0013
, 3
&RAFT
FISCAL ASSESSMENTS
i
A Part of the 1990 Strategy for the
Construction Grants Program
U.S. Environmental Protection Agency
Library, Room 2404 PM-211-A
401 M Street, S.W.
Washington, DC 20460 ..
Program Evaluation Division
John Thillman
James Cummings
Gail Withuhn
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SUMMARY
A problem in the Construction Grants program is the
financial assessment of alternate methods of treating waste-
»
water and of the accompanying economic effects upon citizens.
EPA and states have made available engineering resources to
help grantees make the best technical (engineering) choices
to treat wastewater. However* communities frequently have
made decisions having long-term consequences without adequate
»
financial data. We now must begin to channel a greater share
of our grant assistance into the area of financial planning
for POTW's. Such an effort is essential to a program that
is characterized increasingly by financial activities at the
federal level and by fiscal and economic consequences in
localities.
drantees Frequently Make Poor Financial Choices -
In many cases grantees choose methods of treating waste-
water:
o based upon inaccurate estimation of O&M costs and
revenues.
o based upon inaccurate cost data
o' based upon inadequate exploration of alternatives
o based upon inadequate exploration of funding options
t
o with no recognizable capital improvement plan
o that do not recognize the need for future expansion
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The consequences of poor decisions can be devastating.
Some of the most severe are:
1) Excessive costs (capital and O&M), especially in
small municipalities or those lacking the ability
to pay.
2) Failure to meet effluent limitations or to achieve
water quality standards — because of poor planning
and funding of O&M* .,
Further, EPA will only buy more problems in the future
if it does not create an incentive for grantees to design
revenue sources for plant replacement and future expansion*
The roots of these problems are chiefly a lack of sophis
tication by grantees, a lack of clear EPA guidance* grantees'
unlikely expectations of growth and of water use, and a lack
of total financial planning assistance.
A Strategy for Financial Planning Will Help Grantees Make
Appropriate Choices
The agency can combat the problem of poor financial
choices with a strategy that encourages financially sound,
self-sufficient POTW's. The strategy we recommend contains
3 elements.
•
(1) Reach potential grantees at Step 1 before they
choose wastewater treatment options. The intent is to influ-
ence grantees' choices so that they select optimal financial,
as well as environmental methods. Providing cost comparison
models, peer matches, or case studies will establish a context
of constraints and trade offs within which grantees can
choose rationally a method of treating wastewater.
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(2) Help each grantee assemble the best possible
financing plan. This element occurs after facility planning
is complete and design engineering is under way. We, or the
state (under delegation), would help put together financing
mechanisms for replacing equipment or expanding.the plant.
We would help develop bond financing and user charge systems.
The agency would make grant eligible all activities associated
with the financial planning of POTW's.
(3). In cases of genuine hardship, EPA would increase
"by exception" the funding provided by the federal government
for a POTW's design and construction. Element 3 would become
part of EPA's strategy when either Element 1 or Element 2
disclosed that a particular community would suffer hardship.
Communities experiencing hardship as defined later in this
paper could include as many as 25 percent of all grantees -
yet these same communities require only 15 percent of the
agency's POTW funding. This area clearly has many political
and economic benefits with a minimal cost to EPA.
Table 1 below summarizes the strategy.
Table 1: Recommended Financial Strategy
Element Is Early Influence during Step 1
Help Grantees to make good* early, financially influenced
judgements in selecting a way to treat wastewater:
r
o Through agency supplied cost comparison models
o Through peer matches
o Through Agency sponsored case studies
o By making the assistance of financial consultants
an eligible expense
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Element 2: Exploration of Financing Alternatives
during Step 2
Help Grantees to explore financing alternatives for their
wastewater treatment choicest
o Analysis of the financing capability of grantees
o Bond financing schemes for construction costs
o User Charges for O&M, debt service, and routine
replacement
o Financing mechanisms for eventually replacing
major equipment or expanding the treatment
system.
Element 31 Evaluate Hardship during Steps 1 or 2
Increase funding for capital construction of POTW's in
instances when environmental benefits are significant
and community hardship is great.
To expedite financial planning, we urge that all activities
associated with financially planning a community's wastewater
treatment be made grant eligible. We further urge that EPA
truly "market" the concept of financial planning as a means of
assuring the self-sufficiency of POTW's.
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INTRODUCTION
The regulations of the Construction Grants Program, for
all practical purposes, assume that grantees have the "necessary
legal, financial, institutional, and managerial resources"1. /-^
*Z $
to build and operate waste treatment plants. Unfortunately,
the "brief statement" that each grantee must submit to this
effect in its facility plan top frequently covers a lack of
understanding. Requirements that grantees examine alternative
and innovative technologies, devise adequate user charge
systems, and make public typical monthly charges have abated
*
their ignorance only partly. Further,, the communities most
in need of help, the smallest, are not involved in the
financial planning required of the 208 regional agencies.
The result has been POTW's that are expensive per capita and
often out of compliance. The economic effects upon some
citizens have been severe.
