By Basil Sharp

Water use needs a price, but Labour's misguided water tax is unfair and would not deter polluters.

We need an efficient, sustainable and fair way of allocating water. From the little detail available, Labour's proposed water tax does not sound like it offers this. Not only does it fail to target polluters, it risks perverse and distorting effects.

The Labour Party proposes applying a royalty - call it a water tax - of up to 2c per 1000 litres of water. The money collected would be given to councils and iwi to restore local waterways. It is not unusual for governments to charge a royalty on resources they own. Our Government applies royalties to minerals vested in the Crown.

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First hitch: water ownership in New Zealand is not well defined. Labour says it is owned by the community; National says it is unowned. The question of ownership has obvious Treaty implications that will have to be settled.

Clearly government has the right to levy a tax. But the reasoning behind this proposal is seriously flawed. Second hitch - and it's a major - the policy is based on taxing productive inputs, in this case water, and not the environmental degradation from pollutants entering waterways.

Polluter-pays taxes should be targeted at the pollutants entering our waterways. Under Labour's proposal, a rural user who has invested in clean management practices will pay the same tax per litre as those whose practices are not up to standard.

So too for landowners located close to waterways relative to those located some distance away. Not all water-users are the same. How might this work across different land uses, soil types and business models? Dairy, beef, cropping, horticulture?

Third issue: taxing just one group of users in the economy is distortionary and discriminatory. Urban use of scarce water reduces the assimilative capacity of our water resources. Should Auckland households pay the tax on water supplied from the Waikato River? What about the micro-breweries located in metropolitan areas?

Large businesses with market power have a greater ability to pass costs on to consumers. Not so for primary sector producers, who will more than likely absorb the cost. To claim that an annual charge of about $8000 is not significant is disingenuous to say the least.

Then there are the questions around revenue recycling. If Government collects the revenue, how will it distribute the funds to councils?

One possibility would be to base the distribution on the likely benefits from restoration and catchment management. This will involve extra costs to councils judging among different methods. Another would be to redistribute the revenue in proportion to revenue collected, or according to scarcity.

Detail is important. Each option will involve transaction costs. What fraction of the revenue collected will actually go towards improving our waters? It certainly will not be the $100 million a year estimated by David Parker. Before rushing off to pass legislation on a water tax these issues need to be carefully thought through.

The Resource Management Act was aimed at the sustainable management of our natural resources. What we have today is what we put in place 1991 along with the various reforms. It has failed us.

I totally support cleaning up our waterways. But I cannot see how this water tax would do that. What a lost opportunity that the political parties who support pricing water are only considering taxes - an administered price, set by government - not a market price. If pollution is the problem, then tax it, not water.

As I have argued before, allowing a market price to emerge through introducing tradeable water use rights is a much smarter approach, for both our rivers and economy.

Sir Geoffrey Palmer first floated the idea almost 30 years ago. He recognised there was no incentive to make efficient use of water because of the first-come-first-served system and limits on trading access, which are still in place.

His solution: abstraction rights could be traded within limits that ensured sustainable minimum river flows. Focusing on use rights (and the responsibilities that come with them) sidesteps the politically charged issue of ownership.

Voters, be careful what you wish for. I expect two things will happen once a water tax is in place: the rate will increase and gradually more sectors will face the tax. It's politics.

• Basil Sharp is professor of energy and resource economics at the University of Auckland.