The opponents of Measure M make some pretty inflammatory comments. They paint pictures of raw sewage running in the streets, massive fines from the EPA, a potential sewage spill into the ocean mixing with our drinking water (though our drinking water does not come from the ocean).
Scary rhetoric is nothing new in politics. It distracts from the real discussion on the merits of Measure M.
To be fair to our opponents, lack of information makes it easy to fall for the alarmist narrative promoted by the city that the only solution is an 87% sewer rate increase and the only alternative is 0%. We take a different position because we have informed ourselves by reading thousands of pages of public records, including the reports from consultants, to separate the reality from the fiction.
We all want a safe sewer system, but we contend that it can be achieved with lower costs. Measure M repeals the excessive 87% sewer rate increase, but it allows the City to try again and set more reasonable rates. That is specifically stated in section 5.c of the full text of the initiative, which the city chose not to include in the voter handbook or to even publish on the City Clerk’s website. The so-called impartial analysis drafted by the City Attorney also conveniently fails to mention that option to the voting public.
In this article we’ll point out a few tactics that have been used to set the wastewater rates at levels higher than necessary to accomplish the repairs that are needed in the wastewater utility.
Double-Compounding of Inflation Rates
The city hired a consultant to develop a Cost of Services Study which proposed the increased rate structure. The pricing model factored anticipated inflation into the proposed rates. PDF-page 54 of that study includes Table 3.2.4, titled “Inflation Rates for Financial Modeling”. It includes 5 different categories of expenses in their model that will probably change over time due to inflation: capital inflation, labor inflation, general inflation, utilities inflation, chemical cost inflation. Inflation is already included in the rates they proposed.
Ordinance No. 2901 which the city council adopted for the rate increase includes the following:
“Annually on July 1 of each year, the rates provided herein shall automatically adjust to reflect the prior year, April to April, annual percentage change in the Consumer Price Index - All Urban Consumers, Los Angeles - Riverside - Orange County, California, published by the U.S. Bureau of Labor Statistics.”
In other words, the 87% rate increases over the next 5 years already take inflation into consideration. Yet the city will AGAIN add inflation increases each year, on top of the 87% increases suggested by the consultant. We don’t know how much these future adjustments will be, but the rates in 2020 will have increased well over 87%. The city is double-compounding the inflation rates.
How big an impact does that have? The actual sewer rate pricing model is more complex than this, but let’s just look at a simple example that demonstrates the power of double-compounding.
A 3% annual inflation adjustment compounded at the end of each of 5 years turns $1.00 into $1.16. Over the 5 years, inflation increased rates 16% from the starting point.
A 3% annual inflation adjustment DOUBLE-compounded at the end of each of 5 years turns $1.00 into $1.34. Over the 5 years, double-compounded inflation increased 34% from the starting point instead of only 16%.
Moreover, some very large costs in the wastewater budget – such as debt payments – are fixed and do not change with increases in the consumer price index. Yet, rates will be increased with inflation as if they do.
Overstated Capital Improvement Costs
The Cost of Service Study factors into the rate structure the expected cost of wastewater system repairs as capital improvement projects (CIP). PDF-page 56 of that report indicates the rate increases assume that $115.8 million of CIP will be needed from fiscal year ending (FYE) 2016 through FYE 2020.
An appendix to an April 12, 2016 staff report to the city council shows that the Public Works Department only plans to do $74.2 million of CIP in the same time frame, not $115.8 million. Again in an October 25, 2016 presentation to the city council, on slide #23, staff reports the same $74.2 million of CIP through FYE 2020.
The rates adopted by the city council assume 56% more spending on capital improvements than staff plans to actually do in that time frame. Had the rates been set based on a need to spend $74.2 million on CIP instead of $115.8 million, the rates would obviously be quite a bit lower.
To keep this in perspective, the wastewater utility currently brings in around $30 million of revenue per year. A $41.6 million overstatement of CIP needs is a difference of more than 16 months of the utility’s entire revenues.
Debt Service Coverage
In January of 2016, at the same time the city council adopted the rate increases, the council set some financial policies for the utility enterprises. One of those policies is that the utilities should have a debt service coverage ratio of 1.25.
What’s a debt service coverage ratio? Well, it’s the ratio of (revenues minus the cost of operations) to (debt service).
