Testimony: Utility Franchise Fees Imposed by Cities are Often Taxes in Disguise

Testimony Before the Minnesota House Property Taxes and Local Government Finance Division

March 3, 2016

Peter J. Nelson, Center of the American Experiment

My name is Peter Nelson and I am Vice President and Senior Policy Fellow at Center of the American Experiment.  Thank you for the opportunity to discuss the use of utility franchise fees to raise revenue for cities.

Part of my job at the Center is to conduct research and develop public policies to make government finances more accountable, transparent, and outcome based.

Beyond research and policy development, the Center at times gets involved in litigation.  We don’t file lawsuits ourselves, but we periodically file Amicus briefs in cases we believe can improve government administration and protect people from abuse.

Last fall I got involved in a case challenging the City of St. Paul’s right-of-way maintenance assessment.  In the process, I learned a great deal about the legal distinction between a tax and a fee; how local governments evade limitations on their taxing power by calling something fee; and how raising revenue through fees undermines transparency, making it more difficult for citizens to hold elected officials accountability.

Taxation is the primary mechanism the government uses to raise revenue to fund the government.

The power to tax is inherent in sovereignty and essential to the very existence of government.  At least that was U.S. Supreme Court Chief Justice John Marshall’s opinion back in 1819.

This inherent power is limited within our state constitution.  Article X provides that taxes shall be uniform and shall be levied for public purposes.  In addition, the constitution exempts various entities from taxation and circumscribes how local governments can levy special assessments for local improvements.

Importantly, taxation is the only method by which a city can raise money to pay for general public purposes.  If this were not the case, the state constitutional limitations on collecting taxes for public purposes would be meaningless.  The constitution’s uniformity protection and the various exemptions from taxation could easily be defeated if state and local governments could choose to raise revenue to fund public purposes outside the tax system.

Nonetheless, that is exactly what an increasing number of cities around Minnesota are starting to do.

Though a cities’ power to tax is quite clear, cities are working to “diversify” their revenue streams by imposing fees and using the fee revenue to fund core services unrelated to the fee.

In the case of St. Paul, they charge a right-of-way maintenance fee to every property owner to fund the general maintenance of city streets, including snow plowing, street cleaning, traffic signals, and milling and overlaying of streets.

By calling it a fee, the city avoids the constitution’s uniformity requirement and the city is able to apply the fee to all property owners, including churches, nonprofits and other exempt properties.

While Assumption Church pays a $16,900 fee and First Baptist Church pays $15,700 fee, the 25-story UBS Tower pays only a $5,500 fee.  That’s not exactly uniform and it certainly doesn’t exempt churches.

St. Paul is very clear on why they took this route.  The City’s ROW Study Report explicitly states, “The changes in the ROW assessment since 2003 were all a result of policy maker wishes to control the growth of property taxes by shifting the responsibility for revenue generation to property owners that benefit from these on-street services.”

Thus, the idea is to (1) limit property tax growth and (2) make more property owners contribute revenue—property owners that would otherwise be exempt.

That is the explicit rationale put forward to justify franchise fees.

The League of Minnesota Cities website says, “Franchise fees are an often overlooked alternative for Minnesota cities to diversify their revenue streams.”

Minneapolis’s website says franchise fees are “vital to the people of Minneapolis because they help pay for core services.”  There is no difference between funding core services and public purposes.

Burnsville is in the process of establishing a franchise fee and they are even more explicit on their intent.  Their website explains, “Utility franchise fees help cities cover the increasing costs of providing important services … without raising property taxes.”

It didn’t take too much digging to uncover more examples.  I just went to Excel Energy’s rate book, reviewed the utilities franchise agreements and picked the two highest fees.  They were Rogers and Brooklyn Park.  A quick google search found a Star Tribune article entitled, “Rogers residents protest new franchise fee to cover future road repairs,” and aSunPost article entitled, “Brooklyn Park City Council supports franchise fees to fix streets.”

The first problem with all of these fees is that they are going to fund core city services that should be funded through taxes and subject to the legal limitations on taxes.

State statute does allow cities to apply franchise fees “to raise revenue or defray increased municipal costs accruing as a result of utility operations, or both.”  Thus, the statute appears to authorize cities to impose the fee to raise revenue for any public purpose, which is in fact a tax.  In addition, a city can impose the fee to fund the cost of regulation, a classic regulatory service fee.  And it can use the fee to do both.

The statute creates a mess of confusion.  How can a city impose a fee that is both a tax and fee when the legal requirements around each revenue raising measure are different?

Ultimately, cities appear to be levying these fees and ignoring the legal requirements around taxes.  That means the fees are being unconstitutionally applied to organizations that would otherwise be tax exempt organizations and they might also run afoul of the state constitution’s uniformity requirements.

Cities can’t ignore these constitutional limitations on taxation just because the state statute calls it a fee.  Not too long ago the Minnesota Supreme Court explained, “When it has been apparent that a city’s true motivation was to raise revenue—and not merely to recover the costs of regulation—we have disregarded the fee label attached by a municipality and held that the charge in question was in fact a tax.”

The second problem is that franchise fees make city budgets less transparent and accountable.  Franchise fees create a second revenue stream that hides the true cost of public services from the taxpayers view.  Franchise fees give elected officials the ability to go back to their constituents and claim they haven’t raised taxes.   While some citizens might be paying attention, such as the handful of Rogers residents that protested, most citizens are not.  Most look at their property tax bill for tax increases and if nothing changes they presume everything is being run just fine.  As a result, franchise fees make elected officials much less accountable to constituents for how city funds are managed.

I took a look at both the Minneapolis and St. Paul budgets to see how much property taxes would need to increase if the tax were required to fund the core services funded by the franchise fee.  For Minneapolis, ending the franchise fee would require a 9.6 percent increase in property taxes and a 16.3 percent increase in St. Paul.  These revenue streams and any increases in these streams are very much hidden from taxpayers.  Even if someone knows their utility bill increased, they have no idea the increase goes to fund core services.

Finally, I want to note that cities are taking a risk in establishing these fees.  If a Minnesota court later finds that these franchise fees did not fund the regulation of the franchise agreement, then any money spent on core services may need to be remitted.  This is exactly what happened in Des Moines, Iowa.  In 2012, the Iowa Supreme Court required Des Moines to refund around $40 million in excess fees paid.

Ultimately, taxes fund public purposes, whereas a fee is generally a voluntarily incurred charge to people who benefit from a service.  This distinction is very important to maintain if constitutional limits on taxation are to mean anything and if citizens are to remain able to understand city budgets and hold elected officials accountable.