At present, the Agency can point only to scattered
examples of attending to local economic impact. It does
not have a comprehensive policy and program to address the
financial aspects of construction grant activities, which
range from the first decision of sizing and funding to final
decisions of expansion and replacement.}
3-40 CPR 35.917 (h)
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Right now the Construction Grants Program contains a
number of financial-regulations and policiest among them
are Section 204 of the Clean Water Act, PRM 76-3, PRM 79-8,
and a draft PRM which expands Step 1 eligibility for analyzing
secondary effects of POTW's. PRM 76-3, for example, requires
facility plans to include total capital costs, annual debt
service, annual operation and maintenance expenses, and the
"total monthly charge to a typical residential customer."
The flaw, however, is that the "total monthly charge" will not
contain debt service, replacement, or improvements, if those
items are covered by generaltaxes. Thus, the ordinary citizen
may face through increased taxes~ incremental charges far in
excess of the "monthly charge'." Similar flaws exist in
other EPA policies.
This paper 1) presents the rationale for making grant
eligible life cycle financial assessments of community waste-
water treatment options, 2) indicates the scope of financial
assessments, including economic hardship, 3) describes in
Appendix A the funding mechanisms available locally, and 4)
evaluates options for implementing a Financial Assessment
Integrity Strategy for POTW's. This paper builds on elements
now in the program and expands the concept of financial
assessment.
THE PROBLEM
Having built sewage treatment plants, many communities
find themselves unable to pay for them. Sometimes they are
unable to service the debt; more often they are unable to pay
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O&M costs. These financial problems particularly affect
small communities: communities having 10,000 or fewer people.
For example, a study of O&M costs in New York State communities
(excluding New York City) found that for plants of less than
1 MOD, the O&M costs of AWT exceeded $1,000 per MGD. In
contrast, the O&M costs for AWT at plants larger than 5 MGD
were less than $200 per MGD —'a ratio of 5 to 1. The ratio
of O&M costs of the two categories for activated sludge
treatment is smaller — 3 to 1 — but still significant* Other
studies report comparable differences between the costs of
O&M for small and large plants.1
For conventional sewage plants, the per capita construction
costs in small towns exceed those of larger towns. When one
adds to these larger costs the higher per capita cost of
sewers in small communities, the financial burden on small
communities becomes considerable.
Further compounding the problem are the financial naivete
of small communities and their propensity to give over the
management of construction grants to A/E firms, who are no
better equipped to make financial recommendations.
Moreover, these financial problems will increase. A
conservative projection is that 88 percent of all of the
plants on the needs list for the next 10 years are small
plants serving small communities.
1 Legislative commission on Expenditure Review, Audit Report
on New York City State Operations and Maintenance Aid,
April 1979.
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A strategy to deal with this problem would be (1) to
influence a grantee's choice of wastewater treatment
before a locked in preference is reached and (2) to fund and
provide tools for grantees to develop comprehensive financial
plans* Such a strategy would lighten financial burdens of
communities and protect the federal financial and environ-
mental investment.
Current Financial Planning in the Construction Grants Program
Many grantees involved in the construction grants program
are unsophisticated technically and financially. To date*
the Agency's concern has been primarily with their lack of
technical engineering skill. However, we have come to realize
that while technical skill is important, financial ability
is as.essential and perhaps more so.
The construction grants program is currently structured
so that a grantees may hire all technical skills conceivably
».
necessary to meet planning, design, and construction require-
ments posed by water pollution problems. In addition, both
States and EPA provide back up technical skill to assist in
.and review the work done for grantees by consultants.
Unfortunately, the Construction Grants Program provides almost
no assistance in fiscal or financial matters related to sewage
treatment needs. This imbalance should be rectified, especially
since the C.G. program is increasingly characterized as an
effort in which most of the federal activity is financial and
where significant financial consequences occur in communities.
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TABLE 2: Underlying and Intermediate Causes
of the Financial Problems Associated
with POTW's
Underlying Causes
ILack of local
Isophistication
Intermediate Causes
Failure to explore
alternatives
Inaccurate cost data]
Poor exploration of
funding options
Poor choice for 'other1
reasons: politics,
orientation towards
growth
Problems
IExcessive and I
(onerous costs!
ILack of assistance I •
Inflated projections
of population growth;
overestimates of
water use
Inaccurate estimate ofj
O&M
Inadequate user charges)
Diversion of revenues
from user^charges
Failure to generate money
for expansion or major
replacement
[Plants out of
I compliance I
No money for!
expansion I
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Small Communities Wastewater Systems, a recent report
for the Water Planning Division written by the Government
Finance Research Center of the Municipal Finance Officers
Association (MFOA), stated that financial analysis and planning
are weak in public sector planning programs of all types. The
report asserts that just as a large business corporation
would "hesitate to invest in a new'plant without projecting
an acceptable financial rate of return on its investment and
knowing how the funding will be provided, local officals
often hesitate to invest in public facilities or programs
without adequate assurance that certain financial criteria
can be met." Decision makers need quantitative information.
Despite the fact that the value of many public goods and
services cannot be expressed adequately in dollars, estimates
are necessary during the planning of a wastewater treatment
system.
