new york city's

In the early 1900’s, the state granted New York City the power to assemble and regulate more than 2,000 square miles of watershed lands in the Catskills Mountains, 125 miles to the north and west of the city. It is an area nearly the size of the state of Delaware and comprises the largest surface watershed in the world. Its environmental condition is essential to providing safe and clean drinking water for the nearly eight million residents of New York City. The watershed area, however, contains within it more than sixty towns and villages. Recent housing and commercial development in these towns has negatively affected the watershed’s nineteen reservoirs. Levels of non-point source pollution have been increasing in the streams feeding the reservoirs, prompting concern over the risk of carcinogen buildup and microbial disease. New York City is considering regulation of uses in the watershed area in order to eliminate the adverse external effects town development has on the city’s water quality.

In 1991, the New York City Department of Environmental Protection (NYCDEP) began to draft proposed regulations that controlled the number of sewer and septic tank hookups allowed within the upstate watershed counties. These regulations would have the effect of severely limiting the number of housing permits and development rights for large areas of land critical to the economic health of many Catskills towns. After analyzing the proposed program of regulation, we have concluded that the regulations will strictly curtail the market for housing in the Catskills, will inefficiently shift costs of maintaining water quality, and will lower the value of Catskill land and development instead. Although the land use regulations are relatively easy to implement and would result in answering the socially desirable needs of the residents of New York City, the program will impose great economic costs on those living within the watershed area itself.

Proposed Regulations

After Congress passed the Safe Drinking Water Act in 1986, most large metropolitan areas were forced to evaluate their water supply system’s ability to ensure quality drinking water. The Federal Environmental Protection Agency (EPA) directed New York City to demonstrate that the Catskills reservoir system, the largest unfiltered watershed in the country, could maintain purity for the next quarter century. If the city could not comply, it would be forced to build an immense filtration plant at a cost of $8 billion dollars and hundreds of millions more to operate yearly.

For nearly 75 years, the city was unaware of the effects rural development growth in the Catskills had on its watershed. Much of the prime land for housing development is located along stream valleys feeding the reservoir system. The proposed regulations would require all lands within 100 feet of the water course to be strictly regulated as to wastewater disposal, stormwater drainage and sewer and septic connections. New York City has estimated these regulations would affect 80,000 additional acres in the watershed area not under its control. New York City views pollution created by private market development as an externality requiring governmental intervention in the development market. Many Catskills residents, however, see just the opposite. They claim upstate towns are being asked to bear the primary cost of providing a resource consumed by outsiders.

Regulation’s Inefficiency Effects on the Housing Market
One way to gauge the economic costs of the regulations is to examine the effect limits on housing permits have on Catskills land values. These limits have two primary effects on the market. First, the price of existing housing will increase. With fewer houses available on the market, demand will be met at a higher price. This effect was seen in a study of development controls on the California coast. Houses sold before the use regulations were enacted were more costly than those sold after. The researchers attributed the increase in value solely to the reduced supply of building sites available rather than the value obtained through proximity to the conserved coastal zone (see Figure 2).

The second effect regulations will have is to decrease the value of undeveloped land in the area. By decreasing the number of houses that can be built, demand for land parcels on which to build houses will also decrease. Less demand for regulated land will mean the value of land parcels will decrease. This effect was shown in a study on rural lot restrictions in Rochester, Minnesota. In a situation similar to the Catskills, increased development in rural Rochester was contaminating the groundwater supply. The county responded by regulating the minimum lot size for housing to two acres. The regulations resulted in high demand for two acre or larger lots, while the value of lots smaller than two acres lost much of their economic value.

By denying full use of the land through governmental power, land use regulations allow the city to claim benefits while avoiding the full cost of purchasing the land - an inefficient market condition. In economic terms, the city does not consider marginal costs when regulating the use of a parcel of land. It will seek to regulate as much land for which its marginal benefit is positive, possibly designating more land than is necessary (see Figure 3). If however, the city had to face the opportunity cost associated with preventing land development, it would seek to preserve land until the point where the marginal benefit of regulating an additional acre was equal to its marginal cost -- a significant cost factor that might prevent the city from achieving its objectives.

