Can a city’s utility charges be a tax? It’s a tough case to prove.

The City of Hermann provides water, sewer, natural gas, electricity and trash pickup to its residents, allowing them no choice of providers. When the City jacked up the rates and transferred the “profits” to other City accounts, some residents resented the City’s flexing of its monopoly power. They sued, claiming that the City’s governing board had sidestepped Missouri’s constitutional requirement (Article X, sections 16- 24, known as the Hancock Amendment) that tax increases be approved by voters. The court had to decide whether a utility rate increase was a disguised tax.

Here’s an overview of the Missouri Supreme Court’s 26-page opinion in Arbor Investtment Company LLC v. City of Hermann, released May 31, 2011, in which the court determined that the  City of Hermann’s utility fees were not taxes.

The Five (or Six or Seven) Factors

The Missouri Supreme Court identified five factors in the 1991 case Keller v. Marion County Ambulance District which may be applied to distinguish user fees (not requiring a vote of the people) from a tax (which requires a vote). These factors, the court pointed out, are not exhaustive, but provide a framework for analysis:

1. When is the fee paid?
2. Who pays the fee?
3. Is the amount of the fee affected by the level of the service that it is for?
4. Is the fee for a good or a service?
5. Is the good or service one that has been historically provided by the government?

The City of Hermann’s utility charges are paid in response to monthly billing, after the services have been metered. This resembles a user charge, rather than a tax that is paid annually. Of course, it also resembles a sales tax that is paid upon a sale.

The City’s utility charges are assessed only against utility customers, unlike some kinds of taxes, which are charged without reference to who is using government services. For example, sales taxes are charged to non-resident and residents alike.

The amount of the City’s utility charges, at least above minimums and flat charges, is related directly to use, other than for Hermann’s “communications fee,” which is used to support the 911 network.

The City’s utility charges fees are imposed for goods or services, rather than being a general tax to be used however the City government chooses. This factor was not at issue in this challenge, though the plaintiffs claimed that the amount of the fees were in excess of the reasonable capital and operating costs incurred in providing the services.

The Supreme Court found the fifth factor in favor of a finding of a tax, though the City of Hermann has a long history of providing these services in Hermann. The court indicated that the City’s prohibition of any other provider offering these goods and services supports a finding that the utility charges are a tax, without explaining why, other than to state that the lack of alternatives was a part (a sixth factor?) of the analysis. Even so, a finding that the utility charges resembled a tax on this point was not enough to overcome the opposite findings on the other factors.

Borrowing from its opinion in Beatty v. Metropolitan St. Louis Sewer District, the court looked at a sixth factor, whether the payment was enforceable by imposition of a lien on the user’s property or merely by disconnection or discontinuance of the service. Without taking judicial notice of the fact that many if not most private and municipal utilities have the right to impose liens for non-payment of utility charges–in addition to disconnection– the court considered that a tax, such as a property tax, is secured by a lien, while utility providers have the right to disconnect the services to enforce payment.

The court upheld the City of Hermann’s utility rates, stating, “There simply has been no showing that the amount charged is so excessive as to not constitute the provision of a service or good in return for the amount paid.”

Municipal rates are unregulated, but does this lead to excessive rate levels?

We should be concerned with the quality of the facilities for providing our water supply, treatment and management of wastewater and stormwater, and delivery of electricity and telecommunications services. The infrastructure for these essential things was constructed in the 19th and 20th centuries. Repairing, replacing and upgrading them is enormously expensive and in many cases has been deferred.

But private and governmental providers face stiff resistance in raising revenues to confront these challenges. For many private providers, utility commissions determine the extent to which rate increases are allowed. For other providers, such as cooperatives, homeowner associations and local governments, rate increases are within the discretion of elected officials, who have wide discretion and motivations that may extend beyond the provision of utility services.

In my experience, local governments, looking at water and sewer rates, generally look around to neighboring communities and communities of the same size elsewhere in the state, hoping to stay somewhere below the top. While this strategy may be effective for helping elected officials to remain in office, it may not produce sufficient revenue for maintaining utility systems.