News

Palo Alto's 'illegal tax' could lead to $12M refund to gas customers

Judge reaches conclusion in challenge against city's transfer of money from gas utility to general fund

Palo Alto Utilities workers assess the damage to a gas pipeline on Dec. 28, 2017. Embarcadero Media file photo.

Four years after Palo Alto resident Miriam Green first challenged the city's policy of transferring revenues from its Utilities Department to fund other city services, Palo Alto is facing a court order requiring it to refund about $12 million that it collected from gas ratepayers.

But the refunds may not reach customers any time soon, with both the city and Green's legal team planning to appeal different parts of the decision.

Green's lawsuit, which the City Council discussed in a closed session on Monday night, alleged that the city illegally instituted a tax on its ratepayers when it raised electric and gas rates in 2012, 2016 and 2018 and transferred revenues from the Utilities Department to the city's general fund, which pays for basic services such as police, libraries and street repairs.

Since then, Green and the city have each claimed partial victories. Earlier this year, the Santa Clara County Superior Court concluded that the city's practice of transferring funds from the electric utility to the general fund is legal, while its transfers from the gas utility constituted an "illegal tax" that should be refunded. In October, a Superior Court judge ruled that the refund should total roughly $12 million, though the exact details of how and when it will be made have yet to be worked out.

While this year's rulings represent a milestone, Green's case is unlikely to be fully resolved for months, if not years. Green plans to challenge the determination by the Superior Court that the city's electric fund transfers were legal, Green's attorney Prescott Littlefield told the Weekly. And while the city hasn't made any public statements on the case (Mayor Adrian Fine said there was "no reportable action" after the Monday closed session), its attorneys indicated in court that they plan to appeal the ruling on refunds of gas transfers, said Littlefield, attorney at the firm Kearney Littlefield, LLP.

What's local journalism worth to you?

Support Palo Alto Online for as little as $5/month.

Learn more

The case revolves around an assertion by Green that Palo Alto's transfers of money from utilities to the general fund constitute an illegal tax on ratepayers. After challenging the city's rates in 2016, Green followed suit with another challenge in 2018, though she and the city had agreed to pause the proceedings while the state Supreme Court considered an appeal of the decision in Citizens for Fair REU Rates v. City of Redding. Just like in Palo Alto, that case involved transfers of money from its municipal utility to the general fund.

Plaintiffs in that case had argued that the Redding Electric Utility had "embedded" the cost of transferring money to the general fund in setting its rates. As such, they argued, the utility rates exceed the actual cost of providing electric service.

The Supreme Court rejected the challenge and, in overturning an Appeals Court decision, concluded that the transfer of funding from utilities to the general fund does not, in fact, constitute a tax. The ruling also created a standard by which to judge the legality of such transfers. In the August 2018 ruling, Justice Carol Corrigan wrote that the key question is "whether the charge imposed on ratepayers exceeds the reasonable costs of providing the relevant service." The court cited Redding Electric Utility financial projections showing total rate revenues to be lower than the cost of providing electric services, thus justifying the transfer to bridge the funding gap.

Palo Alto similarly transfers millions of dollars from its enterprise funds to the general fund every year. In fiscal year 2021, the transfers from various funds total $21.74 million, according to the Administrative Services Department. The city plans to transfer roughly the same amount in the next fiscal year. (A new report from the department states that the transfer amount "does not adjust for current pending litigation.")

In approving the transfers, council members have in the past characterized them as a return on the city's investment in its municipal utilities made more than a century ago. The amount to be transferred mirrors PG&E's rate of return on equity, as approved by the California Public Utilities Commission. The city uses five-year financial forecasts for each of its utility funds to determine how much should be transferred from each.

Stay informed

Get daily headlines sent straight to your inbox.

Sign up

But while the city frames the transfers as a way to get a return on its investment, Littlefield argued that they constitute an illegal tax under Proposition 26, which California voters passed in 2010. The law requires a supermajority vote to approve new taxes and prohibits jurisdictions from characterizing certain types of charges as "fees" rather than taxes.

