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Palo Alto faces legal challenge over budget transfers

City's practice of moving money from utility funds to General Fund may also hinge on Redding case

For more than a century, Palo Alto's municipal utilities have served the city as both a provider of critical services and a revenue-generating asset from which the city can transfer money to pay for basic services like public safety, libraries and park maintenance.

The annual transfer has gradually swelled since 1909, when the council shifted $22,755 from the water, electric and gas funds. It crossed the $1-million threshold in 1961 and the $10-million mark in 1995. The current budget includes $20.8 million in transfers from the various utility funds, $700,000 more than in the prior year.

Now, that long and at times controversial practice is facing a legal challenge. Downtown resident Miriam Green has filed a lawsuit against the city, charging that the transfer amounts to an illegal tax. At the same time, the state Supreme Court is preparing to hear an argument over a similar case in Redding, where an appeals court has recently struck down by a 2-1 vote the city's transfer policy.

The case, Citizens for Fair REU Rates v. City of Redding, was accepted by review by the Supreme Court, which has yet to schedule to oral arguments.

If the Supreme Court affirms the appeal court's decision, the ruling would reverberate across the state and impact nearly 30 cities that run their own utilities, a list that includes Alameda, Burbank, Santa Clara, Los Angeles and Palo Alto, where the General Fund budget is already straining under the weight of rising pension and infrastructure costs. It would hand a big a victory for conservative and libertarian-leaning groups like the Howard Jarvis Taxpayers Association and Pacific Legal Foundation, which are supporting the challenge to Redding's fund transfers.

The Green complaint, which the Palo Alto City Council will discuss in a closed session Monday night, makes a similar argument to the one in Redding. In a complaint filed on Dec. 1, 2016, in Santa Clara County Superior Court, Green's attorneys argue that the city has "engaged in, and continues to engage in, the illegal transfer of funds collected by CPAU into the City's General Fund."

This practice, the lawsuit argues, is unfair because it forces rate-paying property owners to pay more for natural gas and electric services than could be justified under state law. The suit cites to a provision of the California constitution, Article XIIIC, Section 1C, which prohibits local governments from levying a tax that "exceeds the reasonable cost" of providing the product for which the tax is established.

That, the suit argues, is exactly what's happening in Palo Alto, as evidenced by the city's practice of transferring money from enterprise accounts to the General Fund.

"An illegal tax on residential CPAU customers exists in the City because the charge imposed on them for service includes surplus capital raised by CPAU that is transferred to the City, resulting in electric and natural gas charges that are not, and cannot be justified," attorneys Gene J. Stonebarger and Richard D. Lambert of the firm Stonebarger Law wrote in the complaint against the city.

Stonebarger is one of three law firms supporting Green's complaint against Palo Alto. Attorneys from the Glendale-based firm Kearney Littlefield LLP and from the San Francisco-based firm Davidovitz + Bennett are also representing her.

This isn't the first time that residents have raised concerns about City Hall's "equity transfer" policies. In 2009, with the General Fund facing a shortfall because of the economic recession, the council approved a historically high transfer of $16.4 million from utilities, prompting some criticism from residents and members of the Utilities Advisory Commission. That same year, the city formalized a new methodology for calculating the annual transfer, which is based the value of utility assets, operating and capital expenses and the rate-of-return of PG&E.

The city's current budget characterizes last year's $19.5 million transfer from utilities as "the return on the initial investment the City made when the Utility Department was created more than 100 years ago." It also notes that tying Palo Alto's transfer amount to PG&E's rate of return is consistent with a methodology approved by the California Public Utilities Commission.

Green's challenge, which is being filed as a class-action suit, will eventually put that proposition to the test. In the meantime, however, both the city and Green's attorneys are content to wait for the Redding verdict. Last May, the two sides agreed to a stipulation to stay the legal challenge until the state Supreme Court resolves that case.

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