibility for

administering LIHEAP, and most states exercise their

authorization to make consolidated payments on behalf

of households to utility companies and fuel dealers.28 In

the Low Income Program for telecommunications, all payments from the fund go to companies on behalf of the

households receiving the subsidized services. Administrative costs for the program are about $1.7 million annually,

less than one-half percent of the program’s fiscal year 2000

outlays of $553 million (in current dollars). The costs incurred by service providers to identify eligible households

and apply the appropriate benefits are unknown.

Concluding Note

Water pipes and treatment plants last for decades. Consequently, today’s infrastructure represents a cumulation

of investment choices and maintenance practices over

many years past, and today’s investments will affect operating costs and service quality for many years into the future. The magnitude and especially the timing of future

investments are uncertain, as discussed in Chapter 2, but

barring major breakthroughs in technology, investment

costs will certainly rise for decades to come as more and

more of the existing infrastructure wears out. Although

this report has focused on the costs of water services

through 2019, if the drinking water and wastewater industries continue to fall short of self-sufficiency, the consequences for the federal budget may last not two decades,

but five or 10.

fits of the additional subsidy to needy households through adjustments in user charges. The increases in the subsidy component of SRF loans should not significantly increase the distorting effects of federal support for investment itself. From the

point of view of water systems receiving the loans, the savings in

repayment costs would be offset by reduced revenues from beneficiary households.

26. The Universal Service Fund’s Low Income Program illustrates

that approach: each of its three types of benefits is capped at a

level essentially unrelated to the volume of service used by a

particular household. The “Link-Up” benefit subsidizes half of

the customary connection fee, up to a maximum of $30. “Lifeline” reduces monthly service bills by $5.25 to $7.85, depending on a number of factors, including whether the state has a

matching program. “Toll Limitation Service” covers the cost to

providers of allowing consumers to block or set a predetermined

limit on long-distance (toll) calls. In the case of LIHEAP, under

which states have significant discretion in determining household benefits, questions about inefficient consumption have

arisen: the Securing America’s Future Energy Act of 2001,

passed by the House, calls for the General Accounting Office to

determine the extent to which those benefits encourage or discourage energy conservation and investments in energy efficiency. It also requests that that agency examine the extent to

which the goals of conservation and assistance to low-income

households could be achieved through cash income supplements

that do not specifically target energy.

27. Federal rules for LIHEAP allow states to use 15 percent of their

grants for low-cost residential weatherization or other energyrelated home repairs. Each year, states may also apply for permission to raise that share to as much as 25 percent; however,

on average, only five states have done so in recent years.

28. From 1995 through 1999, aggregate state administrative costs

averaged close to 9 percent of total spending under LIHEAP. 
APPENDIX

$

Assumptions the Congressional Budget Office

Used In Its Low-Cost and High-Cost Cases

$s with all modeling exercises, the Congressional

Budget Office’s (CBO’s) analysis of future costs for investment in water infrastructure rests on the quality of the

data used as inputs and the validity of the many

assumptions used in converting the data into estimates.

The most readily apparent assumptions are the 11 specific

numerical values that differ between CBO’s low-cost and

high-cost cases and between those cases and the analysis

done by the Water Infrastructure Network (WIN). Those

assumptions include a factor describing savings from improved efficiency in investment by both wastewater and

drinking water systems; three factors pertaining to capital

costs for wastewater systems alone; two specific to capital

costs for drinking water systems; four involving financing

costs; and one pertaining to operations and maintenance

(O&M). The goal in selecting the assumptions was not

to determine the lowest and highest possible values of

each one, but to identify reasonably low and high values

that might realistically occur together in the scenarios.

Aside from the 11 distinguishing assumptions (see Table 2

on page 20), CBO’s scenarios and WIN’s analysis have

much in common, including primary data sources and

“structural” assumptions about which factors influence

other factors. The effects of those common elements is

unknown. For example, CBO cannot quantify the extent

to which differences in the available data and modeling

approaches used to analyze investments for drinking

water and wastewater affected the estimated costs.

Savings from Increased Efficiency

in Investment

Although quantifying the potential impact of improved

management and better technology on future investment

is difficult, CBO considers it likely that U.S. systems

could achieve savings of 10 percent or more, given incentives to do so. Evidence for that assumption comes from

Australia and the United Kingdom, where water systems

have been pressed to become more efficient. Accordingly,

CBO reduced estimated costs for capital investment in

both drinking water and wastewater systems by 15 percent in the low-cost case and by 5 percent in the high-cost

case.1

Capital Costs for Wastewater Systems

In light of the limited data available and the resulting

uncertainty, the two scenarios differ in the depreciation

rates for wastewater infrastructure, the shares of investment for replacing infrastructure that CBO assumed were

1. Both scenarios implicitly assume that the data collected in the

Environmental Protection Agency’s needs surveys do not already

reflect future efficiency savings. The other sources of estimated

capital costs—the Water Infrastructure Network’s analysis of

investment in wastewater systems for replacing infrastructure

and Stratus Consulting’s report on investment in drinking water

distribution—are explicitly based on current prices and valuations and thus do not reflect potential efficiency gains.
46 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

included among the needs estimated in the Environmental Protection Agency’s (EPA’s) survey, and the costs for

dealing with combined sewer overflows (CSOs). The

costs to address sanitary sewer overflows (SSOs) are also

uncertain, but CBO used the same estimate of those costs

for both scenarios, largely for lack of information on

which to base contrasting estimates.

