On April 20, 2015, the California 4th District Court of Appeal ruled that the City of San Juan Capistrano’s conservation-based tiered water rates violate California Proposition 218. (Capistrano Taxpayers Association v. City of San Juan Capistrano, Fourth District Court of Appeal Case No. G048969.) Notably, tiered water rates are a major component of many water agencies’ plans to reduce water usage in compliance with the governor’s recent executive order, which affects both existing users as well as proposed new developments.

Case Overview

The case addressed two different issues, each of which implicates a different provision of Prop 218, which added Articles XIII C and D to the California Constitution. The first issue concerns whether the city’s conservation-based tiered water rates violate Article XIII D, § 6(b)(3), which states that any “fee or charge imposed upon any parcel or person as an incident of property ownership shall not exceed the proportional cost of the service attributable to the parcel.”

The court ruled that tiered water rates do not necessarily violate Prop 218; however, a tiered water rate system must correspond to the actual cost of providing water service at given levels of usage. In this case, the court held that the city failed to calculate the cost of providing water at its various tier levels and instead allocated the price differences between the tier levels based only on water budgets tied to the city’s determination of what constitutes efficient water usage. The court held this practice violates Prop 218.

The second issue was the city’s recycled water fee and whether that fee can be charged to all customers even though not all customers use recycled water. This issue arose under Article XIII D, § 6(b)(4), which states that “[n]o fee or charge may be imposed for a service unless that service is actually used by, or immediately available to, the owner of the property in question.” 

On this question, the court of appeal reversed the trial court, which found that the recycled water fee was a per se violation of Prop 218. The court of appeal reasoned that the recycled water program benefited all residents because recycled water for some freed up potable water for others, so it made water available to everyone in a manner that is not inherently violative of Prop 218. On this issue, however, the court of appeal remanded the case back to the trial court because the record was insufficient to determine if users in the lowest tier of the conservation-based pricing scheme were made to pay for recycling facilities that would be unnecessary but for users in the higher tiers, which would presumably be a violation of 

Article XIII D, § 6(b)(3).

Lessons from Capistrano Taxpayers Association

The court in Capistrano Taxpayers Association set forth some guidance for how a tiered conservation-based scheme could coexist with Prop 218.

Like many other water suppliers, the city calculated its tiered rates based on the American Water Works Association’s M1 Principles of Water Rates, Fees and Charges. The method of calculating fees under the M1 Manual first required a calculation of all the city’s various costs. It then required the city to differentiate between different classes of customers, such as large and small lot customers and agricultural users. The city then calculated water budgets for four possible usage patterns based on assumptions regarding what constitutes efficient use: low, reasonable, excessive and very excessive. Those water budgets formed the basis for the city’s four tiers, with Tier 1 corresponding to low, Tier 2 corresponding to reasonable and the third and fourth tiers reflecting “excessive” usage of water.

This method and similar methods based on water budgets tied to efficient use calculations, rather than incremental cost, may no longer be valid under Prop 218 under the Capistrano Taxpayers Association case.

The Capistrano Taxpayers Association Court did, however, provide some guidance on how a tiered pricing scheme could pass muster under Prop 218. First, water providers must correlate tiered prices with the actual cost of providing water at those tiered levels. The court cautioned, however, that such tiers should be based on actual usage, not water budgets. For instance, if a certain usage level required a water supplier to purchase more expensive water, that additional cost should be reflected in a higher tier. Thus, the “marginal” cost of water will be an important factor in establishing a valid tiered water rate system.

That concept also ties into the funding for capital projects aimed at producing additional water supplies. The costs of such projects may be funded by water rates charged to the retailer’s customers even if the customer does not necessarily use the water produced by the capital project, with the only limitation being that customers who are very low users of water may not have to pay for the project if it would not have been needed if all customers used water at that low rate.