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Policy & Guidance

Interim Economic Guidance for Water Quality Standards

2. Evaluating Substantial Impacts: Public Sector Entities

Public entities seeking relief from meeting water quality standard requirements must demonstrate that the cost of required water pollution control will result in substantial impacts and that there will be "widespread" adverse social and economic impacts if they are required to meet these standards. For the purposes of this workbook, a public entity refers to any governmental unit that must comply with pollution control requirements in order to meet water quality standards. The most common example is a municipality or sewage authority operating a publicly owned treatment works (POTW) that must be upgraded or expanded. Municipalities, however, may also be required to control other point sources or nonpoint sources of pollution within their jurisdiction. The procedures outlined in this chapter apply to all types of publicly financed projects that may be required to meet water quality standards. Throughout this chapter, the term "State/discharger" refers to whoever will actually conduct the financial and socioeconomic impact analysis for the public entity, whether it be the State, the municipality, a consultant or some other organization.

The remainder of this chapter details methodologies and sources of information for determining the financial viability of publicly financed projects. Several worksheets are presented that will assist in demonstrating substantial impacts. States/dischargers are referred to Chapter 4 for guidance on demonstrating widespread impacts. Readers should keep in mind that the guidance in this chapter is not meant to be exhaustive. The State and/or EPA may require additional information or tests in order to evaluate whether substantial and widespread impacts will occur. In addition, the State/discharger should feel free to include any additional information they think is relevant.

As mentioned in Chapter 1, the evaluation of substantial impacts resulting from public entity compliance with water quality standards includes two elements, 1) financial impacts to the public entity and 2) current socioeconomic conditions of the community. Governments have the authority to levy taxes and distribute pollution control costs among households and businesses according to the tax base. Similarly, sewage authorities charge for services, and thus can recover pollution control costs through users fees. In both cases, a substantial impact will usually affect the wider community. Whether or not the community faces substantial impacts depends on both the cost of the pollution control and the general financial and economic health of the community.

If the public entity passes a significant portion of the pollution control costs along to private facilities or firms, then the review procedures outlined in Chapter 3 of this workbook should also be consulted to determine the impact on the private entities. Both public and private entities should consult Chapter 4 for guidance on how to estimate potential widespread impacts on the community.

This chapter focuses on ways to determine if the costs of the proposed project will likely result in substantial impacts. To make this determination the State/discharger will need to complete a five step analysis. As shown in Figure 2-1 the first step in the process is to estimate the cost of the pollution control project and calculate the annual cost of the proposed pollution control project. The second step is to calculate the total annual pollution control cost per household, which includes the cost of the project and existing pollution control costs. In the third step, the Municipal Preliminary Screener is calculated, which quickly identifies entities that clearly will not experience substantial impacts due to the cost of the necessary pollution control. If it is not clear whether there will be substantial impacts, entities should proceed to the fourth step, which is the calculation of the Secondary Test. In this step public entities will need to provide financial and socioeconomic information. For example, the ability of the community to finance the project may depend on existing financial conditions in the community such as debt per capita and the community's bond rating. The socioeconomic health of the community prior to the project's construction will also be an important indicator of whether the pollution control would impose a substantial impact on the community. The fifth and final step of determining whether impacts are "substantial" is evaluating where the community falls in the impacts matrix. This matrix takes into consideration the Municipal Preliminary Screener and the Secondary Test score. Later, in Chapter 4, estimated changes in socioeconomic health indicators will be reviewed to evaluate the extent to which the impacts can be considered widespread.

The remainder of this chapter is divided into five sections that detail the essential steps of an evaluation of substantial impacts for publicly financed projects. Figure 2-1 illustrates the steps and decision points in this process. The five steps are:

2.1 Verify Project Costs and Calculate the Annual Cost of the Pollution Control Project.

Before the impact analysis can be performed, the project costs should be verified and then annual costs calculated.

2.1.a Verify Project Costs

The first step of an economic analysis of a publicly financed project is an evaluation of the proposed project. Public entities should consider a broad range of discharge management options including pollution prevention, end-of-pipe treatment, and upgrades or additions to existing treatment. Specific types of pollution prevention activities that should be considered are:

Many of these approaches are particularly relevant to industrial indirect discharges to the public system. Whatever the approach, the applicant must demonstrate that the proposed project is the most appropriate means of meeting water quality standards and must document project cost estimates. If at least one of the treatment alternatives that meets water quality standards will not have a substantial financial impact, then the community should not proceed with the analysis presented in the rest of this workbook. General information regarding the proposed pollution control project and other projects considered should be supplied in Worksheet A.

