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Congressional Testimony
April 11, 2002 Thursday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 3387 words
COMMITTEE:
HOUSE ENERGY AND COMMERCE
HEADLINE:
DRINKING WATER INFRASTRUCTURE
TESTIMONY-BY: MR. DAN L.
CRIPPEN, DIRECTOR CONGRESSIONAL BUDGET OFFICE
AFFILIATION: FORD HOUSE OFFICE BUILDING
BODY: Testimony The Committee on Energy and
Commerce W.J. "Billy" Tauzin, Chairman
Drinking Water Needs and
Infrastructure Subcommittee on Environment and Hazardous Materials
April
11, 2002
Mr. Dan L. Crippen Director Congressional Budget Office Ford
House Office Building
Mr. Chairman and Members of the Subcommittee, I am
pleased to be here today to discuss future investment in drinking
water
infrastructure. My testimony draws on findings from a forthcoming
Congressional Budget Office (CBO) study that was requested by this Subcommittee
and by your colleagues on the Transportation and Infrastructure Committee.
CBO's testimony before the Subcommittee last year emphasized that
estimates of investment spending through 2019 are very uncertain- in part
because many important data are not readily available-and existing estimates may
be too large. Today, I can make those points more concretely by presenting CBO's
estimates of a low- cost and a high-cost case, which are intended to span the
most likely outcomes within the full set of possibilities. I will begin by
presenting estimates of average annual investment costs under the two cases and
then discuss how CBO derived the estimates and how they differ. I will also
compare those projections with an estimate of the current burden of investment
in drinking
water infrastructure and examine how future
investment might affect household budgets. Finally, I will compare CBO's
estimates with the much- publicized figures from the
Water
Infrastructure Network (the WIN coalition). My testimony focuses on
capital investment in drinking water systems, but it also presents estimates of
future operations and maintenance (O&M) costs under both a low-cost and
high-cost scenario.
Before discussing specific dollar figures, I would
like to emphasize that society as a whole pays 100 percent of the costs of water
systems, either through ratepayers' bills or taxes. Thus, the goal of many
water-industry advocates to make water services more "affordable" can be met
only by reducing the total costs of providing such services or by using taxes
and government subsidies to redistribute their costs from some people to others.
Depending on the method used, the net effect of such redistributive efforts may
be to shift costs from low-income to high-income households, from large to small
users of water, or from ratepayers served by high-cost systems to those served
by low-cost systems. Taxes and subsidies may also distort prices and reduce the
incentives for efficient choices by system managers and consumers, resulting in
the unwanted side effect of higher total national costs for water services.
CBO'S 20-YEAR ESTIMATES
CBO projects that annual capital costs
for drinking
water infrastructure will average
$
11.6 billion from 2000 to 2019 under the low-cost case and
$
20.1 billion under the high-cost case. (Unless otherwise
specified, all costs are in 2001 dollars.) Annual O&M costs over the same
period are projected to average $
25.7 billion under the
low-cost case and $
31.8 billion under the high-cost case. CBO
chose the 2000-2019 period for its analysis to make it easier to compare its
estimates with those of the WIN coalition. Data on actual investment spending in
2000 and 2001, which are provided by the Census Bureau's Survey of State and
Local Government Finances, are not yet available.
Three more points will
help clarify the nature of CBO's estimates. First, they are intended to
represent the minimum amount required to achieve the goals of maintaining
desired levels of service to water customers, meeting federal standards for
drinking water quality, and maintaining and replacing assets cost-effectively.
They exclude investments whose sole purpose is to serve future growth; that is
because much of the data underlying them come from the Environmental Protection
Agency's (EPA's) Drinking
Water Infrastructure Needs Survey,
which focuses only on investments eligible for assistance from the
state
revolving funds, or SRFs. Because of a lack of data, CBO's estimates
also exclude investments to increase the security of drinking water systems.
Preliminary indications suggest, however, that security costs will be small
relative to the estimates presented here.