It is acknowledged that the development of water pollution
abatement techniques are absolutely necessary by the local
communities and that polluters •^Bftf&GtSBf should pay for
pollution abatement. To accomplish their task, they should
become aware not only of the technical options available to
reduce pollution but also of financial options to fund their
choices. EPA funds and supports the entire technical chain
from identification of need to final construction; the
.Construction Grants program should provide sound fiscal/
financial assistance as well.
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One possibility is to make total financial planning for
sewage treatment programs grant eligible. The eligibility
should extend to any Grantee — a municipality, a special
district or a group of municipalities. The eligibility also
should cover either in house expertise or consultants to
local communities.
A STRATEGY FOR SELF-SUFFICIENCY
In order for EPA's investment of billions of dollars in
sewage treatment plants to pay off in terms of cleaner water,
we must support our investment from not only the engineering
but also the financial perspective. To date, that support
•
has been oriented primarily toward the engineering integrity
of the plant and not toward financial soundness.
We now require considerable cost information of grant
recipients. As stated above, the cost information is aimed
primarily at engineering cost effectiveness of the capital
facility. This information is used to restrain the capital
cost of a POTW and ostensibly is used to develop user charge
systems later. While estimates of some of the costs are
supposed to be part of the Step 1 facility plan, the costs
provided do not assist the grantee in assessing the total
costs associated with a particular POTW option. We should
provide for or help the grantee to recognize total costs,
long term expansion as well as short term O&M. For instance,
O&M costs will vary with the type of treatment chosen, as
will future equipment replacement and eventual expansion in
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capacity. Thus, the Construction Grants program should
develop a conscious, comprehensive policy to foster long-
term financial self-sufficiency by all grantees. However,
addressing financial matters in a generic and comprehensive
manner, breaking through the tendency to think of the
V
Construction Grants program in terms of Steps 1, 2, and 3,
requires a different conceptual framework, that of financial
self-sufficiency.
Long-term financial self-sufficiency is not a new concept.
It is encountered frequently in the legislative history of
the Clean Water Act and in discussions with Water Program
staff, usually in terms of operating POTW's on a "utility"
or "enterprise" basis. Unfortunately, such discussions
usually center around the User Charge System, a necessary
but insufficient requirement for a '"utility" like operation..
Listed below are some indicators of self-sufficiency:
1) Determination of Community's Financial Characteristics
2) Initial Estimation of Costs & Comparison of Alternatives
(+ disclosure)
3*) Identification of Financing Mechanisms for Capital
Costs and of Revenue Source for debt service and
O&M
4) Development/Implementation/Revision of Revenue Systems
5) Planning of capital improvements —expansion and
replacement— with an appropriate planning horizon
(e.g., 5 years)
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ELEMENT Is EARLY INFLUENCE
The purpose of early contact with grantees and potential
grantees is to establish a context in which a community can
rationally choose (1) a method of treating waatewater, (2) a
means of financing, and (3) a plan for operating, maintaining,
and eventually expanding its sewage system.
To that end, a community must learn not only what it
must do, but also what it must avoid. Early influence,
whether in the form of panels of peers (representatives of
similar communities which have built POTW's), case histories,
or formal studies contrasting the costs of different methods
of treating wastewater, would aim to do the following:
1. Alert grantees to the pitfalls of choosing and
operating POTW's, such as:
o the inefficiency and high cost per household of
excessive capacity.
o the necessity to have legally enforceable
contracts, rather than "letters of intent," with
industries that want to use a POTW.
o the fact that O&M costs usually surpass annual
debt service.
o the likely local share of the new wastewater
system (typically 35% to 59%).
o the likelihood that O&M costs will increase
faster than personal income.
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o the necessity to present all costs as incremental
costs per household.
o . the increased costs per household when an increase
in capacity means using a different method of
treatment.
2. Alert grantees to generic cost, tradeoffs between:
o alternate and conventional means of treating
wastewater;
o capital costs and O&M expenses.
3. Alert grantees to the different optima for small
and large plants, for urban and rural communities.
4. Alert grantees to the range of possible financing
arrangements, including that of a county's issuing
. bonds on behalf of the grantee(s).
5. Alert grantees to the range of state and federal
assistance, including state management of construction
grants for the smallest recipients*
6. Alert grantees to the necessity of foreseeing a
range of outcomes for each choice: best, worst,
and most likely.
7. Alert grantees to the value of early environmental
assessments.
8. Alert grantees to community needs which will compete
for funds with waste treatment plants (e.g^., schools).
Three vehicles for early influence are panels of peers
("peer matches"), case histories, and generic comparisons
of costs. ."Peers" may be knowledgeable representatives of
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communities that have built and operated POTW's successfully,
professors, or consultants. All serve free as a public
service, with only their expenses reimbursed. Case histories
may be presented as written narratives, slide shows, motion
pictures, or video tapes. Formal cost comparisons contain
the relevant ratios, tables, charts, projections, and cash
flows.
In some sense, these three vehicles address three
different audiencess the sophisticated, financially competent
grantee; the naive, but, able granteej and the grantee who is
overwhelmed by the prospect of a construction grant. Case
histories, however presented, and peer panels are appropriate
for the third category. Cost studies and peer matches will
assist the naive, but able grantee. The sophisticated grantee
should require only the formal cost comparisons.
