(This is a republication of Law360’s November 26 installment of Reed Smith’s California Tax Takes monthly column.)
Constitutional constraints on voter initiatives
California voters have initiative power, which allows them to propose local measures, statutes, and amendments to the California Constitution.1 Generally this power is limited by constitutional voter requirements imposed by Proposition 13 (“Prop 13”) and Proposition 218 (“Prop 218”); however, a recent California Supreme Court decision has called these limitations into question.
In 1978, California voters passed Prop 13, which placed constitutional limits on state and local governments’ ability to increase taxes.2 Voters added more limitations in 1996 by passing Prop 218, the Right to Vote on Taxes Act. Prop 218 added Article XIII C and D to the California Constitution and sought to protect taxpayers by “limiting the methods by which local governments exact revenue from taxpayers without their consent.”3 Specifically, Prop 218 established that local governments need a majority vote to impose or increase general taxes and a two-thirds vote to impose or increase special taxes.4 A tax is “special” if “its revenue is limited to specific purposes; this is true even though there may be multiple specific purposes for which revenues may be spend,”5 and a tax is “general” “only when its revenues are placed into the general fund and are available for expenditure for any and all governmental purposes.”6
In 2010, voters passed Proposition 26 (“Prop 26”) which further limited the ability for state and local governments to circumvent the constitutional constraints imposed by Props 13 and 218. Prop 26 defines “‘tax’ for state and local purposes so that neither the Legislature nor local governments can circumvent [voter requirements] on increasing taxes by simply defining new or expanded taxes as ‘fees.’”7
California Cannabis Coalition v. City of Upland
In 2017, the California Supreme Court decided California Cannabis Coalition v. City of Upland. The case focused on the interplay between two constitutional provisions: (1) the “people’s initiative power”, and (2) the limitations on local governments to “impose, extend, or increase any general tax.”8 Specifically, whether Article XIII C Section 2(b), which requires general tax increases imposed by local governments to be submitted for vote in a general election, applied to voter initiatives.
The decision involved a voter initiative that sought to repeal an existing city ordinance banning medical marijuana dispensaries, establish standards for operating dispensaries within the city, and impose a $75,000 annual licensing and inspection fee. The initiative obtained the necessary signatures to qualify for the ballot, but the City of Upland (“Upland”) determined that the fee was a general tax and therefore refused to call a special election for the proposed initiative and instead ordered the initiative be submitted to the voters at the next general election.
The initiative’s supporters sued Upland claiming its actions violated the California Elections Code, and that Article XIII C Section 2(b) did not apply to taxes proposed by voter initiative. In other words, the initiative’s supporters argued that the constraint imposed by Prop 218 only applied if Upland proposed the tax increase, not the voters. Upland won at the trial court, but lost at the Court of Appeal. Upland petitioned the California Supreme Court, and on June 29, 2016, the Court granted the petition. On November 8, 2016, the initiative appeared on the general election ballot and was defeated. Even though the case was “technically moot,” the court exercised its discretion to hear the case because it presented “important questions of continuing public interest that may evade review.”9
The court held that “the requirement in article XII C, section 2, subdivision(b)—mandating that general taxes be submitted to the voters at a regularly scheduled general election—applies only to local governments and not to the electorate’s initiative power without evidence that such was the intended purpose of the requirement.”10 The court based its decision on the “longstanding and consistent line of cases emphasizing courts’ obligation to protect and liberally construe the initiative power . . . and to narrowly construe provisions that would burden or limit its exercise,” the legislative history of Prop 218, and the fact that nothing in Article XIII C’s text or legislative history supported the conclusion that the phrase “‘local government’ was meant to encompass the electorate.”11
It is unclear whether courts will apply the California Cannabis decision broadly. The decision analyzed Article XIII C Section 2(b) and its general election requirement, but failed to address the two-thirds voting threshold for ballot initiatives under Prop 13 or Prop 218. Article XIII C Section 2 codifies the general election requirement (at issue in California Cannabis) and the two-thirds voting requirement imposed by Prop 218. The voting requirement establishes that “[n]o local government may impose, extend, or increase any special tax unless and until that tax is submitted to the electorate and approved by a two-thirds vote.”12 The California Cannabis decision concluded that the phrase “local government,” which is used throughout Article XIII C, did not include voters. A city or taxpayer could use this reasoning to argue that the two-thirds voting requirement for special taxes in Article XIII C Section 2(d) applies to “local government” measures, but not to voter initiatives. However, if courts read California Cannabis narrowly, its reasoning may be confined to the general voting requirement imposed by Prop 218. Until the scope of the California Cannabis decision is determined, it is unclear whether special tax ballot initiatives require a majority vote or two-thirds vote to pass.