Second, the estimates measure
costs "as financed" and thus take into account the use of borrowing to spread
the investments' financial burden over time. In particular, for each year of the
20-year period, CBO's estimate includes two things: the costs of that year's new
investments that are paid for out of funds on hand-that is, on a pay-as-you-go
basis; and the debt service (principal and interest) paid that year on previous
investments financed through loans and bonds. Economists usually measure
investments in terms of their current resource cost-which covers the capital
cost of all current investments, regardless of how they are paid for, and
excludes payments on past investments. The current resource cost is preferred
over other measures of investment volume for analyzing the efficient use of
society's resources, such as the costs and benefits of water-quality
regulations. But CBO's present analysis takes the water-quality and service
goals as a given and focuses on the costs of meeting those goals. For that
purpose, measuring costs as financed is more useful because it better indicates
the burden facing water systems and their ratepayers at a given point in time.
Third, the relatively large difference between CBO's estimates of
20-year investment requirements under the low-cost and high-cost cases-the
former is 42 percent below the latter-reflects the limitations of the available
data. Indeed, although the two cases are intended to bracket the most likely
outcomes, CBO does not rule out the possibility that the actual level of
investment needed could lie outside that range.
HOW CBO DERIVED ITS
ESTIMATES
As CBO's previous testimony emphasized, some key data for
estimating future investment, such as the average age and condition of the
nation's existing
water infrastructure, are not readily
available. Since CBO could not fill that gap by collecting new data from the
nation's 45,000 community water systems, its strategy in developing its low-cost
and high-cost cases was to take maximum advantage of existing data and analyses.
In particular, CBO analysts used the basic approach developed by the WIN
coalition, working from a study of pipe replacement needs by Stratus Consulting
for the American Water Works Association and from estimated requirements for
other investment categories derived from EPA's Needs Survey. CBO chose not to
rely on the Needs Survey alone; even though the survey strives to include all
relevant investments over a 20-year period for drinking water systems
nationwide, EPA reports that its results do not fully cover the whole period.
(According to EPA, planning documents used by many systems as the basis for
their responses to the survey often cover just one to five years.) The Stratus
study used a different approach than the survey uses to estimate pipe
replacement needs: it combined some national-level data and various assumptions
to estimate 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 rate of pipe
replacement.
Although CBO's low-cost and high-cost cases draw on the
same sources of data, they differ in the assumptions for six factors: three
concern the capital costs estimated by Stratus and EPA, and three involve the
costs of financing the investments (see Table 1). The most critical assumption
is the rate at which drinking water pipes will be replaced over the 20-year
period: the low- cost case assumes an average annual rate of 0.6 percent, and
the high-cost case assumes a rate of 1 percent. That factor alone accounts for
most of the difference-$
8.5 billion annually-between the two
sets of estimates. Using a rate of 0.6 percent in the high-cost scenario would
narrow the difference to $
3.4 billion, a reduction of 60
percent.
The lack of data on the condition of existing water pipes is
the basis for CBO's view that plausible estimates of the annual replacement rate
could be as far apart as 0.6 percent and 1 percent. Both rates have their
genesis in the Stratus study. The study's primary analysis assumed an average
annual replacement rate of 1 percent, apparently as a compromise between the
rates implied by standard rules of thumb about pipe service lifetimes and the
rates actually reported in studies from the mid-1990s. However, the Stratus
study also presented another approach: analysts estimated when
TABLE 1.
FACTORS DISTINGUISHING CBO'S LOW-COST AND HIGH-COST CASES
SOURCE:
Congressional Budget Office.
pipes would reach the end of their useful
lifetimes on the basis of the assumption that the rate at which pipe miles were
installed over time was proportional to the rate of population growth. According
to that analysis, the bulk of the replacement cost will not occur until some
time after 2020, and the average replacement rate required from 2000 through
2019 will be on the order of 0.6 percent.
Similar uncertainties underlie
the rest of the differing assumptions that CBO used in the low-cost and
high-cost cases. Examples of improved management methods and new technologies
here and abroad, plus conversations with industry experts, lead CBO to believe
that efficiency gains will reduce future investment needs- but whether the
savings will be on the order of 5 percent or 15 percent is hard to predict with
any confidence. CBO also cannot precisely determine the costs associated with
future drinking water rules, the share of investments that will be financed
through borrowing, the average borrowing term, or the real (inflation-adjusted)
interest rate.
