September / October 2009 - Sacramento County Bar Association

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Elections Anatomy of a Local Tax Ballot Measure: The City of Sacramento’s “Communications User Tax” By Lawrence J. Duran When we hear the word “tax,” we generally think of the income tax, property tax, or sales tax - but certainly not the telephone tax. The telephone tax has been a major source of revenue for local government for many years, but in recent years it has been declining as new technology replaces traditional land-line telephone service. For example, the City of Sacramento’s tax revenue from land-line telephone service fell from $18 million in 1999 to $9 million in 2007. Given this trend, the City anticipates that its land-line tax base will continue to decline as the growth of Voice over Internet Protocol (VoIP), text messaging, and other new technologies continue to replace landline telephone service. The City was fortunate in that while its land-line telephone revenues were declining, revenue from cellular telephone service grew from $2 million in 1998 to $12 million in 2007. But in 2006 the City's cellular telephone tax was possibly placed in jeopardy as a result of action by the Internal Revenue Service (IRS); and when the City amended its telephone tax ordinance to rectify that situation, the Howard Jarvis Taxpayers Association (HJTA) brought a lawsuit brought against the City challenging its new ordinance. In response, the City placed a new tax measure on the November, 2008 ballot-Measure O. This article describes the political and procedural dynamics of placing this new tax measure on the ballot. Utility User Taxes. Although property taxes are the primary tax for local government, the utility user tax (UUT) is also a major revenue source of revenue for cities and counties throughout California and the nation. For example, in Fiscal Year 2007, the UUT collected from all utilities within the City of Sacramento exceeded $55 million, which was 13 percent of the City's General Fund revenues. As originally enacted in 1969, the City’s UUT applied only to gas, electrical, and land-line telephone services. The City expanded its UUT to include cable television in 1988 and cellular telephone service in 1993. 1 Measure O now expands it to apply to virtually all communication services, including text messaging, VoIP, and video service. The Genesis of Measure O. Just as most state incometax laws “piggyback” on federal income-tax laws, cities and counties have likewise “piggybacked” on federal excise tax (FET) laws for their telephone tax. In doing so, they have followed the IRS' interpretation and application of the FET in applying their telephone tax. But this practice changed in 2006 when the IRS made a major policy change from its past interpretation of FET laws as they apply to cellular telephone service. Specifically, the IRS changed its longstanding interpretation of Internal Revenue Code (IRC) Section 4252 relating to the FET. 2 Although IRC Section 4252(b)(1) expressly states that telephone service is subject to the FET only if the telephone charge is based on both “time and distance,” for the past 25 years the IRS' policy, as articulated in Revenue Ruling 79-404, had been that the Legislature really meant “time or distance.” 3 But after losing litigation on this issue in five federal circuits, 4 in May 2006 the IRS announced that it would no longer follow Revenue Ruling 79-404. 5 Since most cities’ telephone tax were directly linked to IRC Section 4252 as interpreted by Revenue Ruling 79-404, some cities feared that this IRS policy change could, in effect, eliminate their telephone tax on cellular telephone service. If this were the case, that could mean a revenue loss of $12 million annually for Sacramento. Although the City did not believe this view to be accurate, out of an abundance of caution the City followed the lead of other cities and amended its telephone tax ordinance to de-link it from the FET provisions. This new ordinance did not change the telephone tax, but simply sought to clarify that the City's existing telephone tax ordinance remained unchanged. But whenever California cities change a tax ordinance, they may run the risk of having a court invalidate the change if it is not done in compliance with Proposition 218. 6 That is, if the change increases the tax rate or expands the tax base, Proposition 218 requires the tax increase to be approved by the voters. So in de-linking its telephone tax from the FET, the City went to great lengths to make sure it did not expand its tax base. But those efforts were in vain, as HJTA still sued the City seeking to invalidate the 2006 telephone tax unless the City obtained voter approval of the new ordinance. The Decision to go to the Voters. When HJTA filed its lawsuit, the City was already contemplating expanding the telephone tax and submitting it to the voters. Because of 26 SACRAMENTO LAWYER SEPTEMBER/OCTOBER 2009
