EconoMonitor

Ed Dolan's Econ Blog

How to Protect Wetlands and How Not to Do it: Lessons from Tax Policy

Tax reform is a hot topic. Both Republicans and Democrats say they’re for broadening the tax base, closing loopholes, and lowering tax rates. Bruce Bartlett’s new book is getting a lot of well-deserved attention. So while we’re at it, why not reform implicit taxes, too?

Regulations to protect wetlands, to the extent that they reduce the economic value of affected property, are a prime example of an implicit tax. If they go so far as to reduce the economic value of the property to zero, they constitute a regulatory taking. Under the Fifth Amendment, the government must then pay compensation to the landowner. However, courts have typically found that regulations that serve a public purpose but do not reduce the economic value of a property to zero are not a taking and do not require compensation.

I will leave constitutional arguments about regulatory takings to others. Instead, I would like to use the perspective of tax policy to analyze the economics of wetland protection.

Wetland regulation regularly makes the news at both national and local levels. At the national level, consider last week’s Supreme Court decision in Sackett vs. EPA. (Here is a link to the case and another to a more readable summary from the Washington Post.) The case involves an Idaho couple who trucked in some fill dirt to level a lot for a home. After they had done so, the EPA informed them that they had filled a protected wetland. It issued a compliance order requiring them to remove the fill and restore the wetland, at considerable expense, or face a heavy fine. The Sacketts attempted to appeal the EPA’s order but were told such orders are not subject to judicial review. The Supreme Court did not rule on the merits of the EPA’s compliance order, but it did give the Sacketts a procedural victory with a ruling that such orders are subject to review.

On the local level, wetland protection is a big issue in San Juan Co., Washington, where I live. The county is in the last stages of approving a new Critical Areas Ordinance. One of its major goals is to protect wetlands, which are abundant here. It is rare to find working farms that contain none, and some farms are up to 80 percent wetlands. The ordinance also affects residential property.

Let me interrupt the economic discussion to make it clear that personally, I think wetlands are great. I know there are some people who have the old Corps of Engineers mentality that sees a swamp as something to be drained and a puddle as something to be filled, but I am not one of them. I fully agree that wetland protection is a legitimate concern of public policy. My issue is not with protection per se, but with how to achieve it.

Short of outright acquisition of a property where a wetland is located, the best way to protect it is to acquire a conservation easement. A conservation easement places a legal duty on the property owner not to disturb the wetland. Easements can be perpetual or limited in time. They usually convey when the property is sold or inherited. There are three ways to acquire a conservation easement, the first two of which are voluntary and the third involuntary.

One is by donation. For example, the conservation organization Ducks Unlimited protects some 12 million acres of wildlife habitat throughout North America, much of it under conservation easements donated by landowners. Under the right circumstances, donation of a conservation easement can provide the owner with substantial tax benefits.

A second way to acquire a conservation easement is by purchase. For example, the Wyoming Land Trust acquires conservation easements both through purchase and donation.

The third way to acquire a conservation easement is through confiscation without compensation. The EPA’s compliance order against the Sacketts and the San Juan County Critical Areas Ordinance are examples of acquisition of conservation easements through confiscation.

Let’s look at these approaches to acquiring conservation easements from the perspective of tax policy. Each approach involves a different way of allocating the tax burden.

Purchase of conservation easements requires the government to spend funds raised from tax revenue or from borrowing against future tax revenue. How great the economic burden is and who it falls on depends on how good the tax system is. In a good system—one with a broad base, few loopholes, and low marginal rates—the excess burden of the tax is kept to a minimum. Since many of the benefits of wetland protection are widely spread among the population, it makes sense to fund them through broad-based taxes. To the extent we can identify groups, say duck hunters, who benefit disproportionately, we could make a case for more targeted taxes, say, fees for hunting licenses.

Encouraging private donations of conservation easements through tax deductions turns the acquisition of conservation easements from a budget outlay into a tax expenditure. The government must make up loss of tax revenue from a tax expenditure by raising other taxes, reducing other expenditures, or borrowing. Not all landowners will necessarily be positioned to benefit from tax deductions; for example, low-income owners may benefit less than high-income owners. For that reason, using tax deductions to encourage donations of conservation easements is equivalent to offering different prices to different landowners, prices that vary not according to the value of the easement but rather, according to tax position of the owners themselves. On the whole, then, use of deductions is less consistent with good tax policy than are easement purchases.

The third approach, regulatory confiscation of easements without compensation to landowners, amounts to an implicit tax in kind. The burden of the tax falls narrowly on owners of wetland property. The tax rate may be very high, in some cases approaching 100 percent. Narrowly based taxes with high and variable rates are the least consistent with good tax policy.