City staff reports that the wastewater utility’s current debt service coverage ratio is less than one, so that means we are taking in less revenue than it costs to run the plant and make our debt payments. That’s a problem if it continues over a long period of time. Over a longer horizon, we need a ratio of at least 1.0.
The policy set by the city council requires a 1.25 ratio so as to build up a large savings account. A savings account is an important feature to have in a healthy utility, so there is an emergency reserve, but our wastewater system is not currently a healthy utility. To go from a 0.75 ratio to a 1.25 ratio immediately requires very high rate increases.
PDF-pages 61 and 62 of the Cost of Service Study show that the consultant calculated rates with the advance expectation that the council would adopt the 1.25 debt service coverage ratio policy. Particularly in the first 5 years of the rate plan, this policy requires that rates be dramatically escalated, thus the 35% jump the first year and smaller increases in the following years.
Essentially, for every additional $1.00 of debt service, this policy requires the utility to collect an additional $1.25 of revenue each year. Over time, the more debt the utility takes on, the more this policy will require the city to charge you greater and greater amounts to keep larger and larger SURPLUSES in their savings account, well beyond what is needed to operate the plant. They are draining your savings account to fill theirs. Sadly, the nature of government often means that large reserve accounts tend to get plundered and no longer be available when they’re actually needed.
Nationally-known personal finance advisor Dave Ramsey advises individuals to repair their finances in a series of baby steps. He advises to get on a cash budget and rid of credit card debt before starting to save for retirement and before creating a college savings fund for the children.
The wastewater system is also in a financial hole, and it needs to be solved in baby steps to minimize the burden on the rate payers. Our city council is trying to get out of a financial mess immediately instead of with baby steps, and that requires outrageous rate increases.
It is not the fault of the rate payers that the wastewater utility has previously been so badly managed. It creates an undue burden to demand that the rate payers bail out the management mistakes all at once. All it takes is a vote of the city council to lower this policy requirement. We would be in compliance with our bond covenants with a 1.0 ratio.
Labor Inflation Rates
Employees of our utility system should get fair pay rates for the work they do. Utility rate payers should also get good value and not have to sacrifice from their own budgets to give city employees better standards of living than the rest of the community. There has to be a balance. You can’t pay city employees without taking it from other people who also work hard for their money.
PDF-page 54 of the Cost of Service Study includes Table 3.2.4, showing the inflation rates built into the sewer rate model. Though inflation rates for other categories range from 2.5% to 4%, notice that the “Labor Inflation” column of that table assumes 7.5% inflation for labor costs during the first 3 years. That’s NOT for filling vacant positions. The increases for filling vacancies are separately added into the ever-increasing operations costs in Table 3.2.5 on PDF-page 54. The inflation factor is the growth rate for wages for how ever many employees the utility has. That rate compounds to 24% pay rate increases over three years.
The rate payers footing the bill are generally not expecting to see their own paychecks grow by that magnitude, and it is not reasonable to make them pay those sorts of raises to city employees.
Also note that in Table 3.2.5 on PDF-page 54, footnote 3 summarizes some of the driving factors for substantially increased operations costs over time. One of the cited factors is the plan to replace less-expensive contractors that we are currently using with more-expensive city employees who get lucrative benefit packages. The city is not required to do that to keep the plant operating. It just gives us the same service at a higher cost.
Opponents of Measure M like to lash out, claiming that the supporters of Measure M don’t have a plan to fix the wastewater plant. They criticize the “bean-counters” who are looking at the numbers and finding the types of details noted above that unnecessarily drive the rates up. Our plan to fix the wastewater plant is to find the excess, remove it, and fix the plant at a lower cost.
This is not a complete list of our objections to the rate increase plan, but it gives you a sampling. We’re not objecting just as an excuse to throw rocks. We really do believe the needed repairs can be accomplished with smaller rate increases, and it’s the city council’s job to take a critical look at the plans before they approve them.
If you find after reading this, that we are right on even one of our objections, then you are already agreeing with us that we can fix our wastewater system with less money than the rate structure dictated by Ordinance No. 2901.
We need to adopt Measure M to repeal that rate structure and require that the city council ask the tough questions to adopt rates that are no higher than necessary.
On Measure M, “Vote YES to Pay LESS.”