After court defeat, Palo Alto eyes hike to utility tax

After facing a costly court defeat over its historic practice of transferring money from its gas operation to pay for basic city services, Palo Alto is preparing to ask utility customers for help in filling the financial gap.

The City Council is currently exploring an increase in the city’s utility users tax, which is included on utility bills and which currently stands at 5% of electric, gas and water use. If the proposal advances, it would likely be on the November 2022 ballot, along with a business tax.

The intent of the utility tax increase is twofold. One purpose is to fill the hole in the general fund that was left behind when the Santa Clara County Superior Court upheld resident Miriam Green’s challenge of what city officials refer to as the “general fund equity transfer” — the city’s practice of transferring funds from municipal utilities to pay for basic city services such as police, fire, community services and libraries. Another objective is to help Palo Alto pay for new utility programs that would help the city meet its ambitious goal of slashing carbon emissions by 80% by 2030.

In the coming months, the city plans to conduct polls and further revise the tax proposal, which members of the council’s Finance Committee tentatively supported on Tuesday night. As part of its discussion, the committee directed city staff to create models of a gas tax rate that would fill the hole left behind by Green’s litigation, which led to a court order requiring the city to issue $12 million in refunds to gas customers.

The city is challenging the court ruling, with the council voting in a closed session on Monday to file an appeal. At the same time, members are looking ahead at new ways to both charge utility customers and assist them with adopting programs that promote sustainability.

On Tuesday, the Finance Committee agreed a gas tax is the best option on the table. By asking voters to explicitly approve a utility tax increase, the city would be able to address the court’s finding that transfers from the gas operation to the general fund constitute an “illegal tax.” And given that reduction in natural gas use is a major goal of the city’s sustainability effort, committee members concluded that when it comes to taxes, the gas utility should be treated differently from the city’s electric operation.

“There’s a pretty strong climate argument associated with the gas side that is not (associated) with the electricity side,” council member Eric Filseth said during Tuesday’s discussion of new taxes.

His two committee colleagues, committee Chair Alison Cormack and Vice Mayor Pat Burt, both concurred, though they did not take any positions on whether the focus of the tax should be sustainability or restoration of the various city services that the council chose to cut over the past two years because of plummeting tax revenues. A forthcoming survey, which will focus on both the business tax and the utility tax, is expected to help the council resolve that dilemma.

“I think it’s very important in the poll that we ask about the climate part — that we get some barometer: Are people willing to chip in a little bit, or are people maybe willing to chip in more than a little bit?” Cormack said.

Burt was also reluctant to exclude the electric utility from a potential tax increase and suggested that the council’s decision on the matter should be informed by polling.

According to staff analysis, a 1% increase in the utility users tax for electricity, gas and water customers would bring in about $2 million in annual revenues. Raising the current rate from 5% to 15% would thus bring in about $20 million in new annual revenues.

In addition to advancing the proposal to raise the utility tax, the committee reaffirmed its desire to place a proposed business tax on the November 2022 ballot.

The business tax, which remains the council’s main priority for the 2022 ballot, would be based on square footage and exempt small businesses under the current proposal. Committee members did not reach a consensus, however, on whether the exemptions should be based on the building size or business type. Filseth argued that if the city bases its exemptions on size, it would automatically exclude small retailers and restaurants — the types of businesses that the council wants to protect. Burt, who favored basing exemptions on businesses type, noted that using size as the threshold would lead the city to exclude financial institutions and venture capitalists from the new tax.

“Those are the folks that have incredibly high earnings in our community and very low community taxes,” Burt said.

Committee members also struggled to reach a consensus over how much money the new tax should raise, with Burt favoring a range of between $20 million and $50 million and Cormack leaning toward a lower range, somewhere between $10 million and $30 million. In making his case, Burt pointed to San Francisco and East Palo Alto, which had seen an increase in office developments even despite each city’s adoption of a business tax. East Palo Alto, which adopted a tax based on square footage in 2018, was warned by developers before the election that the tax would cause economic activity to dry up. Instead, the city had seen an “avalanche of office proposals come forward” since the tax, he said.

“Even exceeding the upper end of the range we’re considering, it’s really not going to have an economic impact on our business climate,” Burt said.

Cormack disagreed and said she would not support a floor of $20 million or a ceiling of $50 million for the business tax. After some debate, the committee settled on a range between $10 million and $40 million in annual revenues, which would help fund transportation improvements, affordable housing and infrastructure.

“I find it hard to imagine that you can say that a $50 million tax would have no impact on our economic situation,” she said.