Describing the Community and Costing the Alternatives
Assigning the costs associated with sewage treatment
alternatives is a necessary exercise for a local community.
A facility plan requires some of these costs; PRM 76-3 requires
identification and notification of total and annual local
costs. The purpose is to communicate these costs to the
public. PRM 79-8 gives guidelines for telling how expensive
a project is relative to a community's median income. However,
the cost assessment should include not only the capital
costs, operating costs, and replacement costs but also future
expansion costs and per household costs.
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Answers to the following questions (some which are required
in the facility plan) should affect the costs a community
foresees and influence the choice it makes.
Waatewater System Costsi
(1) How much is the local share of the capital cost
(12-25 percent of the total Step 1 - Step 3 grant
costs)?
(2) What are the potential operating costs* including
such items as sludge handling* staff salaries,
chemicals* small repairs, small equipment replacement,
and support equipment?
f
(3) What is the expected life of the major equipment
and the replacement costs (including major collector
lines.)?
Future Needst
(4) What growth (when, where, and how much) does the
community expect? Would this growth require
expanding the treatment plant?
(5) What would be the expected cost of expanding the
treatment facility and collector/interceptor lines?
(6) What is the probability that the community (A) will
decline in population, (B) will have a stable
population but increase or decrease its tax base,
(C) will have a declining economy and tax base?
With these questions answered honestly, a community can
choose a method to meet its treatment requirements.
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ELEMSNT 28 EXPLORING FINANCIAL ALTERNATIVES
The next part of the financial strategy is to explore
the available funding and revenue mechanisms*
Sources of capital for communities to pay for their 10-
25 percent share of the cost of a sewage treatment plant are
typically general obligation bonds or revenue bonds. In
addition, small communities may apply for loans and grants
from the Farmers Home Administration. The Municipal Finance
Officers Association (MFOA) suggests, however, that local
governments be aware that other forms of funding exist.
They arise from changes in legislative actions, innovations
in bond financing and other financing techniques, and altera-
tions in State and Federal grants.
Revenue options range from having the facility generate
revenue to having the community at large support the sewage
treatment plant through dedicated ad valorem taxes. Appendix A
describes these and other sources of funding and revenues
in detail. A key point to build into any financing program,
according to the Municipal Finance Officers Association, is
that if a wastewater system is not going to be financed from
general revenues, it must be self-supporting: Section 204
(6) (1) (E) of the Clean Water Act supports this point.
Therefore a wastewater system must generate sufficient reve-
nues to cover annual operating and maintenance costs, pay
interest and retire outstanding debt, and make the capital
outlays required for periodic plant modifications and
expansions.
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Estimat.e the coat, of future expansions
An important part of EPA's financial strategy should
be its statement of the long-term posture of the Construction
Grants Program. There is considerable feeling, in Headquarters
at least, that the CG program is a "one-time program" intended
to abate existing water pollution — with expansion and replace-
ment to be the sole responsibility of the grantee. Specifically,
the feeling is that while EPA funds reasonable reserve capacity,
the local community should bear the costs of any additional growth
in population or industrial/business activity? that is, the
Agency should not be at risk to provide funds for incremental
pollution resulting from growth.
A statement by EPA reflecting this feeling is especially
important in light of the latest needs survey. The survey
describes existing needs of $105B, but it projects only $30
billion in committed funds over the next _5 years. It does
not appear that this policy of "one-grant funding" or these
monetary constraints have been communicated clearly to
grantees. The result has been considerable uncertainty.
A manifestation of this uncertainty is a lack of diligence
* i.
by many grantees in providing their own financing for long-
term treatment needs. If the Construction Grants program is
to be a 'one-grant program,' EPA should make this policy
explicit (with necessary guidance to accommodate the staged
projects of large municipalities).
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Thus, given a one-grant policy, communities should anti-
cipate the need to expand their systems at the time they
prepare their original finanical plans. They should be aware
of and build.into their revenue schemes the means to finance
replacement and expansion.
Two ways to pay for expansion are benefit assessment
charges and connection charges. Appendix A describes both
types of charges.
Table 3 summarizes this approach to funding*
TABLE 3
1. Determine capital costs.
Raise funds for construction through:
o General Obligation Bonds
o Revenue Bonds
o Farmers Home Administration loans or grants
o Other Sources
2. Determine needs for on-going revenue.
Fund O&M, debt service, and routine replacement through:
o User Charges
o Dedicated Ad Valorem Taxes
3. Determine costs of expansion.
Finance growth through:
o Benefit Assessment Charges
o Escalating Connection Fees
o Other Sources
Communities should understand that some financial require-
ments may not be explicit. For example, paying for certain
kinds of facilities may imply subdivision or zoning regulations
or ongoing community planning programs. All of these have
cost implications for the community and for local developers
through subdivision fees and costs of construction permits.
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Prepare the financial plan
According to the MFOA, a financial plan is long range in
nature, but not static or unalterable. It should be a strategy
for funding and supporting a POTW. Markets change; new
opportunities emerge.