Another way to judge the merit of a tax is by looking at the incentives it provides. In this case, we are interested in incentives to balance the benefits of wetland protection against the costs.

Purchases of conservation easements with funds from general tax revenue provide the best incentives.  In this case, the government, having a limited budget for wetland protection, has an incentive to make offers first on the easements that provide the greatest benefits. Owners will tend to accept those offers if the impact on the economic value of the property is less than the proposed compensation, and reject them if not. The result will be maximum environmental benefit for any given cost.

A policy of encouraging donation of conservation easements by making them tax deductible also encourages some degree of balancing costs against benefits. On the owners’ side, there is an incentive to balance because the size of the tax deduction available depends on the amount by which the easement reduces the economic value of the property. On the government side, we can presume that regulators, like private organizations that solicit donation of easements, would retain the right to reject donations that had trivial or no environmental benefits. Overall, though, the balancing is less precise than for purchase of easements. For one thing, the same easement has greater value to some donors than others depending on their underlying tax position. In addition, the value of the deduction does not come from an actual market transaction, but instead, from an assessment. The assessment process (described here) is both costly and subjective. At best, it can give only an approximation of the economic values at stake.

A policy of confiscating conservation easements without compensation provides the least incentive to balance benefits against costs. From the government side, conservation easements become a free good. That gives regulators an incentive to extend protection to every puddle, no matter how trivial its environmental value, and leave owners to fight back if they dare.

Owners have an incentive to put more resources into fighting regulatory actions that have large impacts on economic values than those with small impacts, but even there, the balancing is highly uncertain. It is difficult for landowners to know whether the conditions on a given site do or do not constitute a protected wetland. Regulations sometimes try to accommodate this problem by allowing traditional uses to continue. Suppose, for example, that you have grown hay on a field that has standing water during the winter months. Probably you will be allowed to continue growing hay, but what if you want to build a barn or plow up a part of the field to plant organic strawberries? That is likely to require some permit or hearing and it may turn out not to be possible.

There is also a problem for new owners. There is no requirement that a seller disclose the wetland status of a property, and indeed, the seller may not know the status. Neither are regulators required to give a binding opinion to the buyer. Even if the buyer invests in an expensive consultant report, there is no guarantee that regulators will accept it as dispositive.

One might expect regulators to avoid investing scarce administrative resources in sites that have small environmental value and large economic costs that would make landowners more likely to fight back. However, the regulatory process does not always conform to such rational behavior. As the Sackett case illustrates, both sides may sometimes be willing to invest vast sums in legal battles over underlying values that are small in both economic and environmental terms.

In sum, when we test wetland protection policy by the standards of tax economics, we arrive at a clear conclusion: If we grant that there is a public policy purpose in protecting wetlands, the best way to do so is through purchase of conservation easements using funds from general tax revenues. Encouraging donations of easements in exchange for tax deductions is a second-best approach. Confiscation of easements without compensation is clearly the worst, whether you call it a regulatory taking, an implicit tax, a tax in kind, or whatever.

I would like to end the discussion at this point, but I anticipate an objection from my conservationist friends and neighbors. I am certain they will object that requiring compensation of landowners would make protection of wetlands unaffordable, given today’s tight budgets at all levels of government. Here is how I would reply.

First, what does it mean for something to be unaffordable? It means that those who have to pay receive benefits that do not justify the costs. Environmentalists make the claim (in many cases a sound one, in my view) that wetland protection produces broad public benefits. If so, and if those benefits exceed the costs of protection, why shouldn’t the pubic pay through general tax revenue? Why should the costs be borne narrowly by a relatively small group of wetland owners? On the other hand, if the benefits fall short of the costs for some sites, then protecting them really is “unaffordable” and should not be undertaken.

Personally, I find it very hard to accept the notion that something that is “unaffordable” becomes “affordable” if you just have the temerity to take it without paying for it. Let’s say you’re a teenager from a poor neighborhood. You spot a nice BMW that you’d really, really like to have, but you can’t afford it. But wait! The owner has carelessly left the key in the ignition! Suddenly the car is “affordable!” Off you go in your new BMW.

Is that the kind of logic we have to resort to in order to justify protecting wetlands? I hope not.

