Court Opens Up Big Prop.13 Loophole for ‘Public Franchise Fees’

Two recent court cases have created a contested loophole in property-tax related Propositions 13, 26 and 218 which would cause a legal and actual tax earthquake in California.

Cities have already started to impose legally unhinged toll booth-like charges, called Public Franchise Fees, on ratepayers of electric utilities and trash haulers for use of city public streets.

A franchise is generally understood by most citizens to be a right or license granted by a company, such as say McDonald’s fast food chain, to a restaurant operator to sell its food products in a specific market area.  But a public franchise is when a city grants a public monopoly to operate a cable franchise, cab company (medallions), trash haulers or a utility company to have underground lines or power poles within the public street rights of ways.

Cities like San Diego are starting to bid-out franchise fees to the highest bidder for use of its public streets by public utilities.  This may be construed as tax farming, which was used in ancient societies to bring in unlimited taxes, which is the opposite intent of tax-limiting Propositions 13, 26 and 218.

San Diego has set a minimum reserve price of $62 million per year for 20 years for electric and gas utility use of its street rights of ways.  An annual surcharge of 3% of the gross electric and gas revenues will be added to the $62 million. The existing franchise fees for the city were $47.8 million for 2020.  The fees collected from Public Franchises would be deposited directly into the general funds of local government for whatever use they deem fit.

Charter cities can impose Franchise Fees while equivalent fees for General Law cities are set by the Public Utilities Commission (CPUC).  The CPUC sets a 1% franchise fee for utilities in general law cities.

The two relevant court cases currently being contested by the Howard Jarvis Taxpayers Association are:

Jacks vs. City of Santa Barbara (2017) – the California Supreme Court ruled that a Franchise Fee of 2% could be imposed on the ratepayers of Southern California Edison (Edison) by the City of Santa Barbara for use of public streets for its facilities.  The CPUC concurrently ruled that Edison could only recover 1% but that the additional 1% could go to the City.  The Supreme Court overruled a lower court decision that a Franchise Fee was a tax. As the court put it: “Valid fees do not become taxes simply because their cost is passed on to the ratepayers.”

Zolly vs. City of Oakland (2020) – In the Zolly case an Appeals Court ruled that cities can charge private waste haulers a Franchise Fee that will be added to monthly trash bills paid by property owners without considering it a tax.  The ruling allows the City of Oakland to charge a $25 million fee this year to Waste Management, Inc. (about $155 per household per year) for the privilege of their street franchise. It is no coincidence that Oakland has a $25 million deficit in its city budget this year.  Apparently, Oakland is structuring a floating Franchise Fee pegged to whatever budget deficit it incurs.

Attorney Tim Bittle with the Howard Jarvis Taxpayer’s Association explained in an email about what the future portends from these court rulings:

“…the potential afforded by this decision for the government to siphon money from the private economy is frightening….Exempt fees for use of public property could be imposed on shipments entering public ports, goods and passengers transported on public roads, water stored in public reservoirs, utilities located beneath or along public rights of way, cell phone calls relayed over towers on public ridges, internet traffic using public wi-fi networks, etc.  Those fees could be set at any amount, and the revenue could go straight to the General Fund for tax-like expenditure, with no special approvals required.  Such an outcome is contrary to voter intent.”

Duplicate and Compounded Taxation?

Is a Public Franchise Fee even necessary when flat Utility User’s Taxes (UUT’s) and Parcel Taxes (both not based on property values and both subject to voter approval) could essentially accomplish the same thing? Municipal Utility User’s Taxes (ranging from 2% to 10.5%) are already collected on telephone, wireless, cable TV, electricity, natural gas, water, sewer and garbage services depending on the city.  For example, the City of Los Angeles collected $611 million in Utility User’s Taxes in 2016-17, reflecting about $460 per household per year.  Why would an additional Franchise Tax with no voter approval required also be necessary?

In cities that collect a Utility Users Tax, it would be a “triple dip,” because as the increased franchise fee drives up utility rates, the UUT (levied as some percentage of the customer’s bill) goes up as well.

Regulated electric and gas utilities are allowed a rate of return on total costs, which is called the Rate Base.  So, adding a 3% Franchise Fee would just add an expense that is included in the Rate Base that increases electric and gas rates resulting in a quadruple tax dip.

