Efficient Water Use in California

Develops an economic model for groundwater extraction by producers sharing a common aquifer. Each maximizes his discounted total net benefit over an infinite time horizon subject to the effect of his pumping on the water table level for the basin. This leads to an individualized socially optimal pump tax policy where each producer's pump tax rate is the product of the marginal social value of groundwater stocks for the basin with the fraction of this value he fails to internalize as part of his "net benefit maximizing" behavior. To provide incentives for groundwater management, pump tax revenues should be redistributed in a way that minimizes distortion of producers' groundwater pumping decisions. Illustrations are given of tax revenue distribution through per-unit surface water or land subsidies. Long-run social benefits accrue to producers as decreased extraction costs due to higher water table levels. Trading in groundwater and optimal quota assignments are discussed.