Moreover, a community's needs and concerns are not
constant. Edwin Wells of Bartle Wells Associates suggests
that a financial plan should specify timing and costs, but be
flexible enough to take advantage of revenue changes. Thus
the financial plan should contain triggers so that as interest
rates and the construction index change, communities alter
their financial schemes.
Yet a financial plan encompasses more than long term
revenue/expenditure projections. It also assesses the credit
capacity of a grantee,1- the best way to market bonds and
notes, the best way to set up accounting systems to service
debt and to manage operation and maintenance, the best way
to manage cash and investments so that capital will be
available for future expansion. For example, marketing
bonds is a specialty and, if properly done, can save a commu-
nity much money through a lower interest rate.
1. Both Booz Allen and Hamilton and Peat, Marwick,
Mitchell have designed procedures to assess the
financial capacity of grantees.
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Many grantees, however, do not have bond ratings because
heretofore they have not gone to the capital markets* Booz
Allen and Hamilton's 1978 study of 346 New York communities
found that 58 (17 percent) were unrated.2 These unrated
grantees need instructions, a handbook telling them exactly
how to get a bond rating. Anecodotal evidence suggests that
the incomplete preparations of many such grantees result in
their receiving lower bond ratings than they deserve.
Get the lowest possible interest rate
"A" rated bonds can vary over 1 percent even in a stable
market, because a rating does not set a specific interest
rate. Just a 0.1% (one tenth of one percent) saving on 1
million dollars equals $10,000. Edwin Wells describes a
campaign to sell municipal bonds as "a combination of infor-
mation and promotion. The objective is to reduce bond interest
costs by stimulating competition. An official statement is
part of the campaign* The statement provides information
and promotes and discloses information with a primary purpose
of stimulating bidding and reducing interest rates."
2. Booz Allen and Hamilton, Assessment of the Capacity of
Local Governments and the State of New York, to Finance
Public Wastewater Treatment Construction, April 28, 1978,
p. Ill 2.
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TABLE 4: Areas in Which Grantees
Need Assistance
FINANCIAL REQUIREMENTS OF
A FACILITY PLAN
AREAS IN WHICH GRANTEES
NEED ASSISTANCE
3,
Cost Effectiveness Analyses.
Choose treatment method
whose total costs (capital
and O&M) have the smallest
present value.
"A brief statement
demonstrating that the
authorities who will be
implementing the plan
have the necessary
financial, institutional,
and managerial resources
available to ensure the
construction, operation,
and maintenance of the
proposed treatment works."
Estimates of total capital
cost, the local share, the
expected method of financing,
annual and monthly debt service
and O&M charges, connection
charges, and total montly charge
to typical resident. (PRM 76-3)
Estimated costs of
prospective sites.
1. Analysis of credit
capacity.
2. Analysis of financing
options.
3. Obtaining a credit
rating.
4. Marketing bonds.
5. Devising a revenue
system to accommodate:
o debt service
o O&M
o Replacement
o Expansion
6. Developing a program
of "cash management,"
since the revenue
stream will be even,
but debt service,
replacement, and
expansion will be
irregular or periodic
expenditures.
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Thus Staff professionals or firms having knowledge of
the bond market and investment brokerage should be available
to assure the best possible financing scheme for a community.
Unfortunately, expenses incurred in marketing bonds are not
allowable. To be allowable* they would have to be specifically
authorized in the Clean Water Act. We believe EPA, should
seek the necessary change to P.L. 92-500 and fund or otherwise
provide to local communities the ability to have the best
professional financial advice available.
A sound financial/fiscal footing for POTW's should lead
to better water quality because communities can service debt,
because the plants will be run more efficiently, and because
replacement and expansion will be built into a community's
needs.
ELEMENT 3; EVALUATING ECONOMIC HARDSHIP
If small communities are financially strapped, will they
be able to pay even the 25 percent of the cost of a well-
designed, appropriate system for treating wastewater? As
part of a total financial strategy we suggest that EPA
consider paying more than 75 percent of the capital costs for
communities meeting "criteria" of economic hardship. 1
Assessing economic hardship would occur as the third phase
of the strategy for assuring financial integrity*
Some states already supplement EPA's funding. EPA should
consider the level of state funding when it decides how
much more to pay in hardship cases.
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STRATEGY
!• EARLY INFLUENCE
Up front agency contact with grantees on the priority
list to show then the generic cost tradeoffs of various
treatment alternatives.
2. FINANCIAL PLANNING
After a grantee chooses a particular treatment option,
EPA requires and funds a complete financial plan.
3. ECONOMIC HARDSHIP
States ascertain community hardship. If a treatment
system would impose undue hardship, EPA would increase
its federal share of the capital costs.
Again, "economic hardship is most likely to occur in
small, rural, relatively poor, unrated or low [bond] rated
communities proposing new conventional treatment systems." 1
Burns and Cahill of Booz Allen Hamilton correlated user
charges as a'percent of median family income with a set of
typical POTW variables. ^ They concluded that:
o Small villages and towns are harder hit than larger
towns and cities.
o The more costly the system, the greater the impact
on the community.