A franchise fee is redundant to a taxable Possessory Interest that occurs when private entities lease government-owned lands.  So, an Investor-Owned-Utility like Edison, PG&E and SDG&E must pay a possessory interest tax when they use city-owned streets under the public franchise.  The Board of Equalization has ruled that a cable TV company’s leases or licenses based on economic rent must be taxed as a possessory interest. An easement within government property granted to a business is taxable as a possessory interest.

A public franchise in a public street is taxed many times over by all sorts of fees, surcharges and taxes in addition to utility ratepayers payment of the franchise fee in their electric and gas rates without any consideration of the cumulative taxation.

Under IRS law, a franchise fee is a “Section 197 Intangible,” that is not deductible but allows it to be amortized by depreciating it over 15 years.

What Rights a Franchise?

In the Jacks case the court ruled that a street right of way franchise is not a tax, special assessment or utility tax but the “receipt of an interest in public property that justifies the imposition of a charge on the recipient to compensate the public for the value received”.

However, Charles B. Warren, ASA-Real Property appraiser, pointed out in an email that a public utility street franchise is a very limited property right or interest:

1.     The city typically only owns a public street easement that cannot be sold, leased, hypothecated or assigned.

2.     Public street easements typically are acquired by dedication for no cost by land developers.

3.     The city can convey the right for secondary use of the street for public utilities only through a revocable license within an easement.

4.     The public utility has the costly burden of relocation of its facilities at its sole cost upon request of city.

5.     Since public utilities can only locate their utility lines inside the street easement to reduce the potential nuisance of multiple lines, poles and structures, there is no outside alternate route from which to determine a market value.

Because of the above-listed constraints, street franchises have been historically priced on the basis of a proportionate share of the costs to maintain and replace the pavement of the street.

However, what the Jacks and Zolly cases did was change the basis of the price of the franchise to the “value of the rights conveyed to the public utility.” But a public street is a non-market property that is considered a Public Good and is non-exclusive and a monopoly unlike private property that is exclusive and available in an open, competitive market.

Mock Franchise Auction

According to Warren there is no cost, income or market for secondary use of a street right of way for public utilities and, thus, it has no value, only costs to maintain it.

Likewise, the franchise monopoly right to use the public street likewise has no cost, income or price other than that set in a mock auction between bidders or levied as a percentage of gross revenues of a utility — however, the ongoing-interest in the utility business has costs, income and a regulated market.

In the case of San Diego’s franchise fee auction, the highest bid is effectively a tax auction, as the bid price and annual fee will just be passed through to ratepayers not utility stockholders or bond investors. This has been proven in eminent domain court cases involving the taking of public street franchises where the court concluded there was an “absence of any loss” to a utility company.  Nonetheless, consultants for the City of San Diego apparently valued the SDG&E franchise right as part of the business enterprise from $2.09 to $2.65 billion and the annual fee at $264,075,000, (about 9.9% of its value) but is nothing more than a pass through expense to ratepayers without anchoring the fee to any property or business rights other than the city’s arbitrary 3% fee.

San Diego’s “Green Blog” calls the franchise fee a ”monumental theft” and advocates municipal takeover of SDG&E.  But paradoxically that would deny the city of franchise fees, property taxes and possessory interest taxes lobbied for by environmentalists to fund “climate change” programs.

San Diego’s mock auction is thus a subterfuge where the city is trying to cover up a utility rate increase by making it appear that the city is trying to get the highest price for the grant of the monopoly right to a private, investor-owned utility that is, in effect, just passed through to ratepayers.

California state government often disguises taxes by so-called market mechanisms: witness its fraudulent Cap and Trade industrial emissions program which is also effectively a tax on consumer products.

The Institute for the American Experiment states, in its publication “Utility Franchise Fees Imposed by Cites are Often Taxes in Disguise,” that franchise fees are a no-cap tax that is not classified as a property tax increase merely by calling it a fee.

The Zolly case is still being heard and it remains to be seen if the court will continue to allow open-ended franchise taxes that serve as slush funds for local government, thus circumventing voter approved tax limitation initiatives.