Second, just in case the argument from affordability does not work, let me offer a more pragmatic one based on politics. The public supports environmental protection, but that support is not without limit. Public support is a scarce resource that conservationists should cherish and expend only where it will do the most good. Wetland protection, as currently practiced, often recklessly disregards that common-sense principle. Private conservation organizations have the good sense to go spend their limited resources wisely. They prioritize. They go after the most environmentally valuable objectives first. They even reject donations of land or easements if maintaining them would have costs greater than their environmental value.

In contrast, regulations are often so broadly drawn that they seem determined to bring  every puddle within their scope. The government comes down like a ton of bricks on small fry like the Sacketts. That couple, with their six-tenths of an acre, were threatened with fines of up to $75,000 per day. What do regulators get in return? Maybe some individual EPA officials are able to build their careers on cases like that, but what the environmental cause as a whole gets is a big political backlash.

There is a real danger that the backlash will produce a rollback as mindless as the regulatory effort itself sometimes seems to be. It is likely to sweep away the good with the bad. And who will be at fault? In my view, no one but those environmentalists who actively encourage regulatory overreach; the ones for whom “property rights” and “costs” have become four-letter words; the ones who extoll the balance of nature but have lost sight of the concept of balance among human interests.

13 Responses to “How to Protect Wetlands and How Not to Do it: Lessons from Tax Policy”

rjsigmundMarch 28th, 2012 at 8:29 am

i live in a wetlands, a real one (Burton wetlands, Geauga) …no problem with protecting them

i have a problem with the definition, at least as it's been applied in ohio…a part of someones property that is wet a few months of the year can be so designated, even if its bone dry all summer…

LeahMarch 28th, 2012 at 11:16 am

Remember that wetlands are not always wet; there are many types of wetlands, such as vernal pools, which are only "wet" during the spring. By comparison, uplands (the dry land) are not always dry – sometimes they can be flooded if they are located within a floodplain – but this does not mean they get designated as a 'wetland' simply because they get flooded once in a while. A wetland is a wetland based on hydrology, hydric soils and wetland-dependent vegetation, and sometimes wetland-dependent species of wildlife that live in them. For some helpful examples, go to http://aswm.org or read the blog at http://aswm.org/wordpress

rjsigmundApril 1st, 2012 at 9:06 am

it's exactly that definition of wetlands that i object to: "based on hydrology, hydric soils" – when in on-the-ground reality some such areas may have no unique characteristics worth protecting…

Ed Dolan EdDolanApril 1st, 2012 at 11:16 am

Right. I hope you notice the comments by Ed Kilduff and Gary Alexander later in this thread. They agree with you, as do I. The technical definition is fine for science, but it is largely devoid of economic content.

Tom WackerMarch 28th, 2012 at 9:52 am

I have property with wetlands in a town that has been conserving wetlands for over 30 years. I was aware that wetlands are protected when I bought it and don't feel I'm entitled to compensation for my lost use of them since I never expected to have the use of them in the first place. I'll take a windfall from the govt, like the next guy, but to rewrite the rules now and tell everyone with wetlands that they are entitled to compensation doesn't seem necessary to me. Furthermore, I benefit from restrictions of others' wetland developement by keeping the water in front of my house clean.

Ed Dolan EdDolanMarch 28th, 2012 at 10:11 am

Fair comment, Tom. Like many kinds of property taxes and land use restrictions, the burden of changes in wetland regulations falls largely on the owner of the land at the time the change was made. The loss (or gain, depending on the kind of regulation) is then capitalized into the value of the property, and new owners are not affected.

Any compensation scheme would have to recognize that point. That is one of the reasons I compared wetland regulation to a perpetual easement that conveys with the property. In your case, hypothetically a former owner would have been compensated for the easement, but you would have bought it subject to the easement, paying an appropriate price, and would not be eligible for compensation unless the rules where changed or reinterpreted in some substantive way.

You also touch on another issue that complicates the narrative–the possibility that the beneficial external effects of wetlands protection raise the value of adjacent properties. Usually these regulations are imposed area-wide, so I would suppose that the proper compensation that would be paid would be based on the net effect on the value of the property of the change as applied to the whole area.

Where the wetlands are an interconnected system that you cannot leave one parcel out of, you have the further problem of potential holdouts. However, even if the wetlands system were so interconnected that regulators had to use some eminent domain concept to ensure that no unregulated parcels remained, I would still say fair compensation should be paid, just as in the case, for example, where the government uses eminent domain to take part of your land for a road.

burkbraunMarch 28th, 2012 at 11:50 am

Why should the landowner be the one to tabulate the "cost" of a wetland, as per a tax/purchase scheme? This relegates wetland protection to only the most marginal parcels, while the public benefit may depend on protecting far more expensive parcels (on bay fronts, ocean vistas, and the like). I think the calculation of public benefit needs to take substantial precedence here, without being your straw man of "free takings". Which would require some limit, such as an absolute amount of acreage per year, or a land exchange system.