Proposition 26 makes exceptions for charges that governments impose to pay for a "specific government service" that is provided directly to the payer and that is not provided to those that are not charged. The law specifies, however, that the charge must not "exceed the reasonable costs to the local government of providing the service or product."

Proposition 26 also places the burden on local governments to prove by a preponderance of evidence that the charge is "no more than necessary to cover the reasonable cost of the governmental activity" and that the manner in which these payments are allocated "bear a fair or reasonable relationship to the payor's burden on, or benefits received from, the governmental activity."

"The ultimate goal is for the cities to get in line with the Constitution as it is currently written," Littlefield said. "If they want to continue to make a profit from utilities, they need to ask ratepayers for explicit permission to do so."

The ruling in the Green case is unlikely to entirely halt Palo Alto's historic practice of transferring revenues, though it could prompt the city to adjust its calculations. In considering electric rate transfers, the county Superior Court ruled in January that, just like in Redding, the transfer of taxes from the electric utility to the general fund did not constitute a tax. Rather, the city had satisfied its burden in showing that the costs associated with the electricity operation were appropriately allocated to ratepayers.

The court also concluded, however, that the city did not meet this burden when it comes to gas rates. Using the Redding standard, the court concluded that the gas rates exceeded the reasonable costs of providing the service. The ruling required the city to exclude general fund transfers from its calculation of "reasonable cost of service," which is used to justify rates.

Now, the city and Green's attorneys are engaged in the second phase of the litigation, which will determine when and how the refunds will be issued. A key ruling in this phase was issued on Oct. 27, when county Superior Court Judge Brian Walsh determined that the city should refund about $12 million to gas customers based on rates that they were charged in 2012, 2016 and 2018. The total includes a $5 million refund to gas customers in 2012, $4.8 million in 2016 and $2.8 million in 2018.

Walsh also rejected in his ruling a suggestion from the city that these refunds be provided as credits to gas customers, rather than as transfers back to the utility from the general fund.

"Here the issue is the city's improper transfer of funds from the gas utility to its general fund," Walsh wrote. "Consequently, allowing the city to issue refunds to class members without directing that those refunds be paid from the general funds or another fund containing monies appropriated for the payment of judgments would not remedy the wrong that occurred here. Without this direction the city could presumably recover any credits issued to ratepayers from future ratepayers who should not be required to fund these illegal taxes any more than past ratepayers."

He also noted that to the extent that a refund from the general fund creates a "hardship" for the city, the utility can provide the refunds through an installment plan.

Craving a new voice in Peninsula dining?

Sign up for the Peninsula Foodist newsletter.

Sign up now

Follow Palo Alto Online and the Palo Alto Weekly on Twitter @paloaltoweekly, Facebook and on Instagram @paloaltoonline for breaking news, local events, photos, videos and more.

Palo Alto's 'illegal tax' could lead to $12M refund to gas customers

Judge reaches conclusion in challenge against city's transfer of money from gas utility to general fund

by / Palo Alto Weekly

Uploaded: Wed, Dec 16, 2020, 3:16 pm

Four years after Palo Alto resident Miriam Green first challenged the city's policy of transferring revenues from its Utilities Department to fund other city services, Palo Alto is facing a court order requiring it to refund about $12 million that it collected from gas ratepayers.

But the refunds may not reach customers any time soon, with both the city and Green's legal team planning to appeal different parts of the decision.

Green's lawsuit, which the City Council discussed in a closed session on Monday night, alleged that the city illegally instituted a tax on its ratepayers when it raised electric and gas rates in 2012, 2016 and 2018 and transferred revenues from the Utilities Department to the city's general fund, which pays for basic services such as police, libraries and street repairs.

Since then, Green and the city have each claimed partial victories. Earlier this year, the Santa Clara County Superior Court concluded that the city's practice of transferring funds from the electric utility to the general fund is legal, while its transfers from the gas utility constituted an "illegal tax" that should be refunded. In October, a Superior Court judge ruled that the refund should total roughly $12 million, though the exact details of how and when it will be made have yet to be worked out.

