A tax policy strategy faces with future water availability using a dynamic CGE approach

In last years, policy demand for information about the economic consequences of water management has increased significantly. It is due to the interaction between the hydrological and economic realm works both ways: water is transformed for economic use and the impact of economic use on water availability and quality consequently has implications in both the short and long term for the transformation process to modify water for economic use (Brower and Hofkes, 2008). From literature, it is demanded additional analysis on policy interventions that could provide an incentive for adaptation responses to climate change (Dinar, 2012). Policy strategies could mitigate the longer-term economic effects of environmental change. In this line, the main purpose of this work is to find a tax policy strategy to apply to water management that lets mitigate the economic-wide impacts of water constraints, specifically in drought years, through an improvement in water efficiency in the long term. To do it, we use the methodological approach of a dynamic computable general equilibrium model (CGE). These models take into account the various inter-linkages between economic sectors and are particularly useful for the evaluation of water pricing policies (Brower and Hofkes, 2008). Therefore, an additional objective of this paper is to contribute to a growing literature that uses CGE models as a tool for the analysis of water management due to the majority of the studies are usually focused on energy and climate change. Since the challenge of water is a long-term matter, dynamic CGE models can help us to analyze water management with a view of the future economic impacts. These models present a wide range of possibilities that lead us to compare the economic impacts between a standard neoclassical CGE model with the ones of a model following a structuralist approach (Taylor, 1990). On the other hand, specific water basin models can help to evaluate and predict the impact of policy interventions on both economic and water systems (Brower et al., 2008). With these questions in mind, we examine the economic impacts from different alternative policies in a Spanish region which is dominated by a relevant irrigation scheme. The Ebro River Basin is the Spain´s largest river basin, occupying 17 per cent of its territory. Within the Ebro River basin, the irrigation of the province of Huesca has over 200,000 hectares, representing almost 40% of the utilised agricultural area (UAA) of Huesca and the 6% of the agricultural irrigated farmland in Spain (MARM, 2010). The output generated by the irrigation of Huesca reaches over 80% of total agricultural production in the province (DGA, 2009). The rationale for choosing the province of Huesca in Spain is based on various aspects. First, the major irrigation scheme of Spain is located in this area, which covers over 127,000 hectares, in particular, the Upper Aragon Irrigation System (CGRAA in Spanish acronyms) which includes 58 irrigation communities. This irrigation scheme also supplies water to several towns and cities, as well as ten industrial estates, and it is highly representative of irrigation in the Ebro valley. Second, the ready availability of data and collaboration in previous studies with this scheme has provide relevant information on water uses, levels of efficiency, cropping patterns and crop yields from 2001 to 2010, that mean that the CGRAA is ideally suited for the purposes of this study. In recent years, this irrigation scheme faces with a downward trend of water supply and some restrictions in water resource availability due to among other reasons the revegetation of headwaters, see Bielsa et al. (2011), the effects of climate change and the lack of regulation in this irrigation scheme. The current levels of water use efficiency in this irrigation scheme are very significant and suppose an efficient use, although it could be improved. They represent a great leap if we compare with the situation three or four decades ago. However, the volume of water supply in some years is insufficient for crops such as corn, rice, alfalfa or fruits, which are the most profitable and with high interest for agri-food industry, livestock and imports. These water constraints are provoking shocking changes in the cropping pattern removing towards less water demanding crops and with lower profitability, instead of the expected evolution (more weight of fruits, vegetables, corn,...). Finally, the water situation in this irrigation scheme could be a reflection on the situation in other arid areas with water constraints or with a downward trend in the volume of water available in the last years. In these areas the introduction of the most profitable and demanding crops could be really limited by the lack and insecurity of water supply. This water situation is represented into a recursive dynamic computable general equilibrium model that is developed with different structures and used for policy simulations. It is a multi-sector model in which water is also considered as a production factor. In this paper, we evaluate the economic impacts of alternative assumptions applied to different tax policies that combine both exogenous and endogenous technological change. First, the results are presented with a standard CGE model in a steady state reference scenario with a 2030 time horizon. A second scenario takes into account the real evolution of water supply in the last years in this area. This forecast is based on a downward trend of water supply and water constraints that lead to water productivity losses in drought years. Keeping the use of a standard walrasian CGE model, this scenario shows that future droughts will drastically influence on the prices of water. In a third scenario, we include in the model a structuralist approach in which water prices are under control to assess the economic impacts of tax policies designed to stabilize the price of water and as a consequence, to smooth the economic-wide impacts in drought years. In a fourth scenario under a standard walrasian approach again, we simulate a tax policy designed to increase water efficiency through endogenous technological change. The level of water efficiency follows a Gompertz function that starts from the real initial value, increases gradually and finally is stabilized with time. In addition, we wonder what could be the level and type of taxes that is needed to increase water efficiency. We focus our analyze on the substitution in production and consumption at the sectoral level to observe the effects of the reallocation of water. Our results show that letting only market laws functioning without a strong policy strategy would be not enough for goods such as water, especially in the long run.