Appeal of Regulatory Techniques
Although land use regulations severely affect the functioning of the housing market, it is a policy that works extremely well in achieving environmental objectives at a minimum cost to government agencies. By declaring polluting activities in the watershed illegal, regulation is attractive to governmental bodies for its simplicity, uniformity, and ease of use. As a governmental entity, New York City would prefer regulation to the time-consuming and frustrating political process of consensus- building with Catskills landowners and local jurisdictions. Regulation skirts the need to identify the true magnitude of costs, while ensuring the preferred outcome of maintaining water quality is reached. Regulation can be seen as an indicator of the city weighing equity factors. New York City has decided government intervention is necessary in order to safeguard the health of 8 million city dwellers over the property interests of the 200,000 residents of the Catskills watershed. We believe, however, using regulation overlooks more efficient options of government intervention. These options would not only ensure water quality, but compensate for costs borne by the Catskills housing market as well.

Options for Correcting Externalities

There are several methods other than regulation that New York City could employ to correct development-caused externalities in the Catskills watershed. Market-oriented government interventions allow supply and demand to decide allocation of resources while acknowledging external costs, thus creating optimal social welfare. We believe the following options may achieve more efficient market conditions in the Catskills - taxes, subsidies, creating a market for permits and outright purchases of affected land.

Levying taxes on development in the watershed can be an effective way of reconciling the social costs related to development activities. A developer would have to consider the cost a tax would add to his location and production decisions, effectively raising his marginal private cost by an amount equal to the damage his project would inflict on water quality. The city could set tax rates so that sensitive areas nearest the reservoirs would be charged the highest rates. Facing increased costs in these areas, developers would build fewer houses. This approach brings the market to efficiency - developers can still build profitably at a level that minimizes their own costs, while development is cut back to respond to the costs of pollution.

Subsidies are another alternative that provides incentives to developers for not building on sensitive land. For every lot left undeveloped, a certain amount of money would be given to the owner equal to the costs development would have inflicted on water quality. After receiving this subsidy, the developer would scale back production in order to maximize his profits at the higher subsidized cost level. In essence, the profit the developer foregoes by not developing the lot is reimbursed to him through a government subsidy. It would be the city’s responsibility to establish a subsidy amount which would entice the developer not to build. Although this approach would make the housing market more efficient, the amount of the subsidy would be complicated for the city to calculate. The subsidy must relate a damage cost to water quality as well as take into account the production costs of the developer. Assessing the differing subsidies required to leave 80,000 acres undeveloped and locating a revenue source to generate the funds would be the primary difficulties to using this option.

Creating a Market for Permits
Selling building permits can help move the market to efficiency by establishing another cost for the developer to consider. The city would set levels of how many lots could be developed and either sell the permits at an established price or allow them to be traded on the market. The two methods allow the city to establish the level of development that can be tolerated, while allowing the private market to decide on the final value of the right to develop. Permits can be sold at a price that covers the costs to water quality a development would produce. Payment could be in the form of dedicated land, developer financed construction of sewage facilities, or a negotiated impact fee. In the case of marketable permits, the developers would bargain with one another for a limited number of development rights, deciding amongst themselves the highest value for the permit. This method is being employed to preserve the New Jersey Pine Barrens from sprawl development. Local property owners within the preserved zone may transfer out their development rights to targeted areas. This allows the governmental body to limit adverse development while local jurisdictions still receive the revenues lost from protected land.

Land Purchase
The best solution to resolving the Catskills development issue is for the city to purchase the 80,000 acres of sensitive land outright. By obtaining the clear rights and title to the property, the city has absolute and total control over development. In essence, the government would act as a private firm, negotiating with the landowner a fair market value for each property. This approach depends on the city determining the number of parcels it needed to insulate the reservoirs from pollution, and matching those needs with willing land sellers in the affected area. This is the most politically difficult of all the options. The cost required to purchase the land would most likely be raised by increases in city water rates. A recent study by the city estimated yearly household water rates would have to rise from $4 to $7 in order to generate the $1.2 billion dollars needed to purchase land (see Figure 4). Although this is a significant cost, it is preferable to the fiscal cost of building an $8 billion dollar treatment plant. This option also holds the most promise of directly solving the problem. By working on a consensus solution regarding property purchases and environmental planning, the city and the Catskills residents can make sure that all of the social costs of ensuring safe water quality and property rights values are considered.

This paper was written by John Fontillas and Colleen Alderson

1. Frech, H.E. III, and Ronald N. Lafferty 1984. “The Effect of the California Coastal Commission on Housing Prices.” Journal of Urban Economics. 16:105-23.
2. Pyle, Lizbeth A. 1985. “The Land Market Beyond the Urban Fringe.” The Geographical Review. 75:32-43.

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