Summary

Wise water management is among the most crucial challenges facing the American West. The normal flows of most western rivers are fully allocated, and new water supplies are scarce. Demand for water continues to increase as urbanization spreads. In addition, over the past 30 years the values placed on various uses of water have changed and the now urbanized West demands water not only for new municipal and industrial uses but also to ensure environmental stewardship. As never before, the public is becoming aware of the value of free-flowing streams and undammed canyons. As these resources—invaluable for fish and wildlife habitat, aesthetics, and outdoor recreation opportunities —become scarcer, the demand to preserve them intensifies. The relationship between water quantity and quality, long ignored, also is now a significant concern. These changing demands for water stress the primary water user in the West—irrigated agriculture.

The roots of irrigation go deep in the West, especially in the Southwest. When the mining, open range cattle, and dry farming economies were no longer able to sustain western settlement in the late nineteenth century, western promoters turned to irrigation. And irrigated agriculture remained the engine of western development until the 1970s. For almost a century, western water management was guided by five assumptions: (1) there should be easy private access to public water resources, (2) runoff should be captured and impounded for use during the dry growing season, (3) these cap-



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Water Transfers in the West: Efficiency, Equity, and the Environment Summary Wise water management is among the most crucial challenges facing the American West. The normal flows of most western rivers are fully allocated, and new water supplies are scarce. Demand for water continues to increase as urbanization spreads. In addition, over the past 30 years the values placed on various uses of water have changed and the now urbanized West demands water not only for new municipal and industrial uses but also to ensure environmental stewardship. As never before, the public is becoming aware of the value of free-flowing streams and undammed canyons. As these resources—invaluable for fish and wildlife habitat, aesthetics, and outdoor recreation opportunities —become scarcer, the demand to preserve them intensifies. The relationship between water quantity and quality, long ignored, also is now a significant concern. These changing demands for water stress the primary water user in the West—irrigated agriculture. The roots of irrigation go deep in the West, especially in the Southwest. When the mining, open range cattle, and dry farming economies were no longer able to sustain western settlement in the late nineteenth century, western promoters turned to irrigation. And irrigated agriculture remained the engine of western development until the 1970s. For almost a century, western water management was guided by five assumptions: (1) there should be easy private access to public water resources, (2) runoff should be captured and impounded for use during the dry growing season, (3) these cap-

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Water Transfers in the West: Efficiency, Equity, and the Environment tured waters should be used for multiple purposes, (4) water rates should be minimal for both agricultural and urban users, and (5) to settle the West and promote regional economic development, water resource development should be federally subsidized. In short, water management meant supply augmentation. But the era characterized by the construction of large subsidized water storage facilities and distribution systems—known as the reclamation era—appears to have ended, and an era of reallocation and improved management has begun. In his last public address, the late Scott M. Matheson, an astute student of western water policy and former governor of Utah, peered into the future and concluded that the “water policies of the nineteenth century no longer meet the needs of the twentieth century and will certainly not serve us well in the twenty-first century.”* Better management is imperative if we are to accommodate contemporary demands for a widening range of consumptive and nonconsumptive uses. This new thinking is already being implemented. Proposals to augment supply face stringent fiscal and political constraints. Instead of new projects, there is an increasing trend to transfer water from existing uses, primarily irrigation, to growing cities. Transfers also are beginning to be used to dedicate water to instream uses. With varying degrees of enthusiasm, many water users and influential segments of the environmental community have accepted the premise that water marketing—the transfer of water rights from existing to new uses at market value—should be a major component of future western water policy. This committee believes that voluntary water transfers are the most significant mechanisms available today for responding to the West's changing water needs but that broad “third party” participation is essential if transfers are to be both efficient and equitable. Third parties include those who hold vested water rights that may be at risk from a transfer, as well as those representing a range of economic, environmental, and social interests related to the transfer who claim a “nonproprietary” stake in the process. The West has a long history of water transfers, which the committee defines as a change in the point of diversion or a change in the type or location of use, ranging from simple internal adjustments to actual sales. Any transfer can have significant third party effects depending on the scale, but the current interest in transfers is sparked primarily by the emergence of water markets. The idea that water is *Matheson, S. M. 1991. Future Water Issues: Confrontation or Compromise? Journal of Soil and Water Conservation 46:96-97.

