The Libertarian Perspective On California Water

Private property rights in all water, combined with full-cost pricing in free water markets, is the best (and indeed only) way to match California's vast water supplies to its growing water demands. In practice, this means

• ending the subsidies that make water for agriculture often cost ten times less than urban water, in exchange for giving farmers secure and fully transferable property rights in whatever grandfathered allotments they reasonably deserve;
• defining secure and fully transferable private property rights not only in all surface water but also in all groundwater, so that (for example) environmental groups are given full ownership of water shares needed for ecosystem maintenance;
• making all urban and agricultural water customers bear the full cost of the water they get, while also receiving the full profits when they use less than they are alloted and thus release (i.e. sell) water back into the system;
• allowing efficient and transparent market transfers of water rights 1) among users within water distribution systems, 2) between water distribution systems, 3) between water basins, and 4) between states (such as those with shares of the Colorado River);
• resisting calls for expensive and ecologically suspect new water projects as long as the above policies are not yet implemented.
  

This libertarian prescription of free water markets has been well presented by free-market think tanks like the Pacific Research Institute and the Reason Foundation. The best analysis I've seen so far is Ending California's Water Crisis - A Market Solution to the Politics of Water by Erin Schiller and Elizabeth Fowler (Pacific Research Institute, 1999). Its themes are underscored by Why Water Markets Can Solve California's Water Crisis - Amy Kaleita (Pacific Research Institute, 2008). An earlier study is Water Marketing In California - Richard Wahl (Reason Foundation, 1993).

For up-to-the-minute analysis, I recommend the blog http://aguanomics.com. For example, just today Dr. Zetland posted his analysis of California's draft 2009 water plan. His prescription:

1. Amend state law to require that ALL water rights (ground, surface, riparian, etc.) be adjudicated.
   
2. Retire ALL water rights that have not been exercised for over 10 years.
   
3. Direct DWR and SWRCB to formulate "plain vanilla" procedures to facilitate short term (<1 yr) water transfers within water basins and between basins.
   
4. Require that water resellers raise rates if water consumption rises above long-term (50+ year reliability) average water supplies. Keep raising them until consumption is below sustainable yield.
   
5. Require that ALL directors of a water district or agency resign if a shortage is declared and require a one-term cooling-off term before they can seek reelection.
   
6. Allocate space on "oversubscribed" conveyance according to market mechanisms (i.e., auctions).

Here's his Water Plan: "Structure rates such that everyone gets a human right allocation of water, allow trading among those who have (ground/surface) water rights, and make sure that the price of water fluctuates with water scarcity." Exactly.

Cut Taxes All The Way To The Ground

A land value tax is not necessarily any worse in terms of forfeiture than any other kind of tax. The government comes after almost any/all of your assets if you owe it taxes.  However, I wouldn't necessarily have land be forfeit when the landholder fails to return the geo-rent to the community (i.e. pay the "property tax").  We could let unpaid taxes accrue with interest as a lien against the eventual sale or transfer of the land, with the amount due capped at the market value of the land at the sale or transfer.

The reason economists say that taxes on land value (and pollution or congestion of a commons) is the "least bad" tax is that such taxes have no deadweight loss.  Any tax on production or exchanges or movable assets causes economic inefficiency.  A tax on these things causes a deadweight loss (i.e. allocative inefficiency) because people who would have more marginal benefit than marginal cost are not buying the good or service, just as a subsidy causes people to buy who impose more marginal cost than their marginal benefit.  However, this effect of taxation does not happen when the supply of the taxed good is perfectly inelastic, as is the supply of land -- more precisely, the area on the surface of the Earth. Sites cannot hide, they cannot flee, and the available amount of them cannot be changed.  (When a tax is not on a good but rather on a "bad", like pollution or congestion, it's the very absence of the tax that causes allocative inefficiency, because external costs are not internalized.)

"Taxing" land value (i.e. geo-rent) is less unjust than any tax on production or exchanges, because geo-rent is not created by the land-holder.  Geo-rent is the extra income a site earns because of the exclusivity of its location within the community, as compared to what such a site would earn at the edge of the community.  (Technically, geo-rent is the extra production you get from exclusive use of a site compared to the most productive available site that is not in use, given the same inputs of labor and capital.)

Taxing geo-rent is not only more efficient than taxing production or exchanges, but it also is less intrusive.  All the government needs to know is who owns each plot of land and how much the unimproved land is worth.  Appraisers and insurers make such calculations routinely, and one variant would have each land-holder self-assess as long as he's willing to take any offer over his assessed value.  There's no need to audit anyone's behavior, as with taxes on income/production/exchanges.  You don't even need to visit the site or look over the fence, as you do with taxes on land improvements or square footage.

Finally, taxing geo-rent imposes a built-in ceiling on government revenue.  Critics of land value taxes claim they wouldn't raise enough revenue because geo-rent is allegedly only a small fraction of GDP.  That sounds like a good thing to me.   If government revenue is restricted by definition to geo-rent and fees for polluting/congesting/consuming the commons, then government cannot be nearly as big as when it is allowed to tax labor, production, exchanges, and all resulting products.  Once you have taxation of people's labor and exchanges and produced assets, there is no limit to what the government can take from you.

Professor Foldvary lays out all these arguments in these two excellent papers:

• The Ultimate Tax Reform: Public Revenue from Land Rent - Foldvary (2006)
• Geo-Rent: A Plea to Public Economists - Foldvary (2005)