WIN’s rule-of-thumb assumptions about the lifetimes for

sewer pipes, treatment plants, and vehicles—50 years,

20 years, and 5 years—seem reasonably conservative (in

other words, short). Reflecting those assumptions and the

relative importance of the three types of capital stock,

CBO adopted a weighted (economic) depreciation rate

of 3.3 percent for its high-cost case. Those rules of thumb

could in principle underestimate replacement costs if

wastewater systems have built up an investment backlog;

presumably, however, most overdue investments would

be affecting service quality and thus would probably be

included in EPA’s needs survey and reflected in WIN’s

estimate of costs for investments besides those for replacing infrastructure.

Conversely, some experts have suggested to CBO that

reasonably optimistic lifetimes for pipes and treatment

plants would be 75 years and 30 years, respectively.

Moreover, replacement rates over a period of 20 years

could fall below the average level implied by those lifetimes, depending on the age of the existing stock. In the

absence of better data on actual lifetimes and current ages,

however, the low-cost case assumes lifetimes of only

60 years for pipes, 25 years for treatment plants, and

7 years for vehicles, and uses the corresponding weighted

overall depreciation rate of 2.7 percent.2

The low-cost and high-cost scenarios assume, respectively,

that 25 percent and 15 percent of the investments in the

relevant categories of EPA’s needs survey—secondary and

advanced treatment, new collector and interceptor sewers,

combined sewer overflows, and stormwater management

—represent replacement of existing infrastructure. Since

such investments are captured in the analysis by applying

the depreciation rate to the total capital stock, that

15 percent to 25 percent overlap must be subtracted from

the total in the needs survey to avoid double-counting.

CBO chose those percentages to illustrate the uncertainty

surrounding WIN’s estimate of 20.5 percent—which was

derived by assuming that investments to replace existing

infrastructure represented 50 percent of the investments

cited in EPA’s survey for addressing SSOs and zero percent of the investments in other survey categories.

CBO’s low-cost case takes its estimate of the costs for

addressing CSOs from EPA’s needs survey. WIN’s analysis uses the same figure, but WIN argues that EPA’s estimate is too low and is a significant source of downward

bias in its analysis. The CSO Partnership believes that

EPA’s estimate is a reasonable one if states exercise the

maximum flexibility in reviewing and revising their water

quality standards, but costs could reach $100 billion if

states maintain the current standards. Consequently,

CBO’s high-cost case incorporates that latter figure.3

Capital Costs for Drinking

Water Systems

The main factor responsible for the difference between

the two scenarios’ estimates of investment costs for drinking water is the assumed rate of pipe replacement. The

Stratus Consulting report that underlies WIN’s analysis

2. Because the modeling framework that WIN developed derives

its estimate of the value of the existing stock of wastewater infrastructure by cumulating past investments and subtracting depreciation, the lower the rate of depreciation in the past, the larger

the current capital stock. For consistency, therefore, CBO calculated an alternative estimate of the 1999 capital stock for the

low-cost case, using the lower depreciation rate assumed in that

scenario. The alternative estimate is 12.3 percent larger, which

partly offsets the impact of the lower depreciation rate on estimated future investment.

Also, CBO’s analysis, like WIN’s, calculated each year’s investment for replacing infrastructure by applying the depreciation

rate to the current net stock of capital, not the gross stock. That

approach is clearly not a literal description of replacement at the

level of individual investments: a pipe or treatment plant does

not cost less to replace simply because it is older and thus has

depreciated more. Rather, it should be viewed as a way of approximating the total amount of replacement needed for a large

capital stock containing assets of various ages.

3. The assumptions in both scenarios are “gross” costs—that is, the

costs before subtracting anything for overlap with investments

to replace infrastructure or efficiency savings.
APPENDIX A ASSUMPTIONS THE CONGRESSIONAL BUDGET OFFICE USED IN ITS LOW-COST AND HIGH-COST CASES 47

focused on an average rate of 1.0 percent per year (averaging over rates randomly selected from a uniform probability distribution from 0.5 percent to 1.5 percent), but it

also presented an alternative analysis that related historical

investment in pipes to population growth. CBO’s highcost case, like WIN’s analysis, adopts Stratus’s assumption of 1.0 percent as a plausible though marked increase

above recent rates. The low-cost case focuses on the alternative “demographic” analysis and assumes a replacement

rate of 0.6 percent—the average of the six rates calculated

for the 2000-2010 and 2010-2020 decades using 50-,

75-, and 100-year pipe lifetimes.4

 Here, as elsewhere in

its analysis, CBO assumes for simplicity that the relevant

replacement rate (1.0 percent or 0.6 percent) holds steady

throughout the 2000-2019 period. In reality, replacement

is likely to accelerate as existing pipes age, so the rates are

best viewed as averages over the period.

The other assumption pertaining to investment for drinking water concerns the costs associated with future federal

regulations. EPA’s estimates of compliance costs for

drinking water regulations are frequently controversial,

with water systems claiming that they are grossly understated. Often, assumptions about compliance methods

are at the heart of the controversy. For example, a study

issued by the American Water Works Association Research Foundation estimated that national annualized

costs to comply with an arsenic standard of 10 micrograms per liter could be as low as $230 million, close to

EPA’s estimate of $180 million to $206 million, if each

system affected by the standard was able to achieve compliance by using the least costly technology.5

 However,

using professional judgments about the likely performance of various technologies under different conditions,

the study’s “best estimate” of compliance costs was much

higher—$585 million. Conversely, an EPA contractor’s

report looking retrospectively at compliance with regulations for nitrate and atrazine found that many systems

used cheaper compliance methods than EPA had assumed

in its regulatory impact analyses.6

 That finding suggests

that the agency’s estimates may overstate costs rather than

understate them, at least in some cases.