Burns and Cahi11, Sewage Treatment Costs s Assessing
the Impact on Communities, p.3l
a) type of municipality,b) population and population
density, c) family income, d) type of proposed
system, e) bond rating, and f) capital cost
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o The greater the family income, the less the hardship,
o Developing a new system has a greater impact than
expanding an existing system*
o Communities with low bond ratings experience more
hardship than communities with higher bond ratings.
Burns and Cahill urge that such communities "be identified
early on in the Construction Grants process so they can be
encouraged to explore alternative, less costly approaches to
wastewater management.1* .
Keith Dearth of EPA found that (1) small communities
located on tributaries with low flows are often required to
construct expensive* resource intensive tertiary treatment
plants, (2) the conventional collection system not funded by
EPA generally represents 80 percent of the capital costs in
rural areas, (3) small communities cannot spread capital
costs among large populations whose homes have been sewered
previously.*-
Importantly, increasing the federal share for such
communities would not greatly tax the construction grant
budget. Booz Allen and Hamilton's study of POTW's in New
• . ,
York State showed that only 15 percent of federal construction
grant dollars go to communities with "inadequate"2 financing
capacity.
1. Keith H. Dearth, "Current Costs of Conventional Approaches,"
National Conference on Less Costly Treatment_Systems for
Small Communities,U.S. EPA, April 12-14, 19777 Reston, Virginia.
2. Inadequate = high probability of being excluded from
the bond market
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Table 4s Distribution of Federal Construction Grant
Funds by Categories of Financial Capacity
ADEQUATE
CAPACITY
MARGINAL
CAPACITY
INADEQUATE
CAPACITY
TOWNS
229
28
89
1
(PERCENT FEDERAL CG
I BUDGET MEETING
I LOCAL FINANCING
I REQUIREMENTS
,68
.1-7
.15
Source: derived from Booz Allen and Hamilton
Adequate: Likelihood that financing a POTW with bonds will not
lower a town's bond rating*
Marginal: Likelihood that financing a POTW with bonds will
lower the town's bond rating.
Inadequate: Likelihood that town cannot enter the bond market
Yet these communities comprised 26 percent of the 346
communities studied. Thus, EPA'a incremental commitment to
such communities will be relatively small. For example,
increasing the Construction Grant budget by 3 percent will
fund 87.5 percent of the capital costs of POTW's in communi-
ties with inadequate financing capacity. The potential benefits
are great. The number of POTW "horror stories" should decrease
substantially.
There are several ways to assess economic hardship.
The Farmers Home Administration, whose grants and low interest
loans may be used for POTW's, considers making grants when
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annual debt service exceeds critical levels of median family
income. EPA's own measures of hardship employ both debt
service and annual O&M charges per household. The State of
Virginia judges hardship to be economic impact greater than
that of the State average (user charges/median family income).
Using elements of several approaches, Burns and Cahill of
Booz Allen and Hamilton have developed a comprehensive tech-
nique to evaluate economic impact. Appendix B presents
these procedures in more detail.
In cases of genuine hardship, EPA has three choicest
1) Coordinate various grant mechanisms and fund more
than 75 percent of the capital costs of a POTW.
2) Fund POTW1s as it has in the past - and see poor
communities saddled with costs they cannot afford
and plants they cannot maintain.
3) Do not build POTW's in hardship cases.
Choice 2 (the way EPA now operates) is the worst of
the three choices. Generally such plants will be out of
compliance. If the environmental benefits of a particular
POTW are small, choice 3 is the best. However, if the
environmental benefits of a given POTW are substantial,
»
EPA ought to consider choice 1.
OPTIONS FOR IMPLEMENTING A FINANCIAL STRATEGY
Before the options are reviewed and one is chosen, some
assumptions should be made explicit.
Assumptions
o The option chosen should increase the self sufficiency
of the sewage treatment plants being funded.
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o lite option chosen should be consistent with the
role of EPA as a "franchiser1* of the construction
grants program.
o , The option chosen should require relatively few
EPA personnel.
o The option chosen should promote simple, useful
systems, local autonomy, local responsibility,
and minimal delay.
o The option chosen should not lend itself to abuses*
o Communities suffering genuine hardship may be reim-
bursed at greater than 75 percent.
OPTIONS
The following four options describe the range of possi-
bilities, but they are not exhaustive.
1. Continue the present policy* Regulations require
grantees to explore several means of treating
wastewater. They do not, however, help or require
communities to assess the total long range and
short range fiscal impact of the options they
consider, nor do the regulations require commu-
nities to examine the financing alternatives.1
2. Make the cost of financial planning as defined
in this paper ah eligible expense (but not a
1.If the draft PRM 80 now being circulated for comments
becomes policy, new Step 1 grantees will receive 75%
reimbursement for assessing the "financial impact" of
the different ways to treat wastewater. Draft PRM 80
represents a choice midway between Option 1 and Option 2.
Unfortunately, it does not define "financial impact."
Nor, because of ARB decision #2, can it assist in
marketing bonds.
