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.