Regulating Water Quantity and Quality in Irrigated Agriculture: Learning by Investing under Asymmetric Information

An input-based incentive approach for controlling an agricultural non-point source pollution problem is developed. A regulatory agency designs a tax scheme and an investment policy to increase its informational base, in order to obtain the desirable water use and emissions for a set of agricultural producers whose individual water use and emissions cannot be observed without costly monitoring. The agency invests in order to increase observability of water use and emissions, and taxes the observed variables. Learning effects enhance the process of acquiring information about the individual producers' behavior. The optimal tax scheme and the cost minimizing monitoring program are determined. This revised version was published online in July 2006 with corrections to the Cover Date.