Many water suppliers throughout California employ a "tiered" rate system. Under these systems, the cost of each unit of water increases as a customer’s usage increases. In Capistrano Taxpayers Association, Inc. v. City of San Juan Capistrano (April 20, 2015) ____ Cal.App.4th ____ the Court of Appeal declared that, while a tiered rate structure can comply with the requirements of Proposition 218, the City of San Juan Capistrano's (the "City") "tiered" rate system violates Proposition 218 (Article XIIID of the California Constitution) because it is not based on the cost of providing service at the corresponding level of usage.
The City adopted a rate structure that includes four water pricing tiers. The rate for Tier 1, for usage up to six hundred cubic feet of water, is $2.47 per one hundred cubic feet. The three higher tiers apply to progressively higher amounts of usage, with increasingly higher prices, up to $9.05 per one hundred cubic feet at Tier 4. The City set the threshold for each usage tier based on water conservation and usage guidelines, such as those established by the World Health Organization. The rates for each tier were set at amounts such that the anticipated total revenue produced would equal the City's cost of providing the water service. The City did not calculate the incremental cost of providing water at the level of use represented by each tier.
Ratepayers challenged the City's tiered water rate structure, alleging that it violated the requirement of Proposition 218 that rates charged to any parcel be proportional to the cost of providing service to that parcel.
The ratepayers also objected to the City’s including the cost of building a new recycled water facility in its total cost of providing its water service. The ratepayers claimed that, because recycled water would not be actually used by some customers and future water from the new facility was not “immediately available,” Proposition 218 prevents the City from charging rates based on the capital cost of that improvement.
The Court of Appeal held that the City had failed to justify its tiered rate system under Proposition 218, because the rates for each tier were not based on the cost of providing water service at the level of use represented by each tier.
The Court rejected the City's argument that higher rates at the higher usage tiers can be justified as “penalties”(which are not subject to Proposition 218) for excessive water use. The Court reasoned that such a theory would "open up a loophole in [Proposition 218] so large it would virtually repeal it."
The Court also rejected the City's argument that Article X, Section 2 of the California Constitution, which requires that “the waste or unreasonable use or unreasonable method of use of water be prevented,” can be used to override the requirements of Proposition 218.
The Court suggested that a tiered rate structure could withstand scrutiny under Proposition 218 if it pass[es] on the incrementally higher costs of expensive water to incrementally higher users." Rates for a water supplier's lowest usage tier could be based on the water supplier's least expensive source of water to supply customers consuming at that level. Higher rates could be imposed on higher levels of usage based on the water supplier's incremental cost of obtaining more expensive sources of water to provide service to those customers. The real world feasibility of developing such a rate structure in the face of Proposition 218 challenges remains to be seen.
Regarding the recycled water facility costs, the court concluded that both the potable and nonpotable (recycled) water supplies were part of a single water service that was immediately available to all customers, and that future capital costs may be included in current water rates. However, concerned about the proper allocation of such costs, the Court remanded the matter for further findings “on whether charges to develop the City’s recycling program were improperly allocated to users whose levels of consumption are so low that they cannot be said to be responsible for the need for that recycling.”
What This Means To You
Water suppliers throughout the state will need to reevaluate their tiered rate schedules to ensure that the rate for each tier can be justified based on the cost of providing service at the level of use represented by that tier. Although the decision has been widely viewed as a severe impediment to conservation efforts, it may still be possible to meet the technical challenge of producing a justifiable tiered rate structure. At a time when strict conservation is being mandated by the Governor and the State Water Resources Control Board, tiered rates – properly justified – can remain a valuable tool to achieving conservation.
Finally, while an increased rate measured by excessive water usage cannot be justified as a penalty, penalties to discourage practices that result in excessive water use may still be used, as long as they are imposed separately from water rates.
Attorneys at Kronick are monitoring this matter for further developments, such as an appeal to the Supreme Court, and can help evaluate the defensibility of existing or proposed new water service rates under the principles articulated by the Court in this case.
If you have any questions concerning this Legal Alert, please contact the following from our office, or the attorney with whom you normally consult.