CBO's analysis of future O&M spending used simpler
methods, and only one factor distinguishes the estimates under the two cost
scenarios. For the high-cost case, CBO merely extrapolated a linear trend from
real 1980-1998 spending on O&M; for the low- cost case, CBO started with the
same linear trend but phased in savings of 20 percent, resulting from improved
efficiency, over the period from 1995 through 2004. Those simpler methods
probably do not capture as much of the true uncertainty surrounding future
O&M costs as do CBO's more-detailed models of capital investment, but again,
O&M was less central to the analysis-in part because it is not eligible for
aid under current federal programs.
COMPARING FUTURE COSTS AND CURRENT
SPENDING
One useful way to view estimates of future investment costs is
by comparing them with a baseline of current spending. For the present purpose,
however, the available data on current spending are inadequate because they do
not measure spending in terms of costs as financed. Specifically, the data
include the capital costs of all investments made 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 the necessary information is
available, CBO's best estimate of investment spending is $
11.8
billion, measured in terms of costs as financed. However, developing that
baseline required CBO to make many assumptions- for example, about the extent to
which drinking water systems borrowed to finance investments over the previous
20 years. Alternative assumptions could have changed the result, perhaps by 20
percent.
The difference between that estimate of 1999 investment
spending (as financed) and CBO's estimates of average annual investment from
2000 through 2019-sometimes dubbed the funding gap-is essentially zero in the
low-cost case and $
8.3 billion in the high-cost case. The
possibility reflected in CBO's low-cost scenario-that the average yearly burden
of investment in drinking
water infrastructure through 2019
might not exceed the 1999 level- contradicts conventional wisdom; however, CBO
considers that scenario reasonable, given the uncertainty about how soon pipes
will need to be replaced, the prospects for increased efficiency, and the
potential for water systems to fund more of their investments through borrowing
and to borrow for longer terms. Of course, the estimate of future needs under
the high-cost case- representing an increase of about 70 percent over estimated
spending in 1999-is also considered reasonable, if less optimistic.
THE
POTENTIAL IMPACT OF HIGHER COSTS ON HOUSEHOLD RATEPAYERS
Supporters of
increased federal aid for investment in
water infrastructure
often argue that rising costs will make households' water bills "unaffordable."
Under CBO's high-cost case, bills for drinking water and wastewater combined
would still represent less than 1 percent of income for the average household,
although that share would be larger for many households that have low income or
that are served by high-cost systems.
CBO estimates that in the late
1990s, average bills for drinking water and wastewater services combined
represented 0.5 percent of average household income. To derive that estimate,
CBO used data from the Consumer Expenditure Interview Survey (conducted by the
Census Bureau under contract with the Bureau of Labor Statistics), which
analysts supplemented by imputing bills for the 39 percent of survey respondents
who did not report their own. That imputation, which was based on the water
bills of respondents with comparable income, may bias the estimate upward,
because many respondents without separate water bills are apartment-dwellers,
who use less water for lawns and gardens than do residents of single-family
homes.
To analyze the impact on households of future investment and
O&M spending by drinking water and wastewater systems, CBO first estimated
the rates that would be required by 2019 to pay for that spending, holding
support from all levels of government constant. It then compared the result with
incomes in that year, taking into account projections of real income growth. The
share of average household income going to water bills in 2019, CBO estimates,
would be 0.6 percent and 0.9 percent under the low- and high-cost scenarios,
respectively.
Of course, averages can mask important differences in
individual cases (see Figure 1). For example, half of all households spent 1
percent or less of their income on water bills in the late 1990s while others
spent significantly more.
COMPARING CBO'S AND WIN'S ESTIMATES
The WIN coalition's estimates of future investments in drinking water
and wastewater infrastructure do not measure costs either as financed or in
terms of resource costs. When its estimates for the 2000-2019 period are
expressed in terms of costs as financed, they are close to CBO's for the
high-cost case.
For each year of the period, WIN's estimates add the
cost of that year's pay-as-you-go investments to the total debt service
(principal plus interest, in constant dollars) to be paid in later years for
newly financed investment. Thus, where a costs-as- financed estimate includes
the current debt service paid on past investment, WIN's estimates include future
debt service on current investment-much of which will be paid after 2019.
