The regulation of a spatially heterogeneous externality: Tradable groundwater permits to protect streams

Groundwater pumping can reduce the flow of surface water in nearby streams. In the United States, recent awareness of this externality has led to intra- and inter-state conflict and rapidly-changing water management policies and institutions. Although the marginal damage of groundwater use on stream flows depends crucially on the location of pumping relative to streams, current regulations are generally uniform over space. We use a population data set of irrigation wells in the Nebraska portion of the Republican River Basin to analyze whether adopting spatially differentiated groundwater pumping regulations leads to significant reductions in farmer abatement costs and costs from damage to streams. We find that regulators can generate most of the potential savings in total social costs without accounting for spatial heterogeneity. However, if regulators need to increase the protection of streams significantly from current levels, spatially differentiated policies will yield sizable cost savings.