Groundwater Externalities, Water Pricing, and Land Use Change

Abstract:

A tax on an input to production may correct consumption externalities, and induce input-saving technological change. This paper analyzes a volumetric groundwater pricing program that was implemented to address water quality and quantity externalities arising from groundwater irrigation. We use high resolution panel data on farm-level land and groundwater use to identify the short-run effects of this water pollution tax on groundwater use, crop choice, land fallowing, and land conversion. We find evidence that a large increase in water prices leads to significant resource reallocation: farmers responded to a 31% increase in prices with a 27% decrease in overall groundwater extraction, a 16% decrease in irrigated agriculture, and a 23% decrease in total agricultural land. Agricultural water pricing may be a cost-effective tool to manage groundwater resources under California's Sustainable Groundwater Management Act, and adapt to increased water scarcity induced by climate change.