Proposition C – San Francisco
The uncertainty of voter threshold requirements after the California Cannabis decision are demonstrated by Prop C, a San Francisco special tax that appeared on the November 6, 2018 ballot through voter initiative.
Prop C imposes a gross receipts tax (the “Homelessness Gross Receipts Tax” hereinafter the “Tax”) on businesses located in San Francisco that receive more than $50,000,000 in total taxable gross receipts. Prop C received approximately 60% “yes” votes, but the votes fell below a two-thirds majority. The revenues generated by Prop C would be deposited into the Our City, Our Home Fund, a fund created by Proposition C that is meant to be used for specific homelessness services.
The Tax becomes effective in January 2019 and will be collected in 2020. But the funds will not be certified for use due to the “legal uncertainties” created by California Cannabis.”13 To address the “legal uncertainties” of Prop C, San Francisco proposed a validation action which seeks legal affirmation from the courts on the validity of Prop C despite not receiving a two-thirds majority.
For more than two decades, passing a new tax measure for a specific purposes, such as funding homelessness services, has required a two-thirds majority to pass via a ballot initiative. California Cannabis challenges this practice. The San Francisco City Attorney’s Office argues that the California Cannabis decision means that “both special and general taxes proposed by voter initiative now likely require only a majority vote of the electorate to pass.” The preemptive nature of San Francisco’s validation action likely comes in response to legal challenges brought against San Francisco for two other voter initiative special taxes on the June 2018 ballot that were both approved only by a simple majority vote. Until these legal battles are resolved, the revenue from the Tax will be deposited into a segregated San Francisco account.
Conclusion
It is unclear how the voter requirement question surrounding Prop C, and similar special tax initiatives, will be resolved. What is clear is that until the uncertainties created by California Cannabis are resolved, special tax voter initiatives that fall short of the two-thirds vote threshold are likely to face legal challenges.
Office of Tax Appeals update:
An Office of Tax Appeal (OTA) representative recently spoke about the appeal process at the OTA. A few of the key points mentioned include the following:
- 175 new cases come in every month;
- Appeals are rated for difficulty between levels 1 and 5. Cases rated a level 1 are the least difficult, and are referred directly to the ALJs for review. Cases rated between level 2 and 5 are referred to OTA staff attorneys for further factual or legal development;
- OTA staff attorneys typically review level two and above cases in 75 to 100 days;
- There is currently no wait time for scheduling hearings for cases rated as a level 1 case;
- Cases are assigned to ALJs based on a variety of factors, including case load and relevant expertise;
- The lead ALJs for each case generally use the pre-hearing conference to set expectations for the hearing’s time allocations, introduction of additional evidence, and introduction of witness testimony; and
- The OTA plans to have a total of 18 Administrative Law Judges (ALJs) and two Presiding ALJs. Currently, there are 17 ALJs, one of which is a Presiding ALJ and one is a Supervising ALJ.
- The OTA cancelled its November 20 Fresno hearing. The OTA is currently scheduled to hold a hearing in Sacramento on November 27.
- See Cal. Const. Art. 2 §§ 8, 11.
- See Cal. Const. Art. 13A, § 3 (1978), amended by Prop 26, § 2, approved Nov. 2, 2010, eff. Nov. 3, 2010; Cal. Const. Art. 13A, § 4.
- Prop 218 § 2 (1996).
- Cal. Const. Art. 13C, § 2 (1996).
- Building Industry Ass’n of Bay Area v. City of San Ramon, 4 Cal. App. 5th 62, 85-86 (Ct. App. 2016) (citation omitted).
- Id. at 86 (citation omitted).
- See Prop 26 § 1(f) (2010); see also Cal. Const. Art. 13A, § 3.
- California Cannabis Coalition v. City of Upland, 3 Cal. 5th 924, 930 (2017).
- Id. at 933.
- Id. at 943.
- Id. at 946-47.
- Cal. Const. Art. 13C § 2(d).
- See San Francisco Office of the Controller, Collection and Appropriation of Proposition C (November 2018) Revenues (Nov. 7, 2018).
- See San Francisco City Attorney’s Office, Voting Threshold For Initiative Tax Measures Following California Cannabis Coalition v. City of Upland (Oct. 17, 2017).
Client Alert 2018-236
