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Cities Are Deceptively Using Reserves To Evade Proposition 26

by | Jun 22, 2021 | Firm News |

In 1996, the People of the State of California approved Proposition 218, “The Right to Vote on Taxes Act” which amended the State Constitution by adding articles XIIII C and XIII D.  Article XIII C prohibits local governments from imposing, extending or increasing special or general taxes without the consent of voters.  At the time it was passed, municipal owned electric utility rates were not considered taxes, even if they included substantial profits flowing to a local government’s general fund.  In fact, local governments found loopholes in Propositions 13 and 218 allowing them to disguise revenue generating taxes as fees and charges for government services and regulations.  They got away with it for many years.

In 2010, the People of the State of California approved Proposition 26 to close those loopholes, by adding an expansive definition of the term “tax” to article XIII C.  It defined tax as virtually any levy or charge imposed by a local government, with seven enumerated exceptions.  Among the exceptions is for service fees that do not exceed the cost to the local government to provide the service.  One would have thought that would be the end of loopholes.  Think again.  Local Governments have devised numerous ways to work around Proposition 26 and avoid having to obtain voter approval of their excessive fees and charges.  For instance, local governments have been using reserves to avoid liability for their excessive utility fees. 

The following hypothetical is helpful to understand the issue:

It is the year 2011 and your city is proposing new electric rates.  To meet its obligations under Proposition 26, in particular, its burden to establish that its rates do not exceed its cost of providing electric service, the city prepares a so-called revenue requirement calculation.  The process typically involves the city preparing a 5-year budget forecast of electric service costs (including operations and maintenance costs or O&M, fuel costs, energy costs, capital costs, and, of course, reserves to fund capital expenditures or to help stabilize rates over the years as fuel costs fluctuate).  In 2011, the city claims the reserves are needed given the high cost of capital improvements or due to the difficulty in predicting future power needs and to ensure that service is reliable.  To pass reserves off as a “cost of providing electric service,” the city assures ratepayers that the reserve funds will be tucked safely into so-called “reserve funds” and only taken out for their assigned purpose, i.e. electric utility capital improvements. 

Fast forward to 2021.  The City is planning to raise rates to generate millions of dollars in excess revenues or profits to fill budget shortfalls in its general fund.  But if its passes the rates, it would likely face a Propositions 218/26 lawsuit claiming its electric rates are illegal taxes that have never been approved by voters.   It needs to find some other source of so-called non-rate revenue to include in its budget forecast to finance the transfer.  The City sees millions of dollars in its reserve accounts “designated” for capital improvements or rates stabilization.  It comes up with an idea to draw on those reserves to cover the transfer, even though, years earlier, it assured ratepayers that the reserves would only be spent on capital improvements and other expenses to operate the utility.  Unfortunately, courts are allowing cities to get away with it.  The way some courts have seen it, ratepayers did not challenge the reserves when they were collected in prior rates, set years ago.  In other words, cities can lead you to believe the reserves are a valid cost to provide electric service in year one and then in year 3 use those reserves for general government services unrelated to the provision of electric service.  By that time ratepayers are out of luck because the statute of limitations has run.    

There may be ways to fight this.  Stay tuned.