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Water Transfers in the West: Efficiency, Equity, and the Environment just another commodity to be allocated by the market has long been advocated by economically oriented policy analysts, but others have strongly disagreed. For a variety of reasons, recent years have brought an increase in the level of transfers in the West, and many of them are market driven. The increased interest in water marketing results from a number of factors. Irrigated agriculture in the West uses large amounts of water. Lower prices for agricultural commodities, comparatively higher energy costs, and the problems of obtaining large amounts of capital all hinder the development of major new water supply augmentation projects for agriculture. There is no longer a strong constituency for subsidized federal water projects. Environmental concerns about irrigation-induced water quality problems are increasingly evident. In short, market forces and political forces have provoked a fundamental shift in values. Today, federal and state policymakers need to ensure that water allocation laws can respond to all water use demands— old and new—in an efficient and fair manner. Water marketing has great potential to enhance the efficiency of water use. Markets respond to price signals to move resources from lower- to higher-valued uses. Markets respect existing property entitlements, and thus water rights holders set the pace of transition and receive compensation when water is transferred. Reliance on water marketing, as opposed to government subsidy and regulation, reflects a general societal belief that markets are a more effective way to allocate scarce resources to meet the twin goals of efficiency and equity. For sound reasons, water transfers will remain a central component of water policy in the next century. However, there is a need for caution. Water markets cannot be expected to resemble more conventional markets for a variety of reasons, including the long tradition of subsidized water, the concentration of large blocks of water in public and private entities, and the equally long tradition that the use of water support the maintenance of a wide variety of public values. Transfers must thus be carefully evaluated because, as with any policy option, there are benefits and costs to their use. And significant costs—some concrete and others quite difficult to measure—can come at the expense of third parties. The goal is not to promote transfers per se but to use them to accomplish better overall water management. To date, most policy analysis has concentrated on ways to lower the transaction costs of transfers. Often neglected, however, is the fact that transfers can impose significant third party effects that must be accounted for in any reallocation. If transfers are to achieve their potential, the decisionmaking process should bring all relevant third parties into the

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Water Transfers in the West: Efficiency, Equity, and the Environment deliberations. This broad participation is necessary because water is a unique resource, different from other commodities, and markets alone cannot accurately reflect all the relevant values of this resource. The focus of this report is on third party interests that are not sufficiently included in existing water allocation processes. This report characterizes the range of existing nonproprietary third party interests and describes the ways in which current water allocation institutions accommodate these interests. In addition to providing this general analysis of third party effects, the committee has examined a number of areas in the western United States where water transfers are occurring, or may soon occur, in an attempt to identify characteristics common to water transfers and to obtain firsthand knowledge about when they are considered “positive” and when they are potentially harmful to third parties. A comprehensive assessment of benefits and costs of water transfers is premature, because transfer theory exceeds transfer practice; thus the committee does not render definitive judgments about the role that water transfers should play in the future of western water allocation and how third party effects should be weighted by decisionmakers. Rather, the committee both acknowledges the merits of water transfers as a mechanism for meeting new demands and recognizes the legitimacy of a wide range of potentially affected third party interests in the transfer process. The committee's basic conclusions are that allocation processes should accord third parties with water rights—and those without them—legally cognizable interests in transfers and that states should develop new ways to consider these interests. Water has never been allocated solely by markets, and market transfers are not an end in and of themselves but a means to the end of a water allocation process that serves both private and public interests. An expanded set of criteria is needed to evaluate transfers and to accommodate the diverse and strongly held economic and cultural values associated with water use. Accordingly, in preparing this report the committee recognized the relevance of both economic techniques, which can be used to measure the value of water use and the costs of transfers, and other methods that permit more subtle and intangible values to be considered. The committee approached its study of water transfers with an optimistic sense of the role transfers can play in a new era of more efficient use. The committee concludes, however, that judicious intervention in water transfer processes will be necessary to avoid or ameliorate the adverse effects of some transfers. In evaluating third party effects, the committee assumed that