Even if the estimates in EPA’s impact analyses were

known to be perfectly accurate, uncertainty would still

remain about the costs of regulations not yet promulgated

or proposed, for which no such analyses exist. Agency

sources do not currently anticipate proposing high-cost

rules beyond those already part of the regulatory agenda,

but some new development in the next five to 10 years

could lead to regulations that would have significant cost

impacts by 2019. In the low-cost case, CBO assumes

incremental costs of zero for future regulations (as does

WIN’s analysis), on the grounds that those already proposed or promulgated could reflect most of the compliance costs that systems will incur through 2019, with

efficiency savings on those “known” regulations roughly

balancing any costs during the period for subsequent

requirements. In the high-cost case, CBO adds $10 billion (in January 1999) dollars over the 20-year period

—the equivalent of $0.53 billion per year in 2001 dollars—on the assumption that the estimate of compliance

costs for known regulations expressed in EPA’s needs

survey ($9.3 billion in January 1999 dollars) covers

roughly half of total costs through 2019 for both known

and future regulations. That assumption takes into account the possibility that costs for the known regulations

will exceed EPA’s estimate as well as the possibility of

spending on later requirements. Somewhat higher figures

could also be justified as plausible but would not have a

major additional impact on total estimated costs.

Financing

In consultation with a half-dozen experts from the water

and municipal bond industries, CBO derived pairs of

4. One factor that could keep pipe replacement rates low is the use

of new techniques to identify pipes that are redundant and can

be abandoned, given existing or potential alternative routes in

the pipe network.

5. Michelle M. Frey and others, “Cost Implications of a Lower

Arsenic MCL,” AWWA Research Foundation Project #2635

(October 2000), p. ES-20, available at www.awwarf.com/

exsums/2635.htm. The study does not specify the type (nominal or inflation-adjusted) or year of the dollars used in the estimates.

6. Abt Associates, Inc., Predicting Community Water System Compliance Choices: Lessons from the Past (submitted to the Environmental Protection Agency, Office of Policy, Economics, and

Innovation, September 2000).
48 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

assumptions about future interest rates, borrowing terms,

and the use of debt financing versus pay-as-you-go (or

paygo) for capital investment. CBO used related assumptions to estimate the average annual spending to service

debt on “old” (that is, pre-2000) investments in drinking

water and wastewater systems; the resulting estimates are

common to both of CBO’s scenarios but somewhat lower

than those used in WIN’s analysis.

The low-cost case uses a real interest rate of 3 percent (as

does WIN’s analysis), and the high-cost case uses 4 percent. CBO chose those assumptions on the basis of an

estimated 3.2 percent weighted average covering marketrate bonds and subsidized rates on state revolving fund

(SRF) loans. The estimate took into account CBO’s longrun projections for inflation and the nominal interest rate

on 30-year Treasury bonds, traditional spreads between

Treasuries and municipal bonds, projections of potential

assistance from SRFs, and current interest rates on SRF

loans. That range from 3 percent to 4 percent may understate the true uncertainty about average interest rates over

the 2000-2019 period; however, once those figures are

combined with the many other pairs of low-cost and

high-cost assumptions, CBO believes that they yield suitably low and high estimates of investment spending.

CBO assumes the average repayment period on borrowed

funds to be 30 years in the low-cost case and 25 years in

the high-cost case; WIN’s analysis assumes a shorter

period of 20 years. Although some (mostly smaller) municipalities continue to borrow at terms as short as

10 years and loans from state revolving funds must still

be amortized over no more than 20 years, industry experts told CBO that water bond maturities have lengthened overall and that 30 years is now the standard term.

Even within the wastewater SRF program, EPA now

interprets its regulations to allow SRFs themselves to

borrow 30-year money and use it to buy local systems’

debt. As investment programs increase, stretching out

debt service will be increasingly important as a way to

contain rate increases; indeed, the Boston-area Massachusetts Water Resources Authority is now borrowing 40-

year money. Accordingly, CBO considers 30 years a

cautiously optimistic assumption for the average dollar

borrowed over the 2000-2019 period and 25 years an

adequately pessimistic alternative.

Similarly, keeping rates low in the face of rising investments will also mean reducing the use of paygo financing

in favor of borrowed funds. In two small 1999 surveys

of drinking water and wastewater systems, indirect data

appear to suggest average paygo shares of roughly 40 percent and 50 percent.7

 Nonetheless, according to industry

experts, systems undertaking large amounts of investment

generally use paygo financing very little (often a share of

just a few percent), suggesting that the national average

paygo share will fall as capital spending rises. Reflecting

the uncertainty about how quickly and how far the average will fall through 2019, the high-cost and low-cost

cases use paygo rates of 30 percent and 15 percent, respectively. WIN’s analysis assumes a paygo share of

25 percent.