apidly changing technology, the City had concerns that the out-dated definitions used in the telephone tax did not treat all technologies the same and therefore the tax was not applied uniformly for all taxpayers. For example, if John Q. Taxpayer subscribed to conventional telephone service he was subject to the tax, but if he subscribed to VoIP, he was not. In addition, telephone companies’ use of fixed-fee calling plans, bundled services, and other business marketing practices had complicated the administration of the telephone tax. To address these issues, the City wanted to update the existing ordinance to include new and emerging technologies so that the telephone tax would apply more fairly to all communications users. Updating the ordinance would also prevent the City's tax revenues from declining as future technology replaces telephone communications. This update entailed replacing the telephone tax with a modern “Communications User Tax” (the Communications Tax). Submitting this tax proposal to the voters would not only address the flaws in the City's telephone tax, but it would also allow the City to settle the HJTA lawsuit. Preparing Measure O for the Ballot. From the very start, City staff saw itself as swimming against the current, so to speak, to even propose taking a tax measure to the voters because elected officials generally are reluctant to place a tax proposal on the ballot. Not only did staff have to convince nine City Council members that this tax measure was necessary, but also that it would have to be placed on the same ballot when the City Council members are up for re-election. 7 And if that were not challenging enough, the City Council’s approval would have to be obtained before the Secretary of State's August deadline in order to get the measure on the November ballot. That meant trying to get the matter heard during City’s time-consuming budget hearings and working around the Council’s summer recess. Meanwhile, the City was still working to settle the HJTA lawsuit, and at the same time preparing to litigate the matter if settlement was not achieved. But the Council members quickly saw the need for the proposed changes, and they readily agreed to take it to the voters. Because of the pending litigation, the City was uncertain as to how it should go about shaping its ballot measure. One thing the City did that proved to be especially helpful was to hire an election consulting firm to poll potential voters on different tax options. As a “general tax” under Proposition 218 the City’s tax measure requires 50 percent + 1 to pass. While the polling data showed that a majority of the voters would support the tax measure, 8 that support was predominantly “soft” support - that is, and were not fully committed. The polling also showed that the amount of tax reduction would not significantly change the results, but that the phrasing of the ballot question would make a difference. The polling suggested that an effective campaign was needed to educate the voters as to why it was in their best interest to approve the tax measure. But this was problematic for the City because legally the City cannot use public funds to campaign or advocate for or against a ballot measure. 9 While elected officials can speak out on the measure, City staff can only present objective information, such as factual information displayed on the City website or presented at community meetings. 10 Thus, the City could only hope that outside interest groups who benefit from the tax would advocate for it (e.g., police and fire labor organizations), and that those who oppose it would not finance a strong campaign against it. During settlement discussions in the HJTA litigation, the City asked HJTA not to campaign against the tax measure, but they refused. So the next best thing the City could do was to shape the ballot in a way that would garner voter support and diminish voter opposition. In this vein, the City included a small tax reduction to offset some of the anticipated increased tax revenues Measure O would likely bring in. In addition, working with HJTA, the City made some word changes in the ballot language. Measure O is Approved by the Voters. On November 4, 2008, Measure O was approved by 64 percent of the voters. Although HJTA did campaign against the measure, it helped that the Sacramento Bee came out in support of it. And while the severe economic decline that occurred before the election could have been disastrous for this tax measure, that proved not to be the case. It is quite possible that the large turnout of young people in the Presidential election may have helped, as it is usually older voters who oppose tax measures. Settlement of the HJTA case eliminated the risk of the City potentially losing up to $24 million in tax revenues it collected from cellular telephone users in Fiscal Years 2007 and 2008; and the passage of Measure O will help to prevent similar lawsuits in the future challenging the new Communications Tax. Measure O also ensures the City’s ability to continue collecting approximately $12 million annually for cellular telephone service. And by including VoIP and other new technologies in the tax base of the Communications Tax, Measure O will not only result in a more fair application of the Communication Tax, but should also increase the City’s tax revenues in the future. Given the problem caused by the IRS policy change, the HJTA lawsuit, and the dramatic decline in property taxes most of those voters were only leaning toward approval, Continued on page 33 SEPTEMBER/OCTOBER 2009 SACRAMENTO LAWYER 27
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September / October 2009 - Sacramento County Bar Association

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