Several commentators have recently criticized the proposed California water bond for allowing private companies to own, operate and profit from water infrastructure paid for with bond proceeds. These criticisms have appeared in the San Francisco Chronicle and California Progress Report, and have been repeated in a number of other publications. The $11.14 billion water bond was adopted by the California Legislature and signed by Governor Schwarzenegger in SB2 (7x), and will be submitted to the voters at the statewide general election on November 2, 2010. I think these private profit criticisms are generally unfounded, but there are legitimate questions about public benefits from the bonds.

The relevant language is found in proposed Water Code Section 79714, which would provide that: “Eligible applicants under this division are public agencies, nonprofit organizations, public utilities, and mutual water companies. To be eligible for funding under this division, a project proposed by a public utility that is regulated by the Public Utilities Commission or a mutual water company shall have a clear and definite public purpose and shall benefit the customers of the water system.” Thus, the only mention of nongovernmental participation in the water bond programs concerns “nonprofit organizations, public utilities, and mutual water companies.”

In order to evaluate the impact of this provision, a basic understanding of public utilities and mutual water companies is required. Pursuant to California law, mutual water companies are private companies that provide water to their shareholders at cost. (See Cal. Pub. Util. Code § 2705.) Mutuals are allowed to provide water to a limited set of non-shareholders, such as schools and public agencies, but if they offer water service to the public at large, then they become public utilities.

Public utilities, sometimes called investor-owned utilities, are private corporations that provide water utility service to the public, subject to comprehensive regulation by the California Public Utilities Commission (CPUC). In particular, the CPUC regulates the finances of public utilities, including customer rates and charges. CPUC ratemaking policies have provided for many years that utilities earn a rate of return (profit) only on private investments; utilities do not earn any profit on investments from other sources, such as state grant funds. Public utilities have existed in California since the 1800s and currently serve water to approximately 20 percent of all Californians.

The impact of the water bond on private water companies and their customers is clear given this background:

• If a public utility were to apply for and win bond funding under the programs outlined in SB2 (7x), those funds would be used to pay for water infrastructure for the benefit of the utility’s customers, and the public utility’s shareholders would not be entitled to receive any profit on that public investment. If a mutual water company were to receive funding, it would not earn any profit on the bond monies, either, since mutuals are by definition operated without profit. Thus, the criticisms leveled at the water bond based on “private profit” are without any factual basis. No public utility or mutual water company shareholder would profit from the water bond.
• If public utility projects were not eligible for bond funding, it would mean that the 20 percent of California citizens who are served by public utilities would be paying taxes to the State of California to pay for water infrastructure for the exclusive benefit of the other 80 percent who are served by public agencies. The unfairness of such an outcome seems obvious.

Based on this analysis, it is apparent that the criticisms of the water bond based on private profit are misplaced. While some public water agencies may oppose funding for public utilities and mutual water companies so that they gain a competitive advantage through asymmetrical public tax subsidies, there is no rational public policy reason for such an outcome.

A more incisive criticism of the water bond would focus on whether public benefit is achieved by collecting taxes from all Californians and then distributing the proceeds to specific projects around the state. While the $11.14 billion fund includes earmarks for many specific areas (sometimes called “pork”), it is clear that not all citizens will receive benefits from the bond proceeds. In addition, an intelligent argument could be made that the water bond will distort economic incentives to use water wisely, since the true cost of water will not be captured in utility rates, but will be hidden in unrelated taxes for many years to come. Those are significant policy questions that voters should consider when heading to the polls in November.