Assumptions about borrowing terms, paygo shares, and

interest rates are also relevant in estimating the costs of

“old” debt service—that is, the financing costs associated

with previous investments still being paid off during the

2000-2019 period. For simplicity, CBO uses the same

assumptions about those costs in both scenarios.8

 In

7. In the one survey, 76 privately owned drinking water systems

(many belonging to the same parent companies) reported total

construction expenditures of $846 million and total gross cash

flow from financing activities (before subtracting debt repayment and dividends) of $526 million. Presumably, paygo accounted for the remaining $320 million, or 38 percent, of construction spending. See National Association of Water Companies, 1999 Financial and Operating Data for Investor-Owned

Water Utilities (Washington, D.C.: NAWC, 2000). 

In the survey of wastewater systems, bond proceeds and SRF

loans accounted for 46 percent of capital spending; interest

earned and other revenue sources provided another 7 percent.

Depending on the classification of those latter two sources, the

residual paygo share lay between 47 percent and 54 percent.

Only 40 to 69 systems provided responses other than zero to the

survey’s questions about capital spending, however, so the sample may not have been representative of all medium-sized and

large wastewater systems. See Association of Metropolitan Sewerage Agencies, The AMSA Financial Survey, 1999: A National

Survey of Municipal Wastewater Management Financing and

Trends (Washington, D.C.: AMSA, 1999).

8. Using two sets of assumptions would have complicated the

problem of matching assumptions about paygo shares with each

of CBO’s scenarios. Lower paygo shares on new investments

imply lower up-front costs; conversely, if paygo shares also vary

 
APPENDIX A ASSUMPTIONS THE CONGRESSIONAL BUDGET OFFICE USED IN ITS LOW-COST AND HIGH-COST CASES 49

particular, CBO assumes that the repayment period on

funds borrowed before 2000 is 20 years (shorter than the

25-year and 30-year periods used going forward) and that

the assumed paygo shares decline by 1 percent each year,

from 50 percent in 1980 to 31 percent in 1999. The

latter assumption is broadly consistent with the theory

that paygo shares decrease as investment programs increase; a higher trajectory of paygo rates could have been

justified by the available (limited) survey data, but would

have implied larger discontinuities between 1999 and

2000. Finally, rather than assume a fixed real interest rate,

CBO’s analysis used each year’s average nominal rate for

10-year Treasuries, reduced by spreads ranging from

5 percent to 15 percent between municipal and Treasury

bonds. CBO then converted total annual payments for

debt service to constant dollars using the gross domestic

product (GDP) deflator. For federal loans through EPA’s

state revolving funds and the U.S. Department of Agriculture’s (USDA’s) rural utilities program, the analysis used

those same interest rates less 2 percent.9

The estimates of average annual costs for “old” debt service resulting from those assumptions are somewhat lower

than WIN’s: $4.4 billion instead of $5.1 billion for

drinking water and $4.3 billion instead of $4.4 billion for

wastewater.10 The differences are primarily attributable

to CBO’s higher paygo shares and differences in data

sources; the use of variable interest rates and the different

method of converting to real dollars did not have much

impact.

Operations and Maintenance

Although the focus of this study is on investment costs,

spending for operations and maintenance is relevant in

that it contributes to the total financial burden facing

water systems and their ratepayers. CBO used comparatively simple approaches to model future O&M costs.

Under the high-cost case, both drinking water and wastewater systems’ O&M are modeled by extrapolating a

linear trend through estimated spending (in constant

dollars) from 1980 through 1998.11 The approach used

in the low-cost case starts from the same trend lines but

assumes that increased efficiency yields savings of 20 percent, phased in 2 percent each year from 1995 to 2004.

The rationales for those scenarios are straightforward.

The trend lines for both drinking water and wastewater

systems’ O&M fit the 1980-1998 data extremely well

(explaining 99 percent of the variation from the means)

and thus appear to be reasonable bases for extrapolating

future spending. At the same time, cost savings of 20 percent seem well in line with the experience of systems that

on previous investments, then lower shares imply higher costs

for old debt service. Thus, whether lower assumptions about

past and future paygo shares should be assigned to the low-cost

or the high-cost case would have been an empirical question,

subject to changes in those shares or in other, interacting assumptions.

9. Data for the analysis came from several sources, including Congressional Budget Office, Trends in Public Infrastructure Spending (May 1999), which in turn drew on the Census Bureau’s

annual surveys of State and Local Government Finances; General

Accounting Office, Water Infrastructure: Information on Federal

and State Financial Assistance GAO-02-134 (November 2001);

and data from EPA on loan volumes and federal outlays for the

state revolving funds. Data on drinking water systems derived

from the census survey, which covers only publicly owned systems, are scaled up by 15 percent to account for spending by

privately owned systems. That adjustment roughly reflects the

population served by privately owned systems; WIN, too, makes

that adjustment in its analysis.

For lack of information, however, CBO did not scale the census

data down by a percentage reflecting investments in drinking

water infrastructure to serve growth, which are not covered in

the estimates of future costs. That factor is one of two that tends

to overstate relevant investment spending in 1999 and future

debt service on pre-2000 investments. The other is the neglect

of any refinancing that systems did as interest rates fell in the

1990s. Two other limitations of the data act in the opposite

direction: they do not distinguish USDA loans from local systems’ spending of their own funds before 1991, and they understate local spending starting in 1992 by an amount equal to the

federal budget cost (that is, the subsidy value) of those loans.

10. WIN’s analysis used the same assumptions for pre-2000 investments as for new investments: a 20-year borrowing term, 25

percent paygo share, and 3 percent real interest rate. 