The most cost-effective approach to meeting water quality standards should be considered. Submissions should include assumptions about excess capacity, population growth, and consideration of alternative technologies where appropriate. The most accurate estimate of project costs may be available from the discharger's design engineers. If site-specific engineering cost estimates are not available, preliminary project cost estimates can be derived from a comparable project in the State or from the judgement of experienced water pollution control engineers. (See Appendix A for sources of engineering cost information.) Capital, operation and maintenance (O&M), and other project costs can be summarized using Worksheet B. For comparative purposes, cost estimates (e.g. capital, O&M, other project costs) for each alternative being considered should be presented in the same units (typically annualized costs, $/yr) and for the same year. The next section explains how to annualize project costs.

For illustrative purposes, the example of a local government upgrading their existing wastewater treatment facility in order to meet water quality standards is used throughout this chapter. Details of this example may differ significantly from other projects undertaken to meet water quality objectives. Other types of public-sector water pollution control, however, would be analyzed in a similar fashion using the worksheets included in this chapter.

2.1.b Calculate the Annual Costs of the Pollution Control Project

Since capital costs typically will be paid over several years, annualized costs are used in the evaluation of economic burden to the community. The capital portion of project costs is typically financed over approximately 20 years, by issuing a municipal debt instrument such as a general obligation bond or a revenue bond. Local governments may also finance capital costs using bank loans, state infrastructure loans (revolving funds), or federally subsidized loans (such as those offered by the Farmers' Home Administration).

It should be noted that interest rates used to annualize costs are dependent on the type of debt instrument used as well as the recipient's credit standing. For example, revenue bonds typically are financed at a slightly higher interest rate because of their dependence on revenues from services as opposed to being guaranteed by the full faith and credit of the jurisdiction. Because interest rates affect the interest payment and thus the annualized capital cost of the project, it is important that the interest rate used on Worksheet B reflects the debt instrument (i.e. municipal bond, commercial bank loan, state revolving fund loan, or other instrument) likely to be used by the municipality.

The calculation of total annualized cost of the project is presented in Worksheet B. First, capital costs are summed and the portion of costs to be paid for with grant monies are deducted, as these costs will not need to be financed. Next, the annualization factor is calculated using the formula supplied on Worksheet B, or the annualization factor is found in Appendix B. Annualized capital cost is then calculated by multiplying the total capital costs to be financed by the annualization factor.

Next, annual operating and maintenance costs are summed, and the total is added to the annualized capital cost. These costs should include the costs of monitoring, inspection, permitting fees, waste disposal charges, repair, administration, replacement, and any other recurring costs. All recurring costs should be stated in terms of dollars per year. The sum of the annualized capital cost and total annual operating and maintenance costs is the total annual cost of the project. In the next section, the annualized costs paid by households in the community are calculated.

2.2 Calculate Total Annualized Pollution Control Costs Per Household

In order to assess the burden that total pollution control costs are expected to have on households, an average annualized pollution control cost per household should be calculated for all households in the community that would bear project costs. In order to evaluate substantial impacts, therefore, the analysis must establish which households will actually pay for pollution control as well as what proportion of the costs will be borne by households. These apportioned project costs are then added to existing pollution control costs paid by households.

It is important to first define the affected community. The "community" is the governmental jurisdiction responsible for paying compliance costs. In practice, pollution control projects may serve several communities or just portions of a community. In the case of a sewage agency serving several communities, once project costs are allocated to each community served, the economic analysis is conducted on a community by community basis. In the case of a community in which only a portion of the community is served, the affected community is defined as those who will pay the compliance costs. In such cases, it may be difficult to obtain socioeconomic data for just part of the community and data for the entire community may be used instead. The area that is affected may not be the same as the area that is paying, therefore it may be appropriate to evaluate widespread impacts, described in Chapter 4, over a community that is defined differently than the paying community.

If project costs were estimated for some prior year, these costs should be adjusted upward to reflect current year prices using the average annual national Consumer Price Index (CPI) inflation rate for the period. The CPI inflation rate is available from the Bureau of Labor Statistics. An additional source reporting the CPI inflation rate is the CPI Detailed Report, which is published monthly by the U.S. Department of Labor, Bureau of Labor Statistics.

The ratio of the current CPI to the CPI for the year of the cost estimates indicates how much costs have increased over the period. This ratio can be applied to the cost estimates to "bring them up to current year costs." Likewise, there are engineering cost indices that can be used for this purpose.