RandyMarch 18th, 2013 at 10:47 pm

I'm not sure I follow your argument here. The government can condemn (take away development rights and/or ownership) pretty much any property it chooses. Why should it get to pay the same for waterfront property as inland property with less market value? And the takings discussion does not relate to a "straw man." It's a fundamental provision of the Bill of Rights.

Ed KilduffMarch 29th, 2012 at 8:59 pm

One of the Amicus Briefs for the Sackett case pointed out that, in the last wetlands case before the Supreme Court (Rapanos), the Court ended up with 5 separate opinions, none of which commanded a majority. The Brief explained that the Court's collective confusion mirrored the larger world regarding wetlands: that it is not at all easy to conclude with any certainty that wetlands (waters of the US) were or were not on a given property. They pointed out that wetlands had achieved the same legal status as Justice Stewart's definition of pornography, namely, that "I know it when I see it." The Court has encouraged EPA and the USACE to come up with a more reliable methodology for identifying wetlands, but despite years of effort, they have not. The best they have come up with is guidance, which is not applicable everywhere and is not enforceable.

I mention all this because the issue associated with this "tax" is complicated by the uncertainty and capriciousness of its application, and the skill (or lack of it) of the people who identify wetlands and thereby apply the "tax". Wetlands are regulated on an "I know it when I see it" basis, and that is an intolerable situation for those subject to this "tax." Coupled with this difficulty is a growing mainstream environmental misconception that wetlands are fragile and need to be left entirely alone. This flies in the face of other ecological notions, such as permaculture, which seek to integrate human, agricultural, and ecological practices.

In short, this "tax" burden could be lessened greatly and applied more rationally. When it is not applied rationally or fairly, this adds to the feeling of overreach that Ed warns us about.

Bryan WillmanMarch 30th, 2012 at 1:34 pm

Another issue with "protection by fiat" is that it never ever deals with areas in cities already (often long ago) filled in or otherwise rendered environmentally unsound. So while somebody who fills in a puddle might get huge daily fines, the city of Seattle, large parts of which are built upon various kinds of fill and large scale terraforming (duwamish fill, denny regrade) pays no such fines, yet gets huge economic benefit.

So it sometimes amounts to "since we destroyed lots of wetlands building the very valuable city we live in, to avoid destroying the remaining wetlands, we'll stick those of you with the misfortune to own and pay taxes any remaining wetland with 100% of the burden of preservation" Aside from being unfair and a kind of nasty misdistribution of wealth and costs, it creates horrible incentives. Have any kind of resource that might someday be environmentally important? Consume or destroy it Right Now!

From a tax perspective, one can argue, for example, that every landholder in Seattle should be required to pay a special tax to compensate the rest of the area for not finishing the task of wetlands destruction that Seattle began.

Gary AlexanderMarch 30th, 2012 at 2:22 pm

Living on Lopez, along with Ed Dolan and Ed Kilduff, I have read both sides of this debate in the local press and I've heard various highly opinionated comments on both sides. I am greatly encouraged by the balanced rationality of Ed Dolan's tax-related solutions and the sensitivity to real-world roadblocks in Ed Kilduff's comment. I hope San Juan county is listening carefully to both Eds. Ed K wrote that enforcement is "complicated by the uncertainty and capriciousness of its application, and the skill (or lack of it) of the people who identify wetlands." Part of Hayek's theory of the "fatal conceit" of central control is that real-life regulators lack the wisdom of Solomon. Where the rubber meets the road — or the boots meet the puddles — we have fallible human beings with the legal power to tax or destroy. With budget cuts and personnel cuts in local government, I fear there will be a premium on the quick grab — i.e., rapid revenue enhancement — and less on due process. Real people follow the path that benefits their own careers and their jurisdiction's bottom line. What's their incentive for implelementing your rational and balanced solution?

Eric CartmanMarch 18th, 2013 at 10:43 pm

Sadly, San Juan County declined to evaluate the economic impact of the proposed new CAO; they didn't think it necessary, and were encouraged to think this by legal advice. Even assuming that the GMA does not require consideration of economic impact (it does), it is beyond me how a rational governing body could ignore it.

EFFJune 8th, 2012 at 3:51 pm

In addition to the takings aspect of the regulations that impose new involuntary encumbrances against existing principle interests in property," these regulations fly in the face of open space taxation", acts that are created to provide benefit to voluntary conservation.