On April 20, 2015, the California Court of Appeal for the Fourth Appellate District ruled that article XIII D of the California Constitution requires an agency to correlate tiered prices with the actual cost of providing (water) services at the tiered use levels.  Capistrano Taxpayers Ass’n, Inc. v. City of San Juan Capistrano, 235 Cal. App. 4th 1493 (2015).   Section 6(b)(3) of article XIII D generally requires a fee or charge imposed on any parcel to be proportional to the cost of service attributable to the parcel.  The Court of Appeal, however, narrowly read this provision as requiring the City of San Juan Capistrano (City) to have calculated, to the penny, the cost of service within each tiered water rate.  While it appears that the City had carefully distributed costs across the rate tiers, the Court nonetheless ruled that the City’s analysis was inadequate.

Background

The City had developed its tiered water rates by first determining total service costs, and then identifying cost components.  Next, it identified customer classes such as residential, construction, and agricultural customers.  For each class, the City identified four water budgets, which were then used to create four distinct pricing tiers.  Using these four budgets, the City allocated total costs in such a way that anticipated revenues from all four tiers would equal total costs.  Despite these calculations, the Court determined that the City did not try to calculate the incremental cost of providing water at the level of use represented by each tier, and that the City had used revenues from the top tiers to subsidize below cost rates for the bottom tiers. The Court found the City’s analysis insufficient, ruling that it had not evaluated the relative costs of each supply source to justify the rates for each tier.

Court’s Analysis

Article XIII D of the California Constitution requires that “[a] fee or a charge shall not be … increased by any agency unless it meets all of the following requirements: (1) Revenues derived from the fee or charge shall not exceed the funds required to provide the property related service…. (3) The amount of the fee or charge imposed upon any parcel or person as an incident of property ownership shall not exceed the proportional cost of the service attributable to the parcel.”  Cal. Const. art. XIII D, § 6(b).

In the context of evaluating the City’s tiered water rates for compliance with article XIII D, the Court of Appeal held that article XIII D does not prevent public agencies from designing tiered water rates.  The Court further found that in designing tiered water rates, an agency must do more than simply balance total costs of service with total revenues because subdivision (b)(1) alone requires this much.  Ultimately, the Court concluded that under subdivision (b)(3), an agency must correlate its tiered prices with the actual cost of providing water at the tiered levels, and may not simply “draw lines based on water budgets.”  Capistrano Taxpayers Ass’n at 1511. The Court found the City’s analysis inadequate because it did not comply with the requirement to evaluate the proportional cost of service for each parcel, as required by section 6(b)(3).

Further, the Court of Appeal held that the City could not simply rely on the conservation mandate in article X, section 2 of the California Constitution as a basis for the rate differential between the higher and lower tiers.  The City argued that a correlation between tiered water rates and the cost of service is unnecessary because the City’s tiered rates encouraged conservation and provided a subsidy for low water users that is required by article X, section 2.  The Court, however, with respect to the rates for the higher tiers, held that “nothing in article X, section 2 requires water rates to exceed the true cost of supplying that water ….”   Capistrano Taxpayers Ass’n at 1510 (emphasis added).  Thus, despite article X, section 2’s emphasis on water conservation, a local agency must adhere to the procedural requirements in Section 6 when adopting or increasing water rates.  This means that an agency may not simply rely on the conservation mandate in article X, section 2 as a substitute for calculating the cost of service within each tier.

Conclusions/Implications

Prior to this decision, article XIII D required a local agency to justify the proportional cost of service associated with tiered water rates.  This decision, while it may not substantively change the law, now provides a platform for potential challengers to focus on cost of service issues associated with tiered rates when attacking a local agency’s new or increased fees and charges.  In designing tiered rates, local agencies are advised to carefully consider the Court’s holdings with respect to justifying tiered rates with cost of service information.

For more information, contact Aaron Ferguson at aferguson@somachlaw.com.

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