Built components of watersheds are associated with impervious surfaces that alter hydrology, disrupt ecosystems, and affect water quality. This study focuses on the impervious factor as a tool for assessment and policy design to address water quality impacts. The empirical model uses a combination of watershed simulation and statistical regression modeling to study sediment loading at various stages of urbanization. The policy design is based on private behavior in a watershed setting to develop appropriate economic approaches. The incentives through taxes, subsidies, and cost sharing are based on water quality impacts. It was observed that nonlinearity in response functions resulted in transition effects that are continuous. This is due to gradual shifts in landscape characteristics as a result of urbanization. On a regional basis, impervious factor had a varying effect on water quality and depend on the state of urbanization and spatial characteristics. Economic policies based on a metric like impervious cover can be used to mitigate the negative effects of urbanization in watersheds through use of appropriate BMPs, urban forestry methods, and spatial targeting. While linear rules in policy are easier to implement, nonlinear rules were more effective in representing the changes in marginal social cost of impervious factor, especially initial and late stages of urbanization. There exists excellent scope in using this targeted policy to address specific problems associated with complex urban systems.