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Water Transfers in the West: Efficiency, Equity, and the Environment reallocation of water among uses will be a principal feature in a new era of western water management; increased conservation, increased use efficiency, and improved reservoir operation also will be essential; the general direction of reallocation will be from agricultural to municipal, industrial, recreational, and environmental uses; water markets involving willing buyer-seller transaction opportunities will continue to expand; and new formal and informal constraints on water transfers will be established until all parties are confident that the reallocation process includes consideration of all relevant interests. THIRD PARTY IMPACTS AND OPPORTUNITIES The term “third parties” is broad and includes everyone who is not a buyer or seller in a transfer negotiation. The general categories of parties who stand to be affected by transfers are (1) other water rights holders; (2) agriculture (including businesses and farmers in the area of origin); (3) the environment (including instream flows, wetlands and other ecosystems, water quality, and other interests affected by environmental changes); (4) urban interests; (5) ethnic communities and Indian tribes; (6) nonagricultural rural communities; and (7) federal taxpayers. Third party impacts can stem from changes in the quality and quantity of water available for other uses, changes in the rate and timing of surface flows, and changes in ground water levels and recharge processes. Generally, these impacts are economic, social, or environmental in nature. Economic effects include impacts on incomes, jobs, and business opportunities. Social impacts include changes in community structure, cohesiveness, and control over water resources; such changes can occur in both rural and urban communities. Environmental impacts include effects on instream flow, wetlands and other ecosystems, water quality, recreational opportunities that are dependent on streamflows, and wildlife habitat. Impacts can be both positive and negative, and assigning value to them is difficult. The underlying challenge of any process used to evaluate transfers is how to determine and balance equitably the relative benefits and costs. Techniques for measuring the impacts of water transfers are more precise for some types of impacts than others. It is difficult and unreliable, for instance, to apply economic measures to those impacts that are not usually measured in market terms, including most social, political, and environmental effects.

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Water Transfers in the West: Efficiency, Equity, and the Environment ASSESSING WATER TRANSFERS AND THEIR EFFECTS To identify and study the impacts of water transfers on third parties, the committee developed a strategy to assess the characteristics of transfers and transfer opportunities. In particular, the type of transfer, primary motivation and process used, affected parties, and nature of the effects were examined (Table S.1). These factors were used to examine the nature of transfer activity in seven western areas: Truckee-Carson basins in Nevada Colorado Front Range-Arkansas River Valley Northern New Mexico Yakima basin in Washington Central Arizona Central Valley of California Imperial Valley of California The case studies strive to (1) identify the incidence of third party effects, (2) identify those effects that were pervasive and those that were unique, (3) understand both the nature and the causes of third party effects, and (4) understand the actions available to mitigate or remedy any harmful effects. The committee's objective was not to judge the desirability of actions taken or not taken in a particular case. Rather, the committee used the analyses to highlight broad lessons about the nature, scope, and impacts of water transfers in general and to develop suggestions for improving the processes used to evaluate and regulate water transfer activity. THE ROLE OF LAW IN THE TRANSFER PROCESS Because water is seasonally and geographically limited in the West, encouraging the productive use of water has always been a key policy objective, from the days of the Anasazi to the present. Water use in the western United States, as in virtually all arid societies in the world, is regulated under rules designed to achieve broad public benefits. The prior appropriation doctrine—which gives the earliest user the right to take water from a stream and put it to “beneficial use” and to continue such use—was adopted during the settlement era as a way to allocate water so that it met both private needs and larger societal goals. As western economies matured, the water rights system proved adaptable to increasing and competing demands. The key to adaptability was that water rights were not restricted to use on a particular parcel of land or to a specific type of use. In principle, rights could

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Water Transfers in the West: Efficiency, Equity, and the Environment TABLE S.1 Factors to Consider When Assessing Potential Water Transfers Type of Transfer Change in ownership Change in point of diversion Change in use Change in systems operation Out-of-basin diversion Primary Process for Transfer Voluntary Involuntary Primary Market Forces for Transfer Government Local State Executive Legislative Judicial Federal Executive Legislative Judicial Affected Parties Rural communities Support services Erosion of tax base Loss of natural resource base Agriculture Remaining water users Reallocation of rights Ethnic communities and Indian tribes Ethnic communities Indian communities Agricultural maintenance and expansion Other Environment Instream flows Recreation uses Fish and wildlife Hydroelectric power Water quality Damages to water users Human health Ecosystem effects Ecosystem protection Endangered species Wetlands Riparian habitat Estuaries Urban interests Intrastate transfer constraints Tax-exempt status changes Federal taxpayers National economic concerns Windfall profits Other water rights holders Junior rights Senior rights Loss of flexibility Nature of Effects Economic (national/regional) Lost revenue Lost opportunities New revenue Environmental Instream/fish and wildlife Recreation Water quality Wetlands Social Rural communities Municipalities Other