11. The estimates were derived from data in the Census Bureau’s

surveys of government finances. CBO averaged data from successive surveys to convert from state fiscal years (typically July 1

to June 30) to calendar years and used the GDP price index to

convert from nominal dollars to constant 2001 dollars. Again,

CBO increased the estimates for drinking water systems by 15

percent to account for privately owned systems not covered by

the surveys.
50 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

have begun to emphasize efficiency and competitiveness

and also broadly consistent with significant decreases in

the average annual growth in O&M spending seen in the

last four years of available data (1995 through 1998).

The approach CBO took in its low-cost case echoes that

used in WIN’s analysis, which also appears to modify

linear extrapolations by phasing in 20 percent efficiency

savings over 10 years.12 For drinking water systems’

O&M, the low-cost case differs from its WIN counterpart only in the data sources: WIN’s analysis based its

extrapolation on data from 1985 to 1994, and, to convert

from nominal to 1997 dollars, appears to have used the

Engineering News-Record’s Construction Cost Index

(which focuses on only the prices of labor, structural steel

shapes, cement, and lumber) rather than the more general

GDP price index. For wastewater systems’ O&M, an

additional factor distinguishes the two approaches:

WIN’s linear extrapolation (using 1972-1996 data) was

not on O&M spending itself but on spending per dollar

of net capital stock.

Although the size of the capital stock is plausibly related

to the amount of O&M, CBO did not see a compelling

case for WIN’s more complicated approach. It is not

obvious that each additional dollar of capital stock should

be associated with an ever-increasing (rather than a

steady) amount of additional O&M spending. Specific

factors that contributed to steady increases in wastewater

systems’ O&M spending (in comparison to capital stock)

between 1972 and 1996, such as a major increase in the

use of secondary treatment methods and increased requirements for handling biosolid residues, may have

largely played themselves out by now. And the linear

trend line through the data on spending per dollar of net

capital stock, while a very good fit, was no better than the

trend line through the data on O&M spending itself.

Of course, the simple approaches CBO used could understate the uncertainty surrounding O&M costs by failing

to capture some ways in which the future could differ

from the past. For example, tighter effluent standards or

additional drinking water regulations might raise O&M

costs faster than projected in the high-cost case, while

more aggressive efficiency campaigns or faster technological progress might yield savings larger than projected in

the low-cost scenario.

12. The documentation available to CBO did not show that efficiency savings were applied to the trend for drinking water systems’ O&M; however, by experimenting with the data that

WIN used, CBO found that including such savings and phasing

them in over the same 1997-2006 period specified for the savings by wastewater systems roughly reproduced WIN’s published estimate of average annual costs over the 2000-2019

period. Although WIN’s report said that its model assumed 25

percent savings, the consultant who led the analysis has confirmed that the correct figure is 20 percent.
APPENDIX

%

Major Sources of Efficiency Savings

)aced with increased pressure from ratepayers and

local government officials to control costs, drinking water

and wastewater systems around the country are looking

for ways to improve the efficiency of their investment,

operations, and maintenance activities. Their efforts have

identified many sources of efficiency savings, most of

which are captured under one or more of the categories

discussed below.

Demand Management

Efforts to influence the demand for water services may

take a variety of forms, including increases in prices to

better reflect the full costs of water services, rebates for

purchases of equipment that uses less water, and campaigns to promote voluntary reductions in water use.

One important application of demand management is to

reduce peak usage and thereby postpone expensive increases in capacity. For example, after determining that

higher demand for water in the summer, driven primarily

by residential landscape watering, cost four times as much

to satisfy as average annual demand ($0.97 versus $0.22

per hundred cubic feet, in unspecified dollars), Seattle

Public Utilities implemented several methods—including

a media campaign, appearances by speakers, demonstration gardens, bill inserts, zoning codes, and seasonal rate

increases ranging from 50 percent to 160 percent—to

reduce summer watering. According to the utility, the

measures have cut the maximum amount demanded on

any one day of the year by almost one-third despite an

increase of 20 percent in the population served. The

measures yielded savings of millions of dollars from

postponed expansions in distribution and supply facilities

and additional savings in energy and labor costs and

increased flexibility in routing water through the distribution system.1

On the wastewater side, pricing based on marginal-cost

principles to reduce cross-subsidies between different

classes of users can improve efficiency not only by alleviating pressure for investments in overall capacity but also

by reducing costs associated with treating particular types

of wastes—as these examples show: fats, oils, and greases

(as from restaurants and auto shops) can raise a wastewater system’s costs for keeping its sewers unclogged; and

metal contaminants can raise the costs of disposing of

treated biosolids by making them unfit for application on

nearby agricultural land.2

 By analyzing the cost impacts

of such wastes and charging accordingly, system managers

can give users incentives to “pretreat” them on-site or

avoid creating them whenever the cost of doing so is

lower than the cost of treating them in the wastewater

system.

Labor Productivity

Labor costs are a major focus of efforts to improve efficiency because they represent the largest single compo1. Allan Dietenmann, “A Peek at the Peak: Reducing Seattle’s

Peak Water Demand” (Seattle Public Utilities, Resource Conservation Section, Feburary 9, 1998).