While this year's rulings represent a milestone, Green's case is unlikely to be fully resolved for months, if not years. Green plans to challenge the determination by the Superior Court that the city's electric fund transfers were legal, Green's attorney Prescott Littlefield told the Weekly. And while the city hasn't made any public statements on the case (Mayor Adrian Fine said there was "no reportable action" after the Monday closed session), its attorneys indicated in court that they plan to appeal the ruling on refunds of gas transfers, said Littlefield, attorney at the firm Kearney Littlefield, LLP.

The case revolves around an assertion by Green that Palo Alto's transfers of money from utilities to the general fund constitute an illegal tax on ratepayers. After challenging the city's rates in 2016, Green followed suit with another challenge in 2018, though she and the city had agreed to pause the proceedings while the state Supreme Court considered an appeal of the decision in Citizens for Fair REU Rates v. City of Redding. Just like in Palo Alto, that case involved transfers of money from its municipal utility to the general fund.

Plaintiffs in that case had argued that the Redding Electric Utility had "embedded" the cost of transferring money to the general fund in setting its rates. As such, they argued, the utility rates exceed the actual cost of providing electric service.

The Supreme Court rejected the challenge and, in overturning an Appeals Court decision, concluded that the transfer of funding from utilities to the general fund does not, in fact, constitute a tax. The ruling also created a standard by which to judge the legality of such transfers. In the August 2018 ruling, Justice Carol Corrigan wrote that the key question is "whether the charge imposed on ratepayers exceeds the reasonable costs of providing the relevant service." The court cited Redding Electric Utility financial projections showing total rate revenues to be lower than the cost of providing electric services, thus justifying the transfer to bridge the funding gap.

Palo Alto similarly transfers millions of dollars from its enterprise funds to the general fund every year. In fiscal year 2021, the transfers from various funds total $21.74 million, according to the Administrative Services Department. The city plans to transfer roughly the same amount in the next fiscal year. (A new report from the department states that the transfer amount "does not adjust for current pending litigation.")

In approving the transfers, council members have in the past characterized them as a return on the city's investment in its municipal utilities made more than a century ago. The amount to be transferred mirrors PG&E's rate of return on equity, as approved by the California Public Utilities Commission. The city uses five-year financial forecasts for each of its utility funds to determine how much should be transferred from each.

But while the city frames the transfers as a way to get a return on its investment, Littlefield argued that they constitute an illegal tax under Proposition 26, which California voters passed in 2010. The law requires a supermajority vote to approve new taxes and prohibits jurisdictions from characterizing certain types of charges as "fees" rather than taxes.

Proposition 26 makes exceptions for charges that governments impose to pay for a "specific government service" that is provided directly to the payer and that is not provided to those that are not charged. The law specifies, however, that the charge must not "exceed the reasonable costs to the local government of providing the service or product."

Proposition 26 also places the burden on local governments to prove by a preponderance of evidence that the charge is "no more than necessary to cover the reasonable cost of the governmental activity" and that the manner in which these payments are allocated "bear a fair or reasonable relationship to the payor's burden on, or benefits received from, the governmental activity."

"The ultimate goal is for the cities to get in line with the Constitution as it is currently written," Littlefield said. "If they want to continue to make a profit from utilities, they need to ask ratepayers for explicit permission to do so."

The ruling in the Green case is unlikely to entirely halt Palo Alto's historic practice of transferring revenues, though it could prompt the city to adjust its calculations. In considering electric rate transfers, the county Superior Court ruled in January that, just like in Redding, the transfer of taxes from the electric utility to the general fund did not constitute a tax. Rather, the city had satisfied its burden in showing that the costs associated with the electricity operation were appropriately allocated to ratepayers.

The court also concluded, however, that the city did not meet this burden when it comes to gas rates. Using the Redding standard, the court concluded that the gas rates exceeded the reasonable costs of providing the service. The ruling required the city to exclude general fund transfers from its calculation of "reasonable cost of service," which is used to justify rates.

Now, the city and Green's attorneys are engaged in the second phase of the litigation, which will determine when and how the refunds will be issued. A key ruling in this phase was issued on Oct. 27, when county Superior Court Judge Brian Walsh determined that the city should refund about $12 million to gas customers based on rates that they were charged in 2012, 2016 and 2018. The total includes a $5 million refund to gas customers in 2012, $4.8 million in 2016 and $2.8 million in 2018.