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Water Transfers in the West: Efficiency, Equity, and the Environment be transferred from one user to another, and water could be delivered as far as technology and economies could move it. Such transfers were subject to the condition that a change in use must not injure any other water rights holder. States have enacted laws qualifying and complicating this simple perspective on the transferability of water rights but not altering the basic legality of this process. The transfer of appropriative rights has always been possible, but it is only recently—in the era of full appropriation of many western streams—that reallocation has become the main source of water for new demands. States and their citizens are realizing, however, that voluntary transfers among private parties may affect an array of interests that are not adequately protected by the laws and processes that govern transfers. Western states, tribal governments, the federal government, and water districts all have opportunities and responsibilities to deal with the effects of transfers. The most direct way to do so is through policy planning, impact assessment, and public interest review of proposed projects. The more comprehensive and predictable the review process, the more incentive water sellers and buyers will have to accommodate these interests throughout the transfer process. In addition, several existing laws offer ways to address the effects of transfers. State instream flow laws can be important for limiting the environmental and economic harm sometimes caused by transfers. State water quality protection goals can be furthered in the transfer process if statutes and procedures are clarified to specify that purpose. Federal project water can be used in ways compatible with state instream flow laws, with transfers allowed only when these state laws are satisfied. Ultimately, protection of instream flows will depend on acquisition of senior rights. CONCLUSIONS AND RECOMMENDATIONS The recognition and protection of third party interests are essential if water transfers are to achieve their potential to reallocate water to meet new demands. Transfers represent both a break with past western water allocation practices and, at the same time, a continuation of past practices. Transfers can bring the benefits of the market to a system that has often subordinated efficiency to distributional concerns. But the West has never treated water as just another commodity and should not do so now. There must be a balance between efficiency and fairness. Each jurisdiction must devise its own laws and processes to achieve this balance.

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Water Transfers in the West: Efficiency, Equity, and the Environment The committee believes that many of the problems and opportunities illustrated in the various case studies will recur throughout the West. Thus valuable lessons for future federal and state water allocation policy can be drawn from the studies. To this end, the committee offers the following conclusions and recommendations (which are discussed in more detail in Chapter 12). Water Transfer Opportunities Water transfers can promote the efficient reallocation of water while protecting other, water-dependent values recognized by society. All levels of government should recognize the potential usefulness of water transfers as a means of responding to changing demands for use of water resources and should facilitate voluntary water transfers as a component of policies for overall water allocation and management, subject to processes designed to protect well-defined third party interests. Third party protection should be seen not simply as a constraint but as a legitimate component of the transfer process. State and Tribal Authority State and tribal governments have primary authority and responsibility for enabling and regulating water transfers, including identification and appropriate mitigation of third party effects. State and tribal administrators should develop and publish clear criteria and guidelines for evaluating water transfer proposals and addressing potential third party effects. State and tribal administrative processes should provide for public and broad third party representation in the review of water transfer proposals. In addition to normal actions such as notices of proceedings, public hearings, and protest opportunities, programs should also include affirmative review of potential third party impacts in cases likely to involve significant effects. State and tribal processes should seek to regulate water rights transfers in ways appropriate to the scale of effects with the dual objectives of avoiding excessive transaction costs while providing meaningful consideration of third party interests. State laws should allow governmental entities to acquire water rights for instream flow purposes with the same priority and protection against injury enjoyed by rights held for other uses. Affirmative state policies may be necessary and appropriate to acquire sufficient instream flow rights to mitigate the effects of historic diminutions of streamflow. States should provide leadership in exercising their wa-

