Rural Water Supply and Sewer Systems:
Background Information

Claudia Copeland
Specialist in Environmental Policy
Environment and Natural Resources Policy Division

Updated January 20, 1999

98-64 ENR

Regulatory Requirements

The public health and environmental requirements of two federal laws are primarily driving projects in rural, as well as non-rural, areas for drinking water and wastewater treatment. The Environmental Protection Agency (EPA) administers both laws.

For the quality of drinking water supply, requirements of the Safe Drinking Water Act (SDWA) apply to communities which are served by public water supply systems, both government-owned and privately-owned systems. As defined in this Act, public water supply systems are those having at least 15 service connections. Public water supply systems serve approximately 243 million persons; the remainder (16 million households, including 45% of rural communities) are served by non-community systems (such as individual wells), which are not subject to the Act or its regulations.

Numerically, water systems with service areas of less than 10,000 persons account for 94% of all community water systems (CWS), yet they supply water to only 20% of the population served by CWS. The smallest water systems (serving fewer than 3,300 persons, many serve small clusters of homes) account for 85% of all Systems and a similar percentage of systems that are in significant noncompliance with drinking water regulations. Most very small Systems have no credit history and have never raised capital in financial markets; also, most are non-public entities and thus do not have access to federal grants and loans. Small to medium systems (serving 3,301 to 50,000 persons) are institutionally more capable than smaller systems, yet they also face financing challenges. The smallest of these have limited access to financial markets and credit worthiness more sensitive to local economic conditions than larger systems.

Public water supply Systems currently are subject to a number of drinking water regulations issued by EPA under the SDWA. Federal regulations which limit levels of contaminants in treated water are implemented by local water suppliers. These require, for example, system monitoring, treatment to remove certain contaminants, and reporting. New regulations are being developed that are likely to impose additional compliance burdens on all public water systems within the next few years.

EPA estimates that compliance with the regulations already promulgated will provide millions of people protection from numerous industrial chemicals, microbes, and other contaminants in public water supplies. However, to comply, many cities and towns must invest in capital equipment, operation and maintenance, and increased staff technical capacity. Recent regulations with particularly costly implications for small towns include water filtration, lead control, and inorganic and organic contaminant control. Overall, EPA estimates that 68% of total compliance costs for drinking water regulations currently being implemented will fall on those systems that each serve fewer than 3,300 persons.

In 1997, EPA reported that small community water systems (serving up to 3,300 persons) have funding needs of $37.2 billion (27% of the total national need) to provide safe drinking water through the year 2014. More than 80% of small systems need to upgrade distribution systems, EPA said. Two-thirds need to improve their water sources, which are usually wells.

For wastewater treatment, requirements of the Clean Water Act (CWA) apply to all communities which discharge municipal sewage waste into the Nation's waters. Under that Act, all municipalities were to achieve secondary treatment of municipal sewage, equivalent to removing approximately 85% of wastes from the municipal wastestream, or more stringent, where that is required to meet local water quality standards, by July 1, 1988. Unlike the Safe Drinking Water Act, regulatory requirements under the CWA have been fixed for some time. The issue for many cities is continuing efforts to finance capital improvements that have been known for several years.

When the 1988 deadline arrived, EPA estimated that 87% of all cities achieved compliance, including 86% of rural Systems. However, of the 2,097 cities which did not achieve compliance and were subject to EPA enforcement and/or penalties, 80% were "minor" facilities, defined as those serving a population of 10,000 or less.

EPA reported in 1997 that cities throughout the country (of all sizes) will require $126 billion over the next 20 years for wastewater facilities to meet water quality standards. EPA estimated that funding needs for small communities' projects (populations less than 10,000) are $13.8 billion. Facilities in the smallest communities (less than 1,000 persons) represent 36% of small community facility needs. Small communities reported greater needs for new sewers and treatment plant upgrades to secondary treatment than for other types of facilities. As with problems in meeting drinking water needs, EPA has estimated that, because small systems lack economies of scale, their customers face a particularly heavy financial burden. The smallest cities are likely to experience the largest overall percentage increases in user charges and fees as a result, EPA has said.

Federal Assistance Programs

The federal government administers a number of programs that assist rural communities in developing water and waste disposal systems. The most prominent are programs of the Department of Housing and Urban Development (HUD); Appalachian Regional Commission (ARC); Economic Development Administration (EDA); EPA; and the U.S. Department of Agriculture (USDA).