If project costs are not distributed simply according to wastewater flow or tax revenues, then consideration should be given to separately analyzing the impacts on users who pay a disproportionate share of the costs. This situation can arise, for example, where industrial dischargers to a sewer system are assessed pollutant surcharges to pay for their share of the cost of advanced treatment necessitated by the presence of their pollutants. Remaining costs would then be split among households according to wastewater flow or tax revenues, whichever is appropriate. The total amount of the pollution control project to be recouped by surcharges should, therefore, be removed from the total project cost before costs are allocated according to wastewater flow or tax revenues.

In calculating the total annual cost of pollution control per household, current costs of pollution control must be considered along with the projected annual costs of the proposed pollution control project. The existing cost per household usually can be obtained from the most recent municipal records. For example, it can be found in the sewer enterprise fund accounts for communities that maintain a separate enterprise fund. It is not necessary, in such cases, to sum all the cost components. Instead, use the most recent operating revenues, divided by the number of households served. In cases where the community does not maintain a separate enterprise fund for sewers, the cost elements can be summed from the consolidated statement for the community. If the portion of proposed project costs that households are expected to pay is known or is expected to remain unchanged, then use Worksheet C to calculate the total annual cost of pollution control per household. If the portion paid by households is based on flow, then should refer to Worksheet C: Option A as well.

The cost per household as a percent of median household income is used in Section 2.3 as a screener to quickly identify those communities that clearly will not face substantial impacts due to pollution control. For guidance in estimating impacts on non-household users (e.g., industrial, commercial), refer to Chapter 3.

2.3 Calculate and Evaluate The Municipal Preliminary Screener Value

Whether or not the community is expected to incur "substantial" economic impacts due to the pollution control project is determined by jointly considering the results of two tests. The first test is a "screener" to establish whether the community can clearly pay for the project without incurring any substantial impacts. The Municipal Preliminary Screener estimates the total annual pollution control costs per household (existing costs plus those attributable to the proposed project) as a percentage of median household income. The screener is written as follows:

Municipal Preliminary Screener=Average Total Pollution Control Cost per Household
Median Household Income

Median household income information for many municipalities is available from the 1990 Census of Population. If median household income is not available for the current year, it should be estimated for the current year by using the CPI inflation rate for the period between the year that median household income is available and the current year. To calculate the inflation rate over the relevant period, use the "percent change from the previous annual average" (annual inflation rate) presented in the CPI Detailed Report. For example, if the current year is 1993, 1990 is the most recent year that median household income is available, and the percentage changes for the 1990, 1991, and 1992 annual averages respectively are: 5.2, 4.1 and 2.9, the adjustment factor equals:

Adjustment Factor = 1.052 * 1.041 * 1.029 = 1.13

Adjusted Median Household Income =
    Median Household Income * Adjustment Factor

Depending on the results of the screener, the community is expected to incur little, mid-range, or large economic impacts due to the proposed project (see Worksheet D). If the total annual cost per household (existing annual cost per household plus the incremental cost related to the proposed project) is less than 1.0 percent of median household income, it is assumed that the project is not expected to impose a substantial economic hardship on households. The screener is therefore set at 1.0 percent of median household income. Communities with screener results of less than 1.0 but still fairly close to 1.0, however, may still want to proceed to the Secondary Test.

Communities are expected to incur mid-range impacts when the ratio of total annual compliance costs to median household income is between 1.0 and 2.0 percent. If the average annual cost per household exceeds 2.0 percent of median household income, then the project may place an unreasonable financial burden on many of the households within the community. In either case, communities move on to the Secondary affordability Test to demonstrate substantial impacts. For example, assume that Community XYZ has a screener of 2.3 percent. Although it appears that the community faces large impacts, substantial impacts have not necessarily been demonstrated and the community must proceed to the next step and apply the Secondary Test. Dischargers with screener values well below 1.0 percent are assumed to be able to pay for pollution control without incurring any substantial economic impacts and are required to meet existing water quality standards. They do not need to proceed to the Secondary Test (see Figure 2-1).

2.4. Apply Secondary Test

The Secondary Test is designed to build upon the characterization of the financial burden identified in the Municipal Preliminary Screener. The Secondary Test indicates the community's ability to obtain financing and describes the socioeconomic health of the community. Indicators describe precompliance debt, socioeconomic, and financial management conditions in the community. Using these indicators and the scoring system described below, the impact of the cost of pollution control is estimated. Specifically, applicants are required to present the following six indicators for the community:

Debt Indicators

Socioeconomic Indicators

A more detailed description of the six indicators, as well as alternative indicators for states with property tax limitations, are presented below. Table 2-1 summarizes the indicators and what is considered to be a strong, mid-range, or weak rating.

