August 27, 2019

A Cap-and-Trade System to Cure Minnesota’s Agricultural Drainage Decision-Making

Zach Sibley

Introduction

Farmers across the U.S. Midwest share a common enemy—standing water on their fields. To maximize the agricultural potential of their fertile lands and leverage economies of scale, public drainage systems have emerged over the past century as the ubiquitous weapon in this fight. The laws governing these systems share in that history. These laws, however, reflect a one-directional process: increase drainage and farmable land.  Now Minnesota’s increased public drainage imperils the state’s downstream land, crops, and water resources. From the downstream landowner’s perspective, these laws mean more frequent flooding resulting in eroded bluffs and banks, increased deposit of debris on downstream lands and lakebeds, and drowned farmland.

Complicating the issue for downstream owners further, these laws leave primary drainage decision-making up to local drainage authorities. Because the watercourses receiving drained waters do not neatly follow county lines, many costs occur outside the local drainage decision-maker’s jurisdiction and fail to be accounted for in its cost-benefit analysis. A properly designed cap-and-trade system, however, could formally introduce cost proxies to better inform the local cost-benefit analysis and encourage localities to reduce their share of increasing peak flow levels through adoption of available mitigation measures. In this way, a cap-and-trade system would most efficiently minimize downstream ecological costs.

Part I of this article provides background on agricultural drainage and introduces Minnesota’s drainage law. Part II analyzes the economic problems with the current drainage regime and compares two alternative legal instruments: a Pigouvian tax and a cap-and-trade system. The analysis will show the cap-and-trade approach provides the most efficient solution to minimize downstream harms from agricultural drainage.

I.  Background

The increased frequency and intensity of downstream flooding is linked to “large-scale land conversion and intensification of agriculture.” Increased drainage means these upstream acres “store less water” and cause runoff to be “higher and more flashy.” The result is increased “peak runoff rates, sediment, and pollutant loads to surface-water resources.” Current peak flow levels and the frequency of large precipitation events produce bank erosion threatening to pull homes and land into rivers, flooding of farms causing crop loss, and the sedimentation of downstream lakes that hinder public enjoyment.

These adverse effects, however, can be mitigated. Management factors like tillage practices and drainage system design, depth, and spacing affect how dramatic these results are downstream. For example, holding water upstream for five to ten more days during high precipitation events and snowmelts would significantly reduce these costs. Available best management practices (BMPs) for drainage system designs can achieve this longer upstream water retention. The goal of this article is to outline a system that makes these BMPs more cost-efficient than increasing drainage with little regard to the effect on peak flow levels or the subsequent costs.

A.  Minnesota Drainage Law Overview
Minnesota Statutes Chapter 103E governs the state’s public agricultural drainage systems. In the language of the statute, public agricultural drainage uses “ditches” that are either open trenches or underground water-carrying tile lines. Ditches facilitate the drainage of water left on agricultural land following precipitation and spring runoff events, discharging those waters into existing watercourses like public rivers. The process to establish or improve a ditch system is referred to as a “proceeding.” A county drainage authority—typically the county’s board of commissioners—conducts a proceeding and has primary jurisdiction to issue final orders regarding drainage determinations.

Drainage proceedings are “purely statutory” and require “strict compliance” with the statutory provisions. Petitions by affected landowners initiate proceedings. Once a petition is filed, no petitioner may withdraw without written consent from all other petitioners. A petition must show the project promotes the “public health,” and that it provides for the “public welfare” or a “public benefit.” Findings of public health and public welfare “must give proper consideration to conservation of soil, water, wetlands, forests, wild animals, and related natural resources, and to other public interests affected.” If a drainage authority finds the petition satisfactory, it appoints an engineer to make a preliminary survey that follows considerations listed under section 103E.245. The drainage authority then holds a preliminary hearing to determine whether the project is feasible and necessary before continuing to more in-depth planning.

To complete a proceeding, the drainage authority orders the engineer and selected “viewers” to prepare detailed cost-benefit reports. Using the engineer’s survey of affected lands, appointed viewers assess the drainage benefits and damages. Their report must also include a benefits and damages statement. The benefits assessed are typically based on: “(1) an increase in the current market value of property as a result of constructing the project; (2) an increase in the potential for agricultural production as a result of constructing the project; or (3) an increased value of the property as a result of a potential different land use.” Damages to be compensated include: “(1) the fair market value of the property required for the channel of an open ditch and the permanent strip of perennial vegetation . . . ; (2) the diminished value of a farm due to severing a field by an open ditch; (3) loss of crop production during drainage project construction; (4) the diminished productivity or land value from increased overflow; and (5) costs to restore a perennial vegetative cover or structural practice existing under a federal or state conservation program adjacent to the permanent drainage system right-of-way and damaged by the drainage project.” The viewers’ report is limited to assessment of damages on lands identified by the engineer, whose survey is likely limited to lands within the jurisdiction.