HUD administers assistance primarily under the Community Development Block Grant (CDBG) program, in title I of the Housing and Community Development Act of 1974, as amended. FY1999 appropriations are $4.75 billion (P.L. 105-276). CDBG funds are used by localities for a broad range of activities intended to result in decent housing in a suitable living environment. Water and waste disposal needs compete with many other public activities for this assistance and are estimated to account for 10% to 20% of CDBG obligations. Program policy requires that at least 70% of funds must benefit low/moderate-income persons. Thirty percent of CDBG funds ($1.4 billion in FY1999) are allocated by formula to the states for distribution to small communities and may be available for rural community projects. According to data from HUD, in FY1993 (the most recent year for which complete data are available), water and sewer activities were the most prominent activity assisted with these funds, accounting for about 29% of funds spent during that year. The larger portion of total CDBG funds, 70%, are allocated by formula to metropolitan areas and cities with populations of 50,000 or more and statutorily defined urban counties and thus do not assist rural areas directly.

The ARC assists with programs and projects to provide basic facilities essential to economic growth in the Appalachian regions of 13 states. Investments are concentrated in areas with significant potential for future growth as well as in areas that suffer the greatest distress. States recommend projects for assistance. In FY1999, the ARC is funded at a level of $66.4 million (P.L. 105-245), budgeted primarily for area development assistance, covering a range of community-based projects including basic infrastructure (but not including highways), business development, and human development.

EDA provides project grants for construction of public facilities, including water and sewer systems, to alleviate unemployment and underemployment in economically distressed areas. Development grants provide for infrastructure projects that foster industries and commercial businesses that provide long-term employment and are part of approved overall economic development programs in areas of lagging economic growth. Economic development grants can be used for a wide range of purposes and frequently have a sewer or water supply element. According to data from EDA, the largest share of public works and development grant dollars awarded in FY1996 (about 47%) went for projects involving water and sewer facilities. In FY1999, EDA's public works grants are funded at $206 million (P.L. 105-277).

In historic terms, the largest federal program for wastewater treatment assistance is administered by EPA under the Clean Water Act. Since 1973 Congress has appropriated $71 billion under this program. Total FY1999 funding is $1.35 billion (P.L. 105-276). Funds are distributed to states under a statutory allocation formula and are used to assist qualified projects on a priority list that is determined by individual states. Prior to 1989, states used their allotments to make grants to cities and other localities. Now, however, federal funds are used to capitalize state loan programs (State Revolving Funds, or SRFs), and project loans are made according to criteria in the CWA Over the long term, the state loan programs are intended to be sustained through repayment of loans, thus creating a continuing source of assistance for other communities. Rural and non-rural cities compete for funding; rural areas have no special priority, nor are states required to reserve any specific percentage for projects in rural areas.

Some small communities and states with large rural populations have had problems with the CWA loan program. Many small towns did not participate in the previous grants program and are more likely to require major projects to achieve compliance with the law. Yet many have limited financial, technical and legal resources and have encountered difficulties in qualifying for and repaying loans. They often lack an industrial tax base or opportunities for economies of scale and thus face the prospect of very high per capita user fees to repay a loan for the full cost of sewage treatment projects. Still, small communities have been participating in the SRF program. an estimated 20% of the $20 billion in loans since 1990 has gone to towns and cities with less than 10,000 population.

In 1996, Congress enacted Safe Drinking Water Act (SDWA) amendments which authorize federal capitalization of state loan programs to help public water systems finance improvements needed to comply with federal drinking water regulations (P.L. 104-182) This new SDWA loan, or SRF, program is similar in structure to the CWA SRF program. Elements that differ under the SDWA SRF include authority for states to make both loans and grants, to assist both privately and publicly owned community water systems, and to provide loan subsidies to economically disadvantaged communities. To give states flexibility in meeting infrastructure needs, the law allows a Governor to transfer as much as 33% of the annual SDWA SRF allotment to the CWA SRF, or an equivalent amount from the CWA SRF to the SDWA SRF. For FY1999, Congress appropriated $750 million for SDWA SRF assistance (P.L. 105-276). However, amounts available for drinking water facility projects are diminished because the 1996 SDWA amendments directed a number of set-asides to fund other program priorities and requirements, such as health effects research, source water protection, and operator certification. Overall, as much as 30% of SRF appropriations could be used for set-asides. (For information, see CRS Report 97-677 ENR, Safe Drinking Water Act: State Revolving Fund Program.) Because the SDWA SRF program is new, it is too soon to know how significant it will be in assisting rural communities.

USDA Water and Waste Disposal Programs

Grants and loans (direct and guaranteed) for water and wastewater projects are available through rural development programs of the U.S. Department of Agriculture (USDA). Funds are limited to communities with population of 10,000 or less. Communities must be denied credit through normal commercial channels to be eligible for assistance. USDA prefers making loans, grants are made only when necessary to reduce average annual user charges to a reasonable level.

Prior to enactment of the 1996 farm bill (the Federal Agriculture Improvement and Reform Act of 1996, P.L 104-127), the USDA grants and loans, as well as other USDA rural development assistance to businesses, industries, and communities, were authorized as separate programs. In P.L. 104-127, Congress endorsed an Administration proposal to consolidate 14 existing grant and loan programs into three categories for better coordination and greater local involvement. The new program is called the Rural Community Advancement Program (CAP). The three components are the Rural Utilities Service (RUS, providing assistance for water and wastewater disposal, solid waste management, and emergency community water programs), Rural Community Facilities, and Rural Business and Cooperative Development.