2. For examples and discussion, see Industrial Economics, Inc.,

Cost Accounting and Budgeting for Improved Wastewater Treatment (prepared for the Environmental Protection Agency, Office of Policy, Planning and Evaluation and Office of Water,

February 1998).
52 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

nent of water systems’ operational costs. For example,

according to a 1999 survey of medium-sized and large

wastewater systems by the Association of Metropolitan

Sewerage Agencies (AMSA), “in-house” wages and benefits accounted for 48 percent of operational costs, on

average. In comparison, services that the wastewater systems purchased from other municipal departments or

private contractors accounted for another 28 percent, and

electricity and other utilities, chemicals, parts, and supplies, the remaining 24 percent.3

But the AMSA survey also shows evidence of the progress

wastewater systems are making in increasing labor productivity. Responding systems had an average of 4.7 fulltime-equivalent (FTE) workers per 10,000 people served,

down from 5.6 FTEs in the 1996 survey and 6.8 FTEs

in the 1990 survey. Because the set of responding systems

changes with each survey, however, those figures may

obscure the actual change over time. A smaller comparison, focusing on the 45 systems that answered both the

1996 and 1999 surveys, shows FTEs per 10,000 people

served falling from 5.0 to 4.7 over those three years, a

reduction of 6 percent.4

One method that systems are using to improve productivity is cross-training to increase the flexibility of their

workforce—for example, by reducing or eliminating the

distinction between “operators” and “maintenance staff.”

Another is reducing staffing, particularly for off-peak

shifts, through more use of automation and communication technologies to allow equipment to operate unattended under normal circumstances.5

Consolidation of Systems

As discussed in Chapter 1, the large majority of drinking

water and wastewater systems are small. All things being

equal, small systems incur much higher unit costs for

treatment and other functions. For example, the Environmental Protection Agency’s data on the costs of monitoring and treatment to comply with the Safe Drinking

Water Act’s standards in force as of September 1994

suggest that the average cost per household was about $4

per year in systems serving more than 500,000 people but

about $300 per year for systems serving no more than

100 people.6

 Among the difficulties small systems face

are a shortage of staff and financial resources to stay current with the latest technologies and management practices and the small scale of their purchases of chemical

supplies and other materials.

Many small water systems, including roughly half of all

small drinking water systems, lie within one of the nation’s roughly 275 metropolitan areas (defined using

census data), and a subset of those may be good candidates for physical consolidation or merger.7

 Some states

have used SRF assistance as leverage to induce small systems to consolidate and to help larger regional systems

absorb smaller neighbors.8

 Alternatively, where the distances make physical connections impractical and thereby

preclude savings from centralized treatment, some efficiencies may still be obtained through consolidating

3. Association of Metropolitan Sewerage Agencies, The AMSA

Financial Survey, 1999: A National Survey of Municipal Wastewater Management Financing and Trends (Washington, D.C.:

AMSA, 1999).

4. Ibid., pp. 12, 67. An alternative measure of staffing—FTEs per

million gallons of water treated per day—also fell by roughly

6 percent, from 3.5 to 3.3, for 41 systems responding in both

1996 and 1999.

5. Apogee Research/Hagler Bailly, Inc., and EMA Services, Inc.,

“Thinking, Getting, & Staying Competitive: A Public Sector

Handbook” (prepared for the Association of Metropolitan Sewerage Agencies and the Association of Metropolitan Water

Agencies, Washington, D.C., undated), pp. 35-36. Many water

systems are finding ways to economize on other operational

costs, notably those for electricity and chemicals. Some of those

savings are found through asset management—in particular,

through the use of life-cycle costing to identify efficient investments in improved technology. 

6. Estimates are in 1992 dollars, based on data in Congressional

Budget Office, The Safe Drinking Water Act: A Case Study of an

Unfunded Federal Mandate (September 1995), pp. 16-17.

7. American Water Works Association, Reinvesting in Drinking

Water Infrastructure: Dawn of the Replacement Era (Washington,

D.C.: AWWA, May 2001), p. 15.

8. The drinking water SRF program prohibits assistance to any

system that cannot demonstrate “the technical, financial, and

managerial capacity to ensure compliance with the [Safe Drinking Water Act] over the long-term.” Environmental Protection

Agency, Office of Water, The Drinking Water State Revolving

Fund: Financing America’s Drinking Water, EPA-816-R-00-023

(November 2000), p. 7.
APPENDIX B MAJOR SOURCES OF EFFICIENCY SAVINGS 53

management, staff, and administrative functions. Even

systems that continue to operate independently may be

able to cooperate in, for example, hiring a “circuit rider”

to provide technical expertise on a shared basis.

Asset Management

As the words suggest, “asset management” refers to efforts

to get the maximum benefit from an organization’s assets,

usually its fixed physical assets. For existing assets, the key

to maximizing the benefits is making efficient choices

about maintenance and replacement. For new assets, the

key is to evaluate total life-cycle costs—not only initial

capital costs but also subsequent operational, maintenance, and disposal costs—to ensure that the investment

is optimally cost-effective.