Walsh also rejected in his ruling a suggestion from the city that these refunds be provided as credits to gas customers, rather than as transfers back to the utility from the general fund.

"Here the issue is the city's improper transfer of funds from the gas utility to its general fund," Walsh wrote. "Consequently, allowing the city to issue refunds to class members without directing that those refunds be paid from the general funds or another fund containing monies appropriated for the payment of judgments would not remedy the wrong that occurred here. Without this direction the city could presumably recover any credits issued to ratepayers from future ratepayers who should not be required to fund these illegal taxes any more than past ratepayers."

He also noted that to the extent that a refund from the general fund creates a "hardship" for the city, the utility can provide the refunds through an installment plan.

Comments

Online Name
Registered user
Embarcadero Oaks/Leland
on Dec 16, 2020 at 6:45 pm
Online Name, Embarcadero Oaks/Leland
Registered user
on Dec 16, 2020 at 6:45 pm

Thank you, Ms. Green, for filing this lawsuit. I hope we'll be getting interest on the amount due us so the city moves with some alacrity. Judge Welsh is right that the refunds should be cash payments, not credits which won't help the utilities customers who've left PA.

Incredible that the city's spending OUR money on another round of litigation to avoid paying us NOW. People and businesses are hurting NOW and could use the refunds sooner rather than later.

I also hope the next lawsuit applies to more than just our gas bills to include water and electric and examines the other PAU fees: cable hookup, cell phone hookup, the $30 a month utility users tax or roughly $9,000,000 a year -- the difference between the $12M settlement and the $20M annual "overcharge."

For decades PAU has stuck us with lots of extra costs. I remember living in fear of opening utility bills back when Enron was gleefully overcharging us. (Look up the video of Enron traders bragging about "sticking it to" (expletives deleted) to all the Grandma Millie's.) Then we got stuck for millions more when PA cancelled the Enron contract "early" and our rates rose again to cover Enron's court costs, our court costs and an early cancellation penalty and I forget what else. (I THINK that cost us another $18,000,000.)

This cash cow is very tired of being milked by PAU for drought surcharges they kept in effect long in effect AFTER the drought officially ended, its incessant glossy newsletters, failed apps and contests and mailings (Are YOU using more utilities?? than your neighbor? regardless of family size etc.), their gold-plated compost bins that people refused to accept but still got charges and cut their trash can sizes in protest...

Sooner rather than later would be good.


Lee Forrest
Registered user
Crescent Park
on Dec 16, 2020 at 6:51 pm
Lee Forrest, Crescent Park
Registered user
on Dec 16, 2020 at 6:51 pm

Getting a rebate from the City of Palo Alto will be a long shot...akin to 'squeezing blood out of a turnip'.


Peter Carpenter
Registered user
Menlo Park
on Dec 16, 2020 at 7:27 pm
Peter Carpenter, Menlo Park
Registered user
on Dec 16, 2020 at 7:27 pm

Any refund from the city will simply put the city in a deeper financial hole given the huge loss in revenues due to the pandemic.

Get ready for serious cutbacks in city services.


Lee Forrest
Registered user
Crescent Park
on Dec 16, 2020 at 7:36 pm
Lee Forrest, Crescent Park
Registered user
on Dec 16, 2020 at 7:36 pm

>"Get ready for serious cutbacks in city services."

^ A better cutback would be trimming the bloated salaries & exorbitant compensation/retirement packages of upper tier city administrators...fat chance.


Green Gables
Registered user
Duveneck/St. Francis
on Dec 17, 2020 at 3:55 pm
Green Gables, Duveneck/St. Francis
Registered user
on Dec 17, 2020 at 3:55 pm

Salaries for public employees will never be reduced. What is a good idea is to take away the title of manager unless they manage others.


Don't miss out on the discussion!
Sign up to be notified of new comments on this topic.

Post a comment

Sorry, but further commenting on this topic has been closed.