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Water Transfers in the West: Efficiency, Equity, and the Environment ter administration and planning responsibilities to identify opportunities for water transfers that might serve as instruments for achieving a wide range of water management objectives. The Costs of Transfers Water transfer law and policies should be designed to consider the interests of the trading partners, third parties, and the environment in a cost-effective manner. The costs of mitigating third party effects should be internalized as a cost of the transfer—that is, the beneficiaries or proponents of the transfer should bear the mitigation costs as a matter of law and equity. Therefore the cost of the transfer should include sufficient funds to help mitigate third party effects, in the form of water, money, or other compensation. To help reduce transaction costs, policies might be designed so that, in general, transfers of acquired rights are limited to consumptive use. This may entail setting state, river basin, or regional standards for the consumptive use of water per unit of irrigated land, based on crop type, historic water availability, and other local variables. Such standards should be flexible enough to account for variations in water availability and local conditions. Third parties should not have to develop data on the transferable quantity; data should be developed by the buyer or seller. Regulatory requirements should be designed to encourage negotiated resolutions of conflicts. Consideration should be given to processes (e.g., a state water court) other than judicial proceedings to provide the initial evaluation of transfer proposals. Area-of-Origin Impacts Water transfers between basins should be evaluated to determine and account for the special impacts on interests in the areas of origin. States and tribal governments should develop specific policies to guide water transfer approval processes regarding the community and the environmental consequences of transferring water from one basin to another because such transfers may have serious long-term consequences. Water transfer processes should formally recognize interests within basins of origin that are of statewide and regional importance, and these interests should be weighed when transbasin exports are being considered. Although each state or tribe should select the approach that suits its needs best, area-of-origin protection generally would include impact assessment, opportunities for all affected interests to

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Water Transfers in the West: Efficiency, Equity, and the Environment be heard, regulatory mechanisms to help avoid adverse effects, compensation (e.g., financial payments or mitigation), and authority to deny a proposed transfer or water use involving a transbasin export if the effects are judged to be unacceptable. States should revise laws that now exempt water facilities from taxation by the county of origin either because the exporter is a public entity or because of provisions that make such facilities taxable only in the county where the water is used. Mechanisms to compensate communities for transfer-related losses of tax base, such as an annual payment in lieu of taxes, may be needed. The Public Interest Public interest considerations should be included among the third party issues and legal provisions for permitting, conditioning, and denying water transfers. To protect third parties in water rights transfers, the public interest language in western states' water laws should be reviewed, clarified, and, where appropriate, more vigorously applied. States should develop definitions and criteria for assessing what constitutes the public interest, perhaps benefiting from the legislative and judicial experiences of the states of Idaho and Alaska. Such definitions should embrace existing water rights holders, environmental water needs for ecosystem protection, and social and cultural values in basins of origin. To the extent that public trust concepts and values cannot be dependably represented under existing laws and policies, states should develop new laws, institutions, and administrative tools for doing so. Key elements of public trust administration might include comprehensive planning at the river basin level, including the identification of existing social and environmental values dependent on water; clearly defined procedures to guide applicants seeking water transfer approval; and institutional arrangements for holding and managing water for instream and environmental uses. Environmental Impacts Environmental impacts can and should be considered by state, tribal, and federal agencies when potential water transfers are evaluated. Federal, state, and tribal water transfer policies and laws should ensure consideration of ecological values affected by transfers, for example, the goals of protecting riparian and wetland habitats and the water needs of endangered species. Adjustment of water laws, administrative practices, and water supply strategies may be neces-

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Water Transfers in the West: Efficiency, Equity, and the Environment sary to achieve this end. States should develop inventories of wetland and riparian systems that depend on surface water systems likely to be sought for transfers so that transfers can then be evaluated in light of ecosystem protection and restoration goals. When water is transferred to new uses in new areas, there is an opportunity to promote overall efficiency by dedicating some of the newly available supply to public uses such as environmental protection. Congress should consider using a share of the receipts gained from marketing federal project water to acquire water to protect western biota and habitats. The federal Land and Water Conservation Fund Act might be amended to permit both state and local grant recipients and federal agency participants to use fund money to acquire water rights for environmental protection and mitigation. The Unique Interests of Indian and Hispanic Communities Traditional Indian and Hispanic communities have unique interests relating to water transfer policies because long-established water uses are often central to the survival of their cultural identity. These interests merit special consideration when proposed transfers are evaluated. States should carefully scrutinize any proposed water transfer that could adversely affect water supplies for Indian and Hispanic communities. States should consider enacting legislation that permits the establishment of historical or cultural zones as a means of insulating these communities from further injury. Transfers that would have adverse impacts on these zones would receive strict scrutiny. Transfers on Indian Reservations Tribal governments should consider special factors in approving and administering water transfers on their reservations. When Indian water rights are transferred or applied to off-reservation uses, tribal governments should establish procedures to evaluate third party effects. State and federal governments should cooperate with tribes in evaluating and implementing mutually beneficial transfers. Water Salvage Laws Water laws should be enacted to promote water conservation and salvage while protecting third party interests. States, tribal governments, and federal agencies should establish programs to reduce the uncertainties and costs involved in water conservation and salvage, by facilitating and providing incentives to encourage conservation