Active asset management in a large water system is challenging; it requires paying attention to the condition of

equipment and the performance of the system and analyzing the discounted costs of different investment and

maintenance strategies. But the potential for managing

assets efficiently has increased with the advent of sophisticated analytical tools that help optimize the design of

pipe networks (in some cases, identifying links that can

be abandoned rather than replaced) and evaluate the

trade-offs involved in maintaining equipment versus

replacing it. The payoffs of such effort can be significant,

by extending the life of equipment, eliminating redundant equipment, reducing O&M costs by as much as

40 percent, and improving the reliability of the system

by roughly 70 percent.9

Innovative Construction Contracting

Some water systems have found that when the time comes

to construct a new treatment plant (or significantly expand or update an old one), they are able to reduce costs

significantly through the use of “design/build” or “design/build/operate” (DB or DBO) contracting. Whereas

traditional practice involves using one firm (often selected

without competition) to do the engineering design and

then competitively awarding the actual construction to

the lowest bidder, both DB and DBO procurements

bundle the design and construction phases into a single

contract, awarded on the basis of competitive bids that

are judged on cost and quality together. Done properly,

the approach may save time, increase accountability, and

reduce costs (in part by allowing design firms to incorporate more proprietary or specialized methods and technologies and by reducing the need to “overdesign” to avoid

later errors in construction or operation). According to

EPA’s Environmental Financial Advisory Board, some

DBO contracts have yielded savings of 35 percent to

40 percent of project costs.10 Savings claims for DB contracts are commonly around 10 percent or 15 percent.

Two examples of DBO projects that provide clear evidence of cost savings are a 120-million-gallon-per-day

(MGD) filtration plant for drinking water for Seattle,

Washington, and a 1.2 MGD wastewater treatment plant

for Washington Borough, New Jersey. In the Seattle case,

a conventional design was substantially complete by the

time Seattle Public Utilities decided to switch to the

DBO approach, and so more information than usual is

available about the costs of the forgone alternative. On

the basis of engineering estimates in the conventional

design, Seattle Public Utilities has calculated that that

approach would have cost $171 million (in discounted

present value, using 1998 dollars) for construction and

25 years of operations, compared with $101 million

under the DBO contract.11 The savings of 41 percent

may be somewhat overstated, however, because engineering estimates of construction costs do not necessarily

reflect the lowest qualified bid that will subsequently be

received.12

9. Apogee Research/Hagler Bailly and EMA Services, “Thinking,

Getting, & Staying Competitive,” p. 12.

10. Environmental Protection Agency, Environmental Financial

Advisory Board, “Private Sector Initiatives to Improve Efficiency

in Providing Public-Purpose Environmental Services” (July

2001).

11. See “The Solicitation Process” on Seattle’s “Project Summary”

Web page for the Tolt Treatment Facilities, at www.cityof

seattle.net/util/DW/TOLT/summary.htm.

12. David Higgens and Frank Mangravite, “Comparison of DesignBuild-Operate and Conventional Procurements on Washington

Borough, N.J., Wastewater Treatment Plant,” International

Supplement to RCC’s Public Works Financing (July-August

1999), p. 1.
54 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

In the Washington Borough case, the conventional approach was taken one step further, and actual construction bids were received. Using alternative assumptions for

such things as the costs of construction change orders

under the forgone approach, the borough and its advisers

estimate that the DBO contract reduced design and construction costs by between 17 percent and 25 percent and

lowered annual operating costs by 4.2 percent.13

13. Ibid., p. 6.
APPENDIX

&

The 4 Percent Benchmark for Affordability

7he Environmental Protection Agency has never

adopted a measure to indicate how much an individual

household can pay for water services before they become

unaffordable. Yet participants in the current debate use

(and attribute to EPA) the assumption that any household with water bills in excess of 4 percent of its income

is experiencing a hardship. In adopting that notion, they

mistakenly apply to individual households “affordability

criteria” that the agency developed for whole water

systems.

The distinction is important because EPA’s criteria compare the revenues collected by a water system to the

median household income (MHI) in a service area, not

to individual household income. Certainly, average

household costs that correspond to 4 percent of a community’s MHI represent an even higher percentage of the

income of an individual household earning less than the

median. Thus, EPA’s (subjective) judgment that 4 percent of MHI is a reasonable ceiling on a water system’s

yield does not translate into a judgment that each individual household served by that system should pay no more

than 4 percent of its income for water services.

The 4 percent benchmark reflects EPA’s separate figures

of 2 percent each for wastewater and drinking water. The

origins of those individual figures highlight the subjectivity inherent in setting affordability criteria.

EPA’s Affordability Criterion

for Wastewater Systems

EPA’s guidance on the affordability of investment in

wastewater systems uses an average household rate of

2 percent of MHI as one assessment factor in conjunction

with measures of the system’s debt, socioeconomic conditions of the area, and financial management conditions.1

The focus on affordability at the system level is also reflected in the guidance’s reference to a 1988 study examining municipal governments’ ability to issue revenue

bonds to finance environmental compliance. EPA assumed that lending institutions would initially be reluctant to accept ratios of user fees to income that were

much above those already in existence in most communities, but the agency was clearly not concerned about

whether individual households could afford higher rates

—it asserted that as new environmental regulations

gained wider acceptance, lenders would not be put off by

higher ratios.2

1. See Environmental Protection Agency, Office of Water, Office

of Wastewater Management, “Combined Sewer Overflows—

Guidance for Financial Capability Assessment and Schedule

Development,” EPA 832-B-97-004 (February 1997).

