The Ta’iz region of Yemen is facing serious water problems. Total water use has become unsustainable. While agriculture places a heavy demand on the region’s water resources, supplies for the fast growing city and the industrial sector are severely rationed despite their much higher willingness-to-pay for water relative to the returns on most agricultural uses. The article considers several decentralized management options for enhancing sustainability and improving intersectoral water allocation. These include, taxing groundwater extractions, taxing inputs used in pumping groundwater, and implementing a tradable water rights regime. The first two options could lead to resource conservation but are politically difficult to implement and may not necessarily result in better intersectoral water allocation. The tradable water rights regime has potential for achieving the twin objectives of resource conservation and improved intersectoral resource allocation. If farmers’ de facto water rights were legitimized, this option would be more acceptable to them. However, the following additional conditions need to be met for making the option viable: (a) a set-aside allocation is made for lifeline supplies for the poor; ( b) the water law provides for separation of water rights from land rights; and (c) community organizations are involved as co-managers of the region’s water resources.