The Court of Appeal for the Third Appellate District recently ruled in Wyatt v. City of Sacramento that a City’s imposition of a surcharge in the form of a “general tax” on property-related utility services payable to the City’s general fund did not violate Proposition 218 (Prop. 218).  (Wyatt, supra (Jan. 29, 2021, C089702) 2021 Cal. App. LEXIS 79.)  The appellate court decision confirms that a surcharge imposed on a utility enterprise is a cost of providing utility services and is therefore properly part of the Prop. 218 analysis of determining whether revenues exceed funds required to provide the services.  The decision further clarifies that, even when revenues from such a surcharge are transferred to a general fund, they do not necessarily violate Prop. 218’s prohibition on funding general governmental services if the surcharge is imposed for specific utility services.

Proposition 218 Background

In 1996, California voters adopted Prop. 218, the “Right to Vote on Taxes Act,” which amended the California Constitution to limit the methods by which local governments could exact revenue from taxpayers without their consent.  Specifically, article XIII D, limits the authority of local governments to assess taxes and other charges on real property and only permits four types of local property taxes:  (1) an ad valorem property tax; (2) a special tax; (3) an assessment; and (4) a fee or charge.  (Cal. Const., art. XIII D § 3 (a)(1)-(4).)  A local government may only extend, impose, or increase a fee or charge if the revenues do not exceed the funds required to provide the property-related services, and the revenues are not used for any purpose other than that for which the fee or charge was imposed.  (Id., art. XIII D § 6 (b)(1)-(2).)  Moreover, a local government may not extend, impose, or increase a fee or charge for general government services (i.e., police, fire, ambulance services) where the service is also available to the public at large in substantially the same manner as it is to property owners.  (Id., art. XIIID, § 6(b)(5).)

After passing Proposition 218, City of Sacramento voters approved a ballot measure adding Section 3.20.010 to the Sacramento City Code, which required city enterprises providing water, sewer, storm drainage, and solid waste services pay a total tax of 11 percent of their gross revenues from user fees and charges to the City’s general fund.  Plaintiff brought a petition for writ of mandate and a complaint for declaratory relief against the City of Sacramento (City) arguing that general taxes imposed on the use of property-related services are “fees” and “charges” within the meaning of article XIIID, section 2(e), and that because such taxes cannot comply with the substantive requirements applicable to “fees” and “charges” they are implicitly prohibited by article XIIID.  The trial court found in favor of the Plaintiff, and the City appealed.

The appellate court first identified the relevant “fee” or “charge” for its Prop. 218 analysis.  It held that, even though part of the tax is included in the City’s utility fees and charges, that alone does not mean the tax itself was a fee or charge within the meaning of article XIII D. The appellate court, citing Citizens for Fair REU Rates v. City of Redding (2018) 6 Cal.5th 1, made clear that the rates set for the City’s utility customers should be the focus of the Prop. 218 analysis.

The appellate court then turned to the question of whether the rates set for the City’s utility customers violated article XIII D, section 6, subdivision (b)(1), (2), or (5). The appellate court determined that the utility service fees and charges were not for “general government services” because they were, on their face, imposed for specific services provided, such as water, sewer, storm drainage and solid waste services to residential customers.

The appellate court then addressed the City’s contention that it may recover the cost of lawful taxes from retail rates. While the appellate court agreed with Plaintiff that transferring funds between accounts as required by Section 3.20.010 does not fit within the definition of a tax, Section 3.20.010 operated at least akin to a tax since it imposed a specific obligation of 11 percent gross revenues on the utility enterprises. Moreover, the appellate court held that because the 11 percent charge was an ongoing cost of the City doing business, the fact that the tax could be imposed differently on different utility enterprises did not change its basic nature as a cost required to provide the services, which the City could ultimately recover from rate payors.

The appellate court further held that not only did the City treat the revenue tax on utilities as a component of its utility service fees, which it is entitled to recover as a cost of business, but the voters’ adoption of the tax resulted in a specific cost obligation being placed on the utility enterprises. Ultimately, by approving the tax in 1998, Sacramento voters increased the cost of providing utility services, rendering those costs as recoverable as part of their utility rates and the subsequent transfer of funds permissible under article XIII D.

For more information on local government rate setting and Proposition 218, please contact Kyler C. Rayden at krayden@somachlaw.com, or Aaron Ferguson at aferguson@somachlaw.com.

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