2. Financial markets do not use a household-level affordability

criterion in determining a system’s overall financial condition

and credit capacity. But they do consider whether rates that are

comparatively low for a region may constrain asset maintenance

and whether rates that are too high may limit expansion of the

industrial customer base. Rate assessments allow for timely capital improvement plans and rates that reflect the full cost of service. In addition to rates, financial analysts examine the diversity

and breadth of a system’s customer base, the strength of the

local economy, the system’s governance and organizational

structure, the quality of its management and strategic focus, and

its liquidity. See Mary Francoeur, Chee Mee Hu, and Thomas

Paolicelli, Rating Methodology: Analytical Framework for Water

and Sewer System Ratings (Moody’s Investor Service, Municipal

Credit Research, August 1999). Conversation with Chee Mee

Hu, December 17, 2001.
56 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

EPA’s Affordability Criterion

for Drinking Water Systems

EPA was led to establish an affordability criterion for

drinking water systems by the 1996 Amendments to the

Safe Drinking Water Act. The amendments specified that

small public drinking water systems would be allowed to

use less effective pollutant control technologies when designated technologies capable of achieving a maximum

contaminant level for a pollutant or satisfying a treatment

technique requirement were not “affordable.” EPA judged

that a technology was not affordable for a small system

if the associated average expense per household served

exceeded 2 percent of the service area’s MHI. 

EPA settled on 2 percent after seeking a value that would

be “closer to the cost of other utilities, and not significantly less than the cost of specific discretionary items.”3

Consumer expenditures on alcohol and tobacco represented 1.5 percent of 1995 pretax MHI, and expenditures

on energy and fuels accounted for 3.3 percent.4

 From that

range, the agency selected 2 percent, in part because it

was roughly consistent with the premium that some

households were choosing to pay when installing a drinking water treatment device or purchasing bottled water.5

EPA recently decided to raise the value to 2.5 percent of

MHI, which highlights the subjective underpinnings of

the agency’s affordability criterion. The change allows

EPA to designate point-of-use treatment devices as “compliance technologies” because it ensures that average

household charges by small systems installing such devices

would remain below the affordability criterion. In effect,

the change limits the recourse of small drinking water

systems to less effective pollutant control technologies.

3. See International Consultants and others, “National Level

Affordability Criteria Under the 1996 Amendments to the Safe

Drinking Water Act (Final Draft Report),” USEPA Contract

68-C6-0039 (August 1998), pp. 6-2, 4-6; and Environmental

Protection Agency, Office of Water, “Variance Technology

Findings for Contaminants Regulated Before 1996,” EPA 815-

R-98-003 (September 1998), p. 19.

4. Environmental Protection Agency, Office of Water, “Variance

Technology Findings,” p. 45.

5. International Consultants, “National Level Affordability Criteria,” p. 4-3.
APPENDIX

'

Acknowledgments

0any people assisted the authors of this study, by typing drafts, reviewing drafts, providing helpful information,

editing and proofreading the study, and preparing the final version for printing and for posting on the Congressional Budget

Office’s Web site (www.cbo.gov). Taking responsibility for any remaining errors, the authors want to express their

appreciation to the people listed below for their contributions.

Congressional Budget Office

Christine Bogusz

Tracy Foertsch

Ed Harris

Annette Kalicki

Angela Z. McCollough

Susanne Mehlman

John Peterson

John Skeen

Eric Warasta

David Weiner

Kathryn Winstead

Rae Wiseman

Dennis Zimmerman

Environmental Protection Agency

Steve Allbee

George Ames

Veronica Blette

Alvin Edwards

Kit Farber

John Flowers

Terry Grindstaff

Sandra Perrin

David Travers

Kevin Weiss
58 FUTURE INVESTMENT IN DRINKING WATER AND WASTEWATER INFRASTRUCTURE

Other

Janice Beecher, Beecher Policy Research

Mel Blackwell, Universal Service Administrative Company

Larry Bowman, U.S. Department of Agriculture

Caroline Carbaugh, U.S. Census Bureau

Peter Cook, National Association of Water Companies

Claudia Copeland, Congressional Research Service

John Cromwell, PA Consulting

Michael Deane, United Water

Andreas Deppe, formerly of Hagler Bailly Services

Rick Farrell, Council of Infrastructure Financing Authorities

Lee Garrigan, Association of Metropolitan Sewerage Agencies

Jim Gebhardt, New York Environmental Facilities Corporation

Barbara Gottschalk, formerly of the Massachusetts Water Resources Authority

Jon Harcum, Tetra Tech, Inc.

Thomas Holtmann, Joint Committee on Taxation

Eric Keil, Bureau of Labor Statistics

Ken Kirk, Association of Metropolitan Sewerage Agencies

Jim Land, Federal Communications Commission

Amy Laskey, Fitch Ratings

Robert Lenna, Maine Municipal Bond Bank

Randall Lutter, American Enterprise Institute

Steven Maguire, Congressional Research Service

Alan Manning, EMA, Inc.

Guy Nagahama, First Albany

Charles Noss, Water Environment Research Foundation

Tom Paolicelli, New York City Municipal Water Finance Authority

Mark Poland, CSO Partnership

Kirby Posey, U.S. Census Bureau

George Raftelis, Raftelis Consulting

Bill Reinhardt, Public Works Finance

Glenn Reinhardt, Water Environment Research Foundation

Haydn Reynolds, Haydn Reynolds and Associates

Kenneth Rubin, PA Consulting

Margot Saunders, National Consumer Law Center

Jon Schellpfeffer, Madison Metropolitan Sewerage District

Nick St. Angelo, Department of Health and Human Services

Buzz Teeter, American Leak Detection

Steve Via, American Water Works Association

Marcelo Vieira, Bond Market Association

Al Warburton, American Water Works Association

Wolf Weber, Bureau of Labor Statistics

Colleen Woodell, Standard & Poor’s

John Young, American Water Works Services Company