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required expense). State personnel reviewing
a facility plan would note that a grantee either
had checked off from a "master list" the items
it included in its fiscal assessment — or had
waived its rights to the assessment. Grantees
would do the financial planning themselves or
would hire competent consultants recommended
by a state league of cities. EPA would make
available guidelines, handbooks, seminars, hot-
lines, and other materials so that grantees
could check the work of financial/ planning,
and engineering consultants.
3. EPA would arrange with groups like the Municipal
Finance Officers Association (MFOA) or the California
League of Cities to furnish a financial planning
service to grantees. The MFOA or State leagues of
)
cities could also arrange "peer matches" and
disseminate case studies. These services would be
grant eligible, but not required. Grantees would
pay 25 percent of the marginal cost of providing
the service. EPA would provide the fiscal assess-
ment package, pay the fixed costs, and pay 75
percent of the marginal costs.
4. State personnel (or possibly EPA personnel from
"service centers") would make fiscal assessments
of grant recipients. Grantees would pay a nominal
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fee for this service. If States managed Constru-
tion Grants for small grantees* state personnel
would be the logical persons to write the financing
plans in these instances.
Options 2, 3, and 4 may vary in the following ways*
1. EPA may vary the percentage of financial planning
expenses it reimburses* For example, using the
principle of disallowing the ordinary' operating
•
expenses of local government (e.g., salaries and
expenses of a mayor, city council members or city
attorney), EPA may reimburse only the expenses of
grantees whose ordinary operations do not include
making fiscal assessments. These grantees are
typically rural, poor, and small. Or, EPA might
use hardship criteria to decide which grantees to
reimburse fully.
2. EPA may require fiscal assessments of all grantees.
3. States may review the quality of the fiscal
• assessments.
Evaluating the Options:
Option 1 makes grantees fully responsible for any
fiscal assessments they choose to make. It also forces
grantees to pay the full costs of assessments. Right now,
grantees which can afford a financial assessment already
understand its benefits and purchase the service. Those
that do not generally cannot afford the service. Thus, this
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option is not consistent with the role of EPA as franchiser,
as a provider of management training and services. Further,
this option does not promote the self-sufficiency of POTW
plants* "POTW" horror stories will occur repeatedly, with
continuing complaints to Congressmen and probably no increase
in plants' compliance*
Option 2 helps grantees to pay the cost of fiscal assess-
ments and thereby provides an incentive for grantees to
undertake full-fledged fiscal assessments. Grantees, however,
remain responsible for deciding to do the assessment and for
its ultimate quality. The self-sufficiency and rate of
compliance of POTW's should improve.
This option is also fairly consistent with EPA's role as
a franchiser, as provider of management services. Yet EPA's
investment is minimal. There is no added review time. The
cost of providing fiscal assessments will appear only in
requests for payment, not in additional personnel and not in
increased budgets.
Option 3 would ensure that fiscal assessments use the
same methodology and exhibit an even quality. Because EPA
would develop the "financial planning package," the Agency
truly would be a franchiser. However, if the methodology
were occasionally inappropriate, grantees might blame EPA.
Option 3 would require EPA to invest more money and personnel
than Option 2. Providing fiscal assessments would have to
appear in EPA's budget. Further, Option. 3 would require
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more time to implement than Option 2. Nevertheless, the
overall self-sufficiency of plants should increase.
Option 4 places full responsibility for fiscal assessments
on EPA and on the states operating under delegation agreements.
Further, Option 4 is the most expensive way to provide fiscal
assessments, requiring both EPA personnel and probably signi-
ficant resources. Self-sufficiency of POTW's should increase.
Conceivably, States could make the assessments. However, the
experience of California in providing an "Evaluation, Assistance
Service *" which checked grantees' accounting systems was
that 205 (g) monies were not sufficient to support an optional
activity. In place of the Evaluation Assistance Service,
California substituted something akin to Option 2: the
opportunity for grantees to attend seminars in accounting
and negotiations. .California (and now EPA) have made the
cost of attending the seminars an eligible expense.
Additional Considerations
If EPA enacts Option 2 and changes no other regulations,
it will put into effect a crude mechanism to vary funding
of fiscal assessments. That mechanism is the criterion of
not reimbursing costs of "normal governmental operations."
Applied to the cost of fiscal assessments, this criterion
would reimburse the costs of a "targeted" group — small
grantees whose ordinary operations do not include making
fiscal assessments. EPA should consider, however, whether
this mechanism is equitable.
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Another consideration is the effects of requiring each
grantee to make a fiscal assessment. On one hand,
requiring fiscal assessments would make more plants self-
sufficient. On the other hand, this requirement would spawn
many more consulting firms. Those firms would not have to
compete fiercely for contracts, nor would they have, to justify
their products. Potential abuses exist*
Third, if EPA both required and reviewed fiscal assess-
ments, the complexity of the Construction Grants program
would increase* For each grantee, review time would lengthen
and the additional consulting agreement would have to be
audited.
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User Charges. These charges distribute the costs of
operating and maintaining and often servicing the debt among
the users of a sewage treatment system. There is usually
a unit of use (perhaps amount of flow) distributed in an
equitable manner among households, businesses and industries.