Debt Indicators

Current ratings for the community summarize a bond rating agency's assessment of a community's credit capacity. The ratings generally reflect current financial conditions. If security enhancements like bond insurance have been used for the bond issue, however, the bond rating on a particular issue may be higher than local conditions justify. Only ratings for uninsured bonds, therefore, should be used.

Many small and medium sized communities have not used debt financing for projects and, as a result, have no bond rating. The absence of a bond rating does not indicate strong or weak financial health. When a bond rating is not available, this indicator should not be included in the analysis of substantial impacts. When available, the rating for the most recent general obligation bond should be used. If a general obligation bond has not been issued recently, the most recent rating for a sewer bond should be used. Recent bond ratings are included in municipal bond reports from rating agencies (e.g., Moody's Bond Record, Standard and Poor's Corporation).

Overall Net Debt is debt repaid by property taxes. It excludes debt that is repaid by special user fees (e.g. revenue debt). This indicator provides a measure of debt burden on residents within the community and measures the ability of local government jurisdictions to issue additional debt. It includes the debt issued directly by the local jurisdiction and debt of overlapping entities, such as school districts. It compares the level of debt owed by the community with the full market value of real property used to support that debt and serves as a measure of the community's wealth.

Debt information is available from the financial statement of each community. In most cases, recent financial statements are on file with the State (e.g., State Auditor's Office). Overlapping debt may or may not be provided in a community's financial statements. The property assessment data (assessment ratio) should be readily available through the community or the State Assessor's Office. The boundary of the affected community generally conforms to one or more community boundaries. Therefore, prorating community data to reflect specific service area boundaries is not normally necessary for evaluating the general financial capability of the affected community.

Socioeconomic Indicators

The unemployment rate is defined as the percent of a community's labor force currently unemployed. If the unemployment rate in the service area is not available, the encompassing county's rate may be used as a substitute. The Bureau of Labor Statistics (BLS) maintains current unemployment rate figures for municipalities and counties. National unemployment data is also needed for comparison purposes. This information can be obtained from the BLS are available by request at (202) 606-6392. A community's unemployment rate is considered to be below the national average if it is more than 1% below the national average. Similarly, a community's unemployment rate is considered to be above the national average if it is more than 1% above the national unemployment rate. If the community's employment rate is equal to the national average unemployment rate, plus or minus 1%, then the community's unemployment rate is assessed as being equal to the national rate.

Median household income (MHI) is defined as the median of the total income dollars received per household during a calendar year in a given area. It serves as an overall indicator of community spending capacity. Median household income, which was also used in the screener process, is available from the 1990 Census or through state data centers. The state value is also needed for comparison purposes. If a community's median household income is more than 10% below the state's median household income, then it is considered to be below the state's median. If a community's median household income is more than 10% above the state's median, then it is considered to be above the state median value. If, however, the community's median household income is equal to the state median, plus or minus 10%, then the community's median household income is assessed as being equal to the state's median household income.

Financial Management Indicators

This indicator can be referred to as the "property tax burden" since it indicates the funding capacity to support new expenditures, based on the wealth of the community. Some states and local jurisdictions may have established legal limits on the amount of property taxes that can be levied as a percent of full market or assessed value of real property. Property assessment data should be readily available through the community or the State Assessor's Office. Property tax revenues are available in communities' annual financial statements.

This rate is an indicator of the efficiency of the tax collection system and a measure of how well the local government is administered. It compares the actual amount collected from property taxes to the amount levied. Property taxes levied can be computed by multiplying the assessed value of real property by the property tax rate, both of which are available from a community's financial statements or the State Assessor's Office.

Alternative Indicators for States with Property Tax Limitations

Two of the indicators may not be appropriate in states with statutory limits on property tax collections and/or rates, or where data on full-market value of taxable property are not available.

The first of these indicators -- The Overall Net Debt as Percent of Full Market Value of Taxable Property -- can be replaced with:

Overall Net Debt Per Capita

In calculating the Secondary Score, the following ratings for Overall Net Debt Per Capita should be used:

Greater than $3,000=weak = 1
$1,000 - $3,000=mid-range = 2
Less than $1,000=strong = 3

The second of these indicators -- Property Tax Revenues as a Percent of Full-Market Value of Taxable Property -- has no appropriate substitute in cases where property taxes are at their limit or where full-market value of taxable property cannot be estimated. In such cases, this indicator should be dropped and the other five factors are assigned equal weights.