Consideration of extra-jurisdictional impacts instead comes under section 103E.015, subdivision 1. These considerations appear throughout a drainage authority’s preliminary and final hearing determinations, and the commissioner of the Minnesota Department of Natural Resources (MDNR) also advises on the environmental impacts at both stages. The reconciliation of the local benefits and damages assessment with these extra-jurisdictional environmental considerations, however, lacks explicit guidance. With no priority of considerations or specified weight, the drainage authority enjoys significant deference in balancing these factors. A drainage authority may go so far as reaching contrary conclusions than those recommended in the MDNR’s advisory letters.

Finally, aggrieved parties may, as their exclusive remedy, appeal to the drainage authority. These proceedings do not provide much relief for parties aggrieved by delayed downstream impacts. Extra-jurisdictional parties are generally not given notice of, and so do not participate in, drainage authority hearings meaning exhaustion of administrative remedies and issue preclusion prevent them from appealing. Rather, those parties with later downstream environmental losses are likely left to common law and statutory environmental rights remedies. Minnesota’s adherence to the appeal right as the exclusive remedy, however, significantly impedes downstream access to these alternative legal remedies.

II.  Analysis

The adverse downstream effects of Minnesota’s increasing agricultural drainage are negative externalities. Upstream drainage authorities ignore these extra-jurisdictional costs in its county-level welfare analysis since the costs are not felt by its constituents. The absence of these costs places a thumb on the scale in favor of local agricultural benefits, skewing decision-making toward increasing agricultural drainage while simultaneously forgoing the costs of implementing BMPs that would otherwise cut into their bottom line.

This article explores legal mechanisms that could correct this misalignment without substantially disturbing the confines of existing drainage law. As the analysis will show, neither the state common law nor its statutory language merely encouraging consideration of downstream environmental effects efficiently achieve this end. Instead, an environmental regulation leveraging a private market structure would better harmonize the value of additional upstream agricultural land with the cost of downstream flooding, erosion, and siltation. The ultimate goal is a system that encourages practices that will reduce peak flow levels following major precipitation events and rapid snowmelts. This requires incentives to implement BMPs and better retain water on upstream lands during these events. In other words, the preferred legal tool will induce upstream drainage authorities to behave as if they were also the owners of the burdened downstream properties.

A.  Environmental Regulations
Common law consistently loses out to environmental regulation in remedying environmental harms because regulation provides superior process, remedies, and standards. The public legislative process, rather than private litigation, better determines the socially desirable amount of peak flow levels. Environmental regulation also encourages preventative remedies where possible and a more cost-effective reactive remedies through sector-wide peak flow reduction enforcement rather than piecemeal, county-specific reductions. Environmental regulations also avoid the cost and ineffectiveness of litigating causation for diffuse environmental harm. Finally, environmental regulation standards allow the level of environmental quality achieved to be based on the public merits of the desired outcomes and not subject to the piecemeal balancing of individual plaintiff and defendant interests.

Given these benefits, this article focuses on environmental regulations and compares the different regulatory options by their cost-benefit analysis, instrument choice, and allocation of policy making responsibility. In particular, this article evaluates two general instruments: an externality tax and Coasean bargaining. Under Minnesota’s drainage laws, the cost-benefit analysis is flawed. Primarily it suffers because statutory language and lack of enforcement allow the undervaluing of the downstream environmental considerations. While all environmental cost-benefit analyses struggle with valuing nonmarket goods, here there are available proxies such as decreased property values, loss of real estate to erosion, debris removal, and drowned crops.

Current Minnesota law also poorly allocates decision-making responsibility. As Joseph Sax noted in his seminal public trust essay, “many aspects of local self-interest are as inconsonant with the broad public interest as are the projects of private enterprises. In both situations one may observe behavior which is rational from the atomistic perspective of the actor, but which, from the perspective of the larger community, is highly disadvantageous.” Minnesota’s allocation of decision-making to local interests is not doomed to be inefficient, however, so long as rational, self-regarding jurisdictions are introduced into a perfectly competitive market. To fix the current regulations, then, the instrument should formalize downstream environmental costs in a drainage authority’s analysis and creates a competitive market for abating peak flows.

B.  The Alternative Policy Instruments
Environmental regulations range from command-and-control standards to completely market-controlled abatement. Market-based approaches combine the desirable public and preventative features of environmental regulation with the case-by-case flexibility of common law by making public use of private interests. Command-and-control standards often fall short of the environmental benefits and cost effectiveness achieved under market instruments and better serve as complements to market instruments, such as a standard matching the cap set by a cap-and-trade system. Moreover, standards are highly technical, politically sensitive and malleable, and prove less cost-efficient.