Under RCAP, USDA state offices will work with state and local governments, Indian tribes and private and community organizations to prepare a strategic plan for delivering RCAP assistance to each state. The intent is that, through these plans, local stakeholders will have greater involvement in setting priorities for rural development, while the new delivery mechanism provides greater flexibility in the use of available funds.

RCAP is similar to a block grant approach that consolidates separate assistance programs in order to achieve flexibility and coordination. However, unlike most block grants which give states and localities flexibility and relief from federal requirements, RCAP remains a program of federal assistance that retains most existing requirements. The key difference is that by involving state and local stakeholders in strategic planning, federal assistance is intended to address local priorities more effectively.

The 1996 farm bill did not alter the basic features or statutory requirements of the water and waste disposal grant and loan programs, which are administered through a network of state and local offices. USDA headquarters allocates program funds to the Rural Economic and Community Development state offices through an allocation formula based on rural population, poverty, and unemployment. District RECD offices actually administer the programs. Through these programs, USDA has assisted more than 12,500 communities and about 17,000 water and sewer projects since 1965.

Water and Waste Disposal Grants

Grants for the development costs of water supply and waste disposal projects in rural areas are authorized under the Consolidated Farm and Rural Development Act. Only communities with poverty and intermediate rate incomes qualify for USDA grants. An eligible project must serve a rural area which is not likely to decline in population below that for which the project was designed, and it must be designed and constructed so that adequate capacity will or can be made available to serve the reasonably foreseeable growth needs of the area.

Grants may not exceed 75% of the development cost of a project to reduce user costs to a reasonable level. Grants may be used to supplement other funds borrowed or furnished by applicants for project costs and may be combined with loans when the applicant is able to repay part, but not all, of the project costs. Eligible applicants may include municipalities, authorities, districts, certain Indian tribes, and similar organizations. Grants also can be made to private nonprofit organizations that have experience in providing technical assistance in evaluating alternative solutions to water and waste disposal problems or improving operation and maintenance practices at existing facilities.

Water and Waste Disposal Loans

The Rural Development Act of 1972 authorized the Rural Development Insurance Fund under the Consolidated Farm and Rural Development Act. Among other activities, this fund is used for loans to develop storage, treatment, purification, or distribution of water or collection, treatment, or disposal of waste in low-income rural areas.

Loans are made to public bodies, not-for-profit organizations, Indian tribes on federal and state reservations, and other federally recognized tribes for projects needed to meet health or sanitary standards, including clean water standards and SDWA requirements. Loans are repayable in not more than 40 years or the useful life of the facility, whichever is less. USDA makes either direct loans to applicants or guarantees up to 80% of loans made by third party lenders.

Loan interest rates are based on the economic and health environment and are designated poverty, market, or intermediate. The poverty interest rate currently is 4.5%, and such loans are made in areas where the median household income (MHI) falls below the higher of 80% of the statewide nonurban MHI or the poverty level and the project is needed to meet health or sanitary standards. The market rate is adjusted quarterly and is set using the average of a specified 11-bond index. It applies to loans to applicants where the MHI of the service area exceeds the statewide nonurban MHI. The intermediate rate is the poverty rate plus one-half the difference between the poverty rate and the market rate for municipal bonds, not to exceed 7%. This rate applies to loans that do not meet the criteria for the poverty rate and which do not have to pay the market rate.

Beginning with USDA's FY1996 appropriation, Congress consolidated the water and waste disposal grant and loan appropriations in a single Rural Utilities Assistance Program, consistent with the approach taken in the 1996 farm bill to consolidate delivery of rural development assistance. In FY1998, Congress appropriated $577 million for the Rural Utilities Assistance Program. USDA estimated that, counting both appropriations and repaid loan monies still available, $1.28 billion in program activity would be supported in FY1998. For FY1999, Congress appropriated $645 million for the RUS water and waste disposal grant and loan program (P.L. 105-277).

In dollar terms, the largest federal programs that solely assist water and waste disposal infrastructure needs are administered by EPA. FY1999 appropriations for the clean water and safe drinking waters SRF programs total $2.1 billion. They do not focus solely on rural areas, however. USDA's grant and loan programs also support significant financial activity and are directed entirely at rural areas. Still, the reported funding needs in rural areas are high (at least $50 billion, according to EPA surveys), and there is heavy demand for funds. in January 1998, USDA reported a $3.4 billion backlog of requests for grants and loans. Meeting the infrastructure funding needs of rural areas efficiently and effectively is likely to remain an issue of considerable congressional interest.