These six indicators are then used to form a composite assessment of the community's economic health and the financial impact of the required project. Worksheet E can be used to record each indicator. For each of the six indicators, the community is rated as weak, mid-range, or strong, based on the thresholds presented in Table 2-1. For example, if a community's median household income equals $15,000 and the state's median household income equals $17,000, the community would be considered weak on this measure. If, however, the community's median household income were $19,000, then the community would be considered strong on this measure.

Next, a Secondary Score is calculated for the community by weighting each indicator equally and assigning a value of 1 to each indicator judged to be weak, a 2 to each indicator judged to be mid-range, and a 3 to each strong indicator. A cumulative assessment score is arrived at by summing the individual scores and dividing by the number of factors used. Worksheet F,provided at the end of Section 2.4, guides the applicant through this calculation. The cumulative assessment score is evaluated as follows:

For example, consider a Community XYZ, which has:

The Secondary Score for Community XYZ, equal to 2, falls into the mid-range category.

If the applicant is not able to develop one or more of the six indicators, they must provide an explanation as to why the indicator is not appropriate or not available. Since the point of the analysis is to measure the overall burden to the community, the debt and socioeconomic indicators are assumed to be better measures of burden than the financial management indicators. Consequently, if one of the debt or socioeconomic indicators is not available, the State/discharger should average the two financial management indicators and use this averaged value as a single indicator with the remaining indicators. This averaging is necessary so that undue weight is not given to the financial management indicators.

2.5 Assess Where the Community Falls in The Substantial Impacts Matrix

The results of the two tests are considered jointly in determining whether the community is expected to incur substantial impacts due to the proposed pollution control project.

In the following matrix, the cumulative assessment score for the community is combined with the estimated household burden. The combination of factors establishes whether impacts can be expected to be substantial. In the example of Community XYZ, their screener equaled 2.3 percent and their cumulative assessment score equaled 2. They are, therefore, in the middle cell in the far right column and thus have a rating of "X" in the matrix presented below (Table 2-2).

In the matrix, "X" indicates that the impact is likely to be substantial. The closer the community is to the upper right hand corner of the matrix, the greater the impact. Similarly, "T" indicates that the impact is not likely to be substantial. The closer to the lower left hand corner of the matrix, the smaller the impact. Finally, the "?" indicates that the impact is unclear.

For communities that fall into the "?" category, if the results of both the Secondary Test and the Municipal Preliminary Screener are borderline, then the community should move into the category closest to it. Take, for example, a community that falls into the center box, with a cumulative assessment score of between 1.5 and 2.5 and a percent of median household income (MHI) between 1.0 and 2.0. If the cumulative score was 1.6 and the percent of MHI was 1.8, then the community should be considered to fall into one of the adjacent "X" categories. If results are not borderline, other factors such as the impact on low or fixed income households, the presence of a failing local industry, and other projects the community would have to forgo in order to comply with water quality standards should be considered. Relevant additional information might include information collected from interviews with municipal financial officers, special reports on industry trends that may affect local employers, and specific financial and economic indicators. The State/discharger should provide any additional information they feel is relevant. This additional information will be critical where the matrix results are not conclusive.

EPA will interpret a "T" rating to mean that the community is not expected to incur substantial impacts as a result of the pollution control project. Communities falling into this category will be required to meet existing water quality standards. If the applicant State/discharger disagrees with the results of the Secondary Test, they may present additional information to the Regional EPA Administrator documenting the unique circumstances of the community. Since the impacts are not substantial, there is no need to demonstrate widespread impacts. EPA will interpret a "X" rating to mean that the community will incur substantial impacts. Before a water quality standard is modified or changed, however, communities falling into this category must demonstrate that impacts are also widespread. For those communities rated "?", EPA's interpretation will rely on the additional information presented by the State/discharger. It should be noted that, in this case, there is no "correct" set of information. It will be up to the applicant to collect whatever information they feel is relevant in describing the unique circumstances affecting their community. For example, the matrix may suggest that the community's financial condition is strong. At the same time, however, a local industry may be failing. In such a case, it is important to determine the importance of that industry to the local economy (as measured by its contribution to area employment, payroll, and tax revenues) and whether the industry itself would be affected by the project. Communities falling into either the "X" or the "?" category should proceed to Chapter 4 to determine whether the impacts are also expected to be widespread.

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