A tax instrument mandates a price for unabated peak flow levels beyond a certain quantity through a tax. Cap-and-trade, conversely, mandates a certain system-wide quantity of peak flow that is measured by allocating tradeable allowances. These alternatives are evaluated on: (1) the flexibility provided for regulated parties; (2) the ease of enforcement; (3) the information necessary to implement; and (4) the incentives created for abatement technology development.

i. Peak Flow Contribution Tax
Taxing peak flow impacts would add the external cost of drainage into a drainage authority’s cost-benefit analysis. A tax may make the implementation of BMPs more fiscally responsible when it would negate the potential tax liability for increasing drainage capacity that would in turn increase a watercourse’s peak flow. It would also encourage drainage authorities to seek out reduction opportunities on other projects to reduce its tax burden. Taxes use simple enforcement measures and make political sense since the drainage law is itself an exercise of government taxing authority. This price-focused instrument avoids political disputes over distribution of allowances. The fixed price is predictable and provides drainage authorities flexibility to determine the right level of peak flow that makes financial sense for the county, which offers greater marginal cost certainty by limiting costs drainage authorities will incur to achieve reductions. A credible, long-term commitment to the tax provides a strong incentive to invest in BMPs. Finally, the tax generates state income that can be recycled into downstream cost reductions like installing erosion control measures or put toward lowering other social costs like a state deficit.

Unfortunately, a peak flow tax is likely an impracticable in the drainage context. A tax does not guarantee abatement. A tax is also costlier for the drainage authorities because they pay both the abatement costs plus the tax for unabated peak flow. A tax also presents practical limitations. First, since peak flow measures how much water could potentially discharge during high precipitation events and snowmelts, there is a practical question whether to tax projected contributions or determine each ditch’s actual peak flow contribution at great expense. Second, since prior projects were funded by private parties, there is an issue of whether the tax would apply retroactively and reopen prior projects to challenges where the tax raises costs above public benefits. Retroactivity may be unfair on petitioners who would have objected to the project had this extra cost been calculated in. Third, in the absence of retroactive effect the incentive to reduce current peak flow levels would be eliminated, requiring a complementary standard to instead regulate all pre-tax projects to achieve reduction.

ii. Cap-and-Trade
Cap-and-trade uses transferable discharge allowances to set socially acceptable peak flow levels. This “cap” may be first set above the desired quantity to start and slowly decreased over time as drainage authorities achieve reductions in peak flow levels. By better defining and allocating property rights in standing water, cap-and-trade can allow for Coasean bargaining to cure the imbalance between upstream benefits and downstream costs.

Cap-and-trade is particularly effective for diffuse environmental externalities. Cap-and-trade minimizes marginal compliance costs through “what, where, and when” flexibility. “What” flexibility means drainage authorities may use whichever BMPs achieves reduction at the lowest cost. “Where” flexibility means the market will encourage BMPs and peak flow reductions on those projects and in those counties where they will be most cost efficient—counties facing lower costs to retain water will be compensated by selling the resulting allowances to counties facing higher abatement costs. “When” flexibility means design features like banking and borrowing allowances as well as multiyear compliance periods give drainage authorities time to abate and do so when it is most cost effective. Moreover, the sale price of an allowance and the ability to bank them may encourage peak flow reductions well below the system-wide cap.

Additionally, distributional effects of allocating the allowances can be left to public decision-making and the allocations provide a straightforward way to compensate uniquely burdened drainage authorities. For example, distributing drainage allocations should be partially free and partially auction-based. Free distributions can provide smaller drainage authorities—those with less abatement opportunities or lower-income farmers—a level field in the tradeable allowance market. The remaining allowances would then be auctioned off, with the revenues being recycled back into downstream mitigation projects or used to offset other social costs.

Drawbacks to a cap-and-trade can also be mitigated through careful design. Cap-and-trade is a quantity-setting instrument, presenting price uncertainty that fluctuates with economic changes. Design features like banking, borrowing, and multiyear compliance periods provide the “when” flexibility needed to decrease price sensitivity to exogenous economic changes. Other drawbacks similarly hinder the efficiency of the other alternative instruments. For example, tax exemptions and free allocation decisions are vulnerable to the same political maneuvering. Considering that both a tax and a cap-and-trade system can result in similar economic effects, the preference for the cap-and-trade system turn on whether it is more politically feasible and whether it avoids the practical design issues presented by a tax. Here, the cap-and-trade system likely answers both questions in the affirmative. The flexibility of a cap-and-trade system, its ability to introduce cost proxies for downstream damages into local cost-benefit analyses, and the ability to encourage reduced peak flow levels indicate that the cap-and-trade system provides the most efficient solution to cure shortcomings under Minnesota’s current drainage regime.

Conclusion

A cap-and-trade system would most efficiently cure the downstream harms perpetuated under Minnesota’s current agricultural drainage regime. Common law remedies do not provide efficient remedies for such aggregate, time-lagged environmental harms. Rather, environmental regulation provides the better avenue to introduce downstream costs into a drainage authority’s cost-benefit analysis and promote statewide reductions. A properly designed cap-and-trade system would avoid the inflexibility of a pure standard and impracticability of a tax. This market-based approached would create a cost proxy for downstream environmental harms, add those costs to local cost-benefit analyses, encourage the use of water retention practices, and promote the most cost-efficient measures to decrease overall peak flow levels.

    Zach Sibley

    Zach Sibley graduated from the University of Minnesota Law School in 2019 with a concentration in environmental and energy law. He is a staff attorney with the Dane County Circuit Court in Wisconsin.

    This article was the third-place winner of the 2019 ABA Water Resources Law Student Writing Competition.