Before the passage of Proposition 13 in 1978, I was a finance director in California. Annually, finance directors would calculate the property tax mill rate to balance their city’s budget. Fees for services were not something that staff was concerned about. Every so often, someone might comment that a specific fee “seemed” too high or too low and staff would compare that fee with neighboring cities. The goal of the comparison was to find the “sweet spot” in the middle, where the fee didn’t attract attention. Given that staff had no idea what it cost to provide a service, this approach made sense.
Governmental accounting, used by all cities, had been developed to protect cash and fixed assets. It uses the “expenditure accounting model” which monitors the flow of cash during an accounting period. No private business uses this model. To be able to correctly price a product is essential for the economic survival of a private business. Consequently, the private sector uses the “expense accounting model” which measures both the inflow and use of assets during a fiscal year.
To implement the “expense accounting model,” private businesses need to know the “total” cost of their products which, if the business is big enough, is calculated by cost accountants. This type of accountant can accurately determine the total cost of a product or service. Cities do not have cost accountants and had no reason to know the cost of their products or services prior to Proposition 13.
The passage of Proposition 13 was not a given. The governor at the time predicted the end of local government if it passed. However, it did pass with over 65% of the votes. Its only effect was to decrease property tax revenues by about 60%. The immediate reaction of cities was to consider significant increases in their service fees. This was a reflexive action that was driven by a need to balance the budget. No consideration was given to the methodology of raising fees. The only issue was how much could be raised.
After the passage of Proposition 13, the California Taxpayers Association, the California Chamber of Commerce, the National Tax Limitation Committee and the California Association of Realtors banded together, contributed money, hired constitutional attorneys to draft a more thorough proposition, and hired Paul Gann, who was an associate of Howard Jarvis, to be the proposition's spokesperson. The result was Proposition 4, commonly referred to as the "Gann Spirit of 13 'Let's Finish the Job' Initiative". It was adopted by 74.3% of the voters of California on November 6, 1979, and became effective on July 1, 1980, retroactive to Fiscal Year 1978-79.
This proposition, which became Article XIIIB of the State Constitution, had a significant fiscal impact on cities as it addressed all city revenues and established a limit on the growth of tax revenues.
Proposition 4 stated that fees for services cannot exceed the "costs reasonably borne" by cities in providing the services. If a fee exceeds the cost, that excess fee is defined as a special tax. Which, under Proposition 13, requires that special taxes be approved by two-thirds of the voters. This eliminated the opportunity for cities to use high fees to get around Proposition 13.
The good news for cities in Proposition 4 was that cities could use the “expense accounting model” to calculate the cost of their fee services. This allowed cities to use the same method that is used by the private sector to price their products and services.
The same year that Proposition 4 became effective, our company was formed to help cities calculate their service “expenses” to comply with the new law. This process was unique and novel at the time for local government but has become normal over the last forty-three years. Cities have a methodology to calculate the costs of their services that was first presented in the 1981 League of California Cities publication, “Cost Accounting for California Cities.”
Over the years, the process has become computerized and used by many cities in California and other states. Cities now have the ability to know the cost of their services. City councils have the ability to charge less than the total cost of a service and routinely do that to maintain a city’s quality of life. However, significant undercharging or subsidizing of fee services will utilize tax revenues that could otherwise be used for tax services such as police, fire, libraries, and parks.
Is there still a need to compare fees for services with other agencies during a cost of services update? If your city is calculating the total cost of its services, then it will know what it costs to provide each service. If your city is charging more for a service than other cities, it is often because of the layers of project review historically mandated by your city council. Be prepared to reduce the amount of review if you want to lower the cost and remember that the fee may also need to be reduced if it exceeds the “costs reasonably borne” test.
What if the council is worried that high fees will drive away development or businesses? What the council really means is, “Will the cost of the project review process in our city drive away development or businesses?” If that’s the issue, then ask staff how to simplify the review process. If the project is really important to the city, lower the fees for that project or enter into a sales tax sharing agreement. Bottom-line: your costs are your costs. If the costs are not recovered from fees, then the entire community is paying for the project by subsidizing it with tax dollars.