What is a market-based approach to water quality?

Last week, the U. S. Department of Agriculture (USDA) and the U.S. Environmental Protection Agency (EPA) released a joint letter to state and tribal regulators encouraging market-based, collaborative approaches to reduce excess nutrients in waterways. But, few other details were offered on how to best take this approach. Now that the EPA has released some clarifications around the Waters of the U.S. ruling, it appears new efforts could be on the horizon.

The total cost of fixing Iowa’s water quality problem comes with a price tag of $4 to $6 billion in a state with an annual total budget of $7 billion. Recognition of this constraint is why some market-based approaches to water quality are being discussed or are active in early stages of trials and pilot projects. Here, we dive in and provide an overview to three possible market-based strategies for water quality improvement: nutrient reduction exchange, wetland mitigation banking, and environmental impact bonds.

Nutrient reduction exchange

Comparable to a cap and trade program, this approach ties downstream municipalities to upstream partners through voluntary efforts to reduce nutrients in waterways. This approach focuses on reducing nitrogen and phosphorus and leveraging cost-effective projects that would be more affordable than removing nutrients at a water treatment plant. An exchange also provides point source polluters the chance to purchase offsets from nonpoint sources. This approach has been tried in the Ohio River Basin, and the Iowa League of Cities is spearheading an effort to adopt a nutrient reduction exchange in Iowa. Their efforts include a nascent registry within the Iowa Department of Natural Resources. Critics of this approach include Food and Water Watch.

In 2018, Senate File 512 passed through the Iowa Legislature, which allocated 45 percent of its available funds to a water quality financing revolving loan fund, known as Iowa’s Drinking Water State Revolving Loan Fund. Projects financed through this fund could be eligible as part of a nutrient reduction exchange. Other funding sources could be made available through the EPA’s Section 319 Nonpoint Source Management Program which provides grants for states towards mitigation. The EPA also issued policy guidance on water quality trading in 2003.

Wetland mitigation banking

Wetlands can minimize flood risks by holding and slowing the flow of water, allowing nutrients and sediment to filter themselves out of the water. Wetlands also provide natural habitat for birds and waterfowl. Many of Iowa’s natural wetlands have been drained for agricultural production and other development. With this strategy, farmers are asked to take land out of production to re-establish wetlands, which can filter hundreds or thousands of acres depending on the size. However, under this system, farmers get no return on that investment, and they can lose revenue by taking land out of production. The incentive and benefits of wetland mitigation banking lie more downstream than with farmers. With wetland mitigation banking, downstream interests are fronting the costs of establishing wetlands rather than farmers.

The idea behind wetland mitigation banking is to provide new investments toward water quality and flood mitigation by restoring wetlands. If developers want to build and must destroy a wetland, they could construct a new wetland or purchase wetland credits in the same watershed. A landowner would benefit by having the upfront costs of developing a wetland covered and enjoy reduced property taxes. Projects would make the most sense on land that has poor crop production value.

Environmental impact bonds

Environmental impact bonds have been used recently by major cities to finance infrastructure projects to improve water quality, particularly from stormwater runoff. Washington, D.C., first used this financial tool in 2016, followed by recent announcements by Baltimore and Atlanta to issue their first environmental impact bonds. What makes environmental impact bonds different from other green bonds is that they use a “pay for success” model focused on achieving environmental outcomes, which requires them to have a measuring and monitoring component for investors.

Iowa could use environmental impact bonds as a financing tool for municipalities to invest in upstream structural practices—unlike Washington, D.C., Atlanta, and Baltimore which used environmental impact bonds for urban infrastructure projects. Environmental impact bonds are a new tool, but show promise to investors by basing the return of these funds on whether structural projects actually achieve their water quality improvement goals.

In conclusion

Each of these strategies for market-based water quality improvement may have a role to play in cleaning up the state’s waters. State officials, private industry, localities, and constituents must work together to identify innovative strategies that leverage public and private funding if progress is to be made. As Iowa continues to debate its water quality issues, market-based strategies could play a key role in building a cleaner, healthier, and more productive future for the state.