A simple system, for instance, might assess a single family
detached house at 2.2 units, a garden apartment at 1.0 units
and a small grocery store at 4 units. The monthly fee might
be $6.00 per unit, determined by dividing total annual costs
by the total number of units.
Another locality might develop user charges by adding
the total amount of money required to service the debt service
(capital construction) to the total anticipated operating
expenses for any particular year. The sum becomes a part of
a ratio of metered plant inflow to cost. The locality next
allocates the flow among users and charges each accordingly.
Other systems of user charges assess participants not
only by the amount of flow but also by its strength.
It is important that user charges reflect the full costs
of operation, maintenance, replacement, and debt service.
To secure a budget for replacement, planners may have to use
the word depreciation rather than replacement in some
discussions.
Ad Valorem taxes supporting the construction, maintenance,
and operation,, and replacement of sewage treatment facilities
distribute the costs of a POTW beyond the user to the community
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A-3
at large. The premise is that, all benefit front clean water.
Ad^Valbrent taxes can be subject to legislative action by the
community at large. .
A Ready to Serve Tax or "stand by charge" is a tax on
undeveloped land where sewer lines are in place. This tax
encourages development within the existing service area.
It reduces the probability of "leap frog" developments which
require massive extensions of sewage lines* pump over of
effluent from one basin to another, expansion of treatment
capacity, or even new sewage treatment plant construction.
A ready to serve tax can be part of a current O&N budget or
become part of a plant expansion or construction fund.
Anticipating Expansion
Benefit Assessment Charge is a way of dividing the cost
of capital construction among the eventual users. It works
by the community establishing a lien on property being served
to support construction of either a POTW or a sewer line.
Typically it is a one time only charge at the time of
construction financing.
Connection Charges are one-time fees imposed on new
users of a system. The fees vary in the same manner as the
user charges, and they are usually part of building permit
fees. They can remain constant, or they can escalate annually.
Escalating connection charges typically increase each year
and are tied to an appropriate index.
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A-4
Connection charges usually.finance plant, expansion. In
order for them to be functional, a grantee should determine
plant expansion costs when the original plant is built, and
the connection charges should be based upon increments of
growth to meet the expansion cost requirements. By tying the
charges to a construction index, the connection charges will
always be current with plant expansion costs. In this way
growth pays for itself*
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APPENDIX B: Ways to Evaluate Hardship
There are several ways to assess economic hardship.
1. RnH.A. The U.S»D.A. makes low interest loans and grants
for community facilities available to rural areas and towns
with populations up to 10,000. Wastewater treatment systems
are eligible for PmH.A. funding. According to Booz Allen
and Hamilton, the FmHA will consider issuing grants only
when annual debt service per household exceedsi
o .75% of a median family income less than $6,000
o 1.0% of a median family income between $6,000
and $10,000
o 1.25% of a median family income greater than
10,000 :
2. EPA's hardship criterion compares user charges from new
facilities to the median family income of a service area.
Hardship occurs when (1) average debt service per household
exceeds one percent of local median family income and (2)
when the sum of debt service and operations and maintenance
charges per household exceed two percent of local median
family income.
3. EPA has also defined an "expensive" wastewater facility.
A facility is "expensive" when average debt service and operation
and maintenance together exceed the following percentages of
median family income:
1.5 % if median household income is less than $6,000
2.0% if median household income is $6,000 to $10,000
2.5% if median household income is greater than $10,000
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B-2
Note that the PmHA criteria evaluate capital cost; the
EPA criteria evaluate the cost of O&M to the level of capital
expense*
4. state of Virginia. Virginia assesses hardship as part of
its review of the priority list. The Virginia approach
essentially divides total user charges for all utilities by
local median family income and compares the result to a
statewide average of utility charges as a percent of state
median family income. If a community pays more in proportion
to its income than the state average, it is termed as a
hardship and is eligible for funds. Virginia then .ranks the
hardship cases; the greater the hardship, the larger the
percentage the state funds the community receives.
5. Burns and Cahill of Booz Allen and Hamilton have combined
three of these approaches to develop a conceptual process for
ranking each community in a state. Based upon median family
income and user charges, their approach has three possible
outcomes:
(1) Hardship, (2) Potential hardship, and (3) No hardship.
Step (1) Assess all user charges in a given State as a
percent of local median family income.
Step (2) Calculate the average user charge as a percent
of state median family income
Once Steps 1 and 2 are completed for each state, one can
rank any new proposed sewage treatment project or proposal
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B-3
anywhere in the U.S. When a municipality considers one or
more specific alternatives* then Steps 3 and 4 show whether
the municipality will suffer hardship.
Step (3) Determine user charges for the new facility as a
percent of local median family income
Step (4) Compare user charges from Step 3 to EPA's is 2%
criterion and to the state average from Step 2.
Place the applicant in one of three categories *
Hardship: , Projected user charges exceed 2% of local
median family income.
Potential Hardship* Projected user charges are less than 2%
of median family income but more than
the state average.
Projected user charges are less than 2%
of median family income and less than
state average.
No Hardships
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