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Water Transfers in the West: Efficiency, Equity, and the Environment and reuse of water. In most cases, conservation programs will not have the adverse impacts that transfers may have. Nevertheless, state, tribal, and federal water transfer review processes should take full account of the third party effects of a transfer of conserved or salvaged water, just as they should with any other transfer. Water Quality-Water Quantity and Surface-Ground Water Interrelationships Water transfer reviews should consider the interrelationships between water quality and water quantity and also between surface and ground water resources. States and tribes should accelerate the development of laws, policies, and administrative procedures to ensure consideration of water quality changes that might result from transfers involving the use of municipal effluent and other water of impaired quality. States and tribes should encourage conjunctive management of surface and ground water, based on knowledge of hydrologic connections and a full consideration of the related water quality issues and other potential third party effects. States and tribes should require agencies to develop technical capabilities for evaluating and monitoring surface and ground water quality as part of the transfer evaluation process. Federal Policy Federal reclamation law makes inadequate provision for the transfer of federal project water because it was assumed that the water would always be used within the project. Given changing demands, the federal government should now have a specific transfer policy. Federal legislative and administrative policies should more clearly support federal water transfers while paying careful attention to third party effects and to the distribution of benefits from transfers involving federal project water. The Secretary of the Interior should develop a formal process for assessing transfers of federal project water. This process should identify the role of those agencies of the U.S. Department of the Interior responsible for natural resource stewardship and should allow for consultation with tribal governments, states, and the interested public to ensure that major third party effects are assessed and mitigated. Congress should set clear policy for the distribution of profits from the resale of federal project water, and this policy should provide a portion of the economic value in federal project water to be recaptured for public use. The Secretary of the Interior should re-

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Water Transfers in the West: Efficiency, Equity, and the Environment quire greater consistency in applying the department's general policy supporting voluntary transfers and should specify that there is authority to transfer water among as well as within project service areas. BALANCING EFFICIENCY AND EQUITY The allocations of water produced by the doctrine of prior appropriation represent the prevailing social values of an early era that favored development of mining and irrigated agriculture. However, as social values change, these allocations are sometimes perceived as misallocations. Throughout its investigation of the nature, scope, and impacts of water transfers, the committee found much evidence of what might be called a “clash among values.” These conflicts are felt more sharply today than ever before because of increasing competition for a limited resource. In many of the cases studied, the clash is between the older, rural, agricultural West and the newer, more urbanized West. In other instances, the clash is between offstream and instream uses of water—the result of a more environmentally conscious West. As transfers become common in western basins, the necessity of comprehensive planning and management will become clear. Water management institutions should develop the technical capability to assess the full range of impacts associated with potential water transfers and should weigh the merits and problems broadly along with other available management options and the effects of each. There are inherent limitations in the capability of market mechanisms to deal with nonmarket goods and externalities, and these must be addressed through institutional change. The committee concludes that state and tribal governments must work to give third parties a more effective voice in the water transfer decisionmaking process. The cases examined by the committee raise a diverse set of questions about effective consideration of third party impacts. In northern New Mexico, for instance, the special needs of a historic ethnic community with water allocation institutions that predate Anglo settlement are not addressed by the existing state system. The Arizona case reflects the conflicting needs and aspirations of urban and rural populations. The Truckee-Carson, Nevada, example illustrates an exceptionally diverse array of interests—two Indian tribes with differing cultural and environmental needs, a growing urban area with increasing water requirements, and more than one natural wetland area needing water to maintain migratory waterfowl and other fish and wildlife values. Designing mechanisms to accommodate third party interests is

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Water Transfers in the West: Efficiency, Equity, and the Environment difficult, almost inevitably imposing new burdens on both the transferring parties and the administrative agencies that review water transfers. The quest is for a balance point that allows broader participation in decisionmaking while not inhibiting desirable transfers. The recognition that third party interests are legitimate is a first step toward this accommodation.