The impact of that difference is substantial (see Table 2). WIN's
published estimate of average annual drinking water investment needs from 2000
to 2019 is $
26 billion (in 2001 dollars); using costs as
financed reduces the estimate by about 18 percent,
FIGURE 1. WATER BILLS
AS A SHARE OF HOUSEHOLD INCOME SOURCE: Congressional Budget Office. FOUND ON
HARD COPY
TABLE 2. CBO'S AND WIN'S ESTIMATES OF INVESTMENT NEEDS FOR
DRINKING
SOURCES: Congressional Budget Office;
Water
Infrastructure Network.
a. Relative to a 1999 baseline.
b. Relative to a 1996 baseline.
c. CBO's approximation of WIN's
results.
to $
21.4 billion. The reason for the decrease
is that the cohorts of investment financed yearly from 1980 through 1999, and
still being paid off from 2000 through 2019, are smaller than the new cohorts
that are projected to be financed during the latter period. When expressed in
comparable terms, WIN's estimate is roughly 6 percent and 84 percent higher,
respectively, than the estimates for CBO's high- and low-cost cases.
Similar contrasts emerge in comparing average future investment with
baseline spending. Again, WIN's estimate of the difference between the two
levels of investment drops significantly-from $
13 billion per
year to $
9.4 billion-when it is expressed in terms of costs as
financed. And again, the latter figure is roughly $
1 billion
higher than the estimate for CBO's high-cost case and $
10
billion above the estimate for its low-cost scenario.
The fact that
WIN's estimates are close to those of CBO's high- cost case when both are
expressed in comparable terms should not be interpreted as independent support
for estimates of that magnitude. CBO and WIN used the same modeling approach,
and CBO's high-cost scenario used specific assumptions that are broadly similar
to WIN's. Thus, it is not surprising that the resulting estimates are also
similar. The lesson that CBO draws from comparing the three estimates is that
under the basic framework of the modeling approach, fairly pessimistic
assumptions are required to obtain estimates as high as WIN's.
Given
WIN's estimates, it is also not surprising that the coalition sees water bills
as accounting for a larger share of future household budgets than CBO does. In
particular, WIN projects that 22 percent of households will be paying more than
4 percent of their income for water services by 2009 (halfway through the study
period) and talks more generally about "a third or more of the population"
reaching that level as rates continue to adjust. (The fraction of households
paying more than 4 percent of their income is simply one of many summary
measures that can be derived from the distribution of water bills. There is no
economic or scientific significance to 4 percent as the threshold at which water
bills become "unaffordable.") In contrast, CBO's estimates for the end of the
study period in 2019 show 11 percent of households paying above 4 percent in the
low-cost case and 21 percent doing so in the high-cost case.
Part of the
difference between CBO's and WIN's projections lies not in the different
estimates of future levels of investment but simply in different conclusions
about current spending. CBO estimates that 7 percent of households paid more
than 4 percent of their income for water services in the late 1990s; using other
data sources, WIN estimates that 18 percent paid that much. WIN's approach is
more limited, in two respects. First, the approach uses data only from the state
of Ohio, which WIN finds to be representative of the nation as a whole in its
costs for drinking water relative to household income. Second, the approach
relies on system-level data (specifically, data from 1997 on drinking water and
wastewater charges for using the equivalent of 250 gallons per day) rather than
on the actual bills paid by individual households based on their own use. WIN's
method may bias its results if low-income households tend to use less than 250
gallons of water per day.
In conclusion, CBO agrees with the consensus
of industry experts that the nation's drinking water systems will require
additional investment in the decades to come. But CBO's estimates make clear
that the timing of the increase is not at all certain, nor is its ultimate size
predictable, once savings from improved management and new technology are taken
into account. Similarly, CBO agrees that higher rates for drinking water and
wastewater services over the next 20 years may lead households to pay a larger
share of their income for them. However, CBO's estimates of the potential impact
higher rates would have on households are much smaller than those reported by
the WIN coalition. Moreover, economists would argue that such considerations
should be addressed through policies that redistribute income-not those that
manipulate the price of water.
LOAD-DATE: April
29, 2002