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Public Policy Skillfully Crafted: Finance, Water Wars & Senator Peace

Senator Steve Peace
Representing San Diego—the Metropolitan Water District’s largest member agency—and as a member of the Senate Select Committee on So. Cal. Water Districts’ Expenditures & Governance, Senator Steven Peace is on the front lines of California’s water wars—and hasn’t been afraid to lead the charge for significant change. His efforts to increase water marketing were recently delayed in the Assembly, but the debate will continue next year. And, as Chair of the Senate Budget Committee, he is also on the front lines of California’s State-local fiscal relationship—and has expressed firm views in the middle of that political minefield. MIR spoke with Sen. Peace about these two critical public policy issues, his views on MWD’s latest changes … and his own political future.

Senator, we have a lot of issues to talk about, but let’s start with water, if we could. It looks like the Colorado River negotiations are back and proceeding. In March, we interviewed Secretary of Resources Mary Nichols, and she said the following: “The lack of resolution on the Colorado River and the widespread perception that the Metropolitan Water District doesn’t have its act together are probably the biggest obstacles that we face in the Bay-Delta negotiations. Met’s a critical player.” I wonder if you could talk about the Colorado River discussions as they relate to California water policy and give us your perspective?

Resolution of the 4.4 Plan is still the kingpin for California’s overall water responsibilities. Ultimately,
the CALFED process, any environmental protection initiatives along with any water bond proposals will depend on a successful resolution of the 4.4 Plan and a
re-operations agreement on the Colorado River.

The parties are negotiating in good faith. And hopefully, we’ll get resolution sometime in the next few days. In the end, it’s going to take the bully pulpit of the Governor’s Office to drive the final spike in the railroad crossing, but once we’re there, a lot of dominos will fall into place.

There’s a great deal at stake here, not only for California but for the entire Southwest, including northern Mexico.

What’s your take on MWD’s role—either positive or negative—in reaching an agreement on all these issues?

Met clearly is at the table, and they are negotiating in good faith. It’s a large organization with a long history, and it’s not easy to turn a ship around in the middle of the ocean. So I don’t expect the tradition of recalcitrance embedded deep within the fabric at Met to go away overnight.

However, Mr. Gastelum, the new General Manager, is working very hard to make Met a more responsive and adroit bureaucracy—more connected to the future than the past.

The ways of doing business within the water world are changing, with or without MWD. The question is whether Met will play a significant part in the way things change. And I suspect we’ll know the answer by the end of the year.

If agreement on the 4.4 Plan comes soon and California’s water needs are comprehensively addressed, it will certainly be an indication of Met’s change of character and desire to root itself in the future. On the other hand, if the process unravels, it will be Met’s death rattle.

Let me jump to water marketing and the role it will or will not play in CALFED. What are the solutions to the distribution of water so desperately needed in the Southland?

Water marketing is critical not only to delivering water to the Southland but other areas throughout California as well. The CALFED process envisions a methodology by which we would move water to areas of need—whether that means fisheries, fresh water preservation, agricultural areas or urban areas. And all are dependent upon the presence of willing buyers and sellers who will step up to the plate when the need arises.

Water marketing is also critical to meeting our environmental goals. Tom Graf of the Environmental Defense Fund was among water marketing’s earliest proponents. After years of attempting and failing to get environmental protections in place, he recognized that relying upon market signals—as opposed to a bureaucracy—was the fastest way to foster environmental action.

There is no option for the future of water delivery that does not include markets and pricing.

In the April issue of MIR, Ed Manning said this about water marketing: “Without a reasonable price for access, there will be no competition, and the cost-efficiencies of a functioning water market will be severely diminished to the detriment of sellers and consumers.” You have a bill—SB 506—that tries to define a price mechanism and guarantees fuller use of water conveyance systems. Could you tell us the status of that bill and what your expectations are for it?

I hope to reach consensus on a price mechanism by first defining what the original Katz legislation meant by giving water purveyors the right to recover “incremental costs” associated with moving water. But it’s only been litigated to the point that the court agrees it hasn’t been defined.

On one side are private entities that either already have water rights or think they can acquire them. Optimally, they’d like free access to transfer facilities.

On the other side, the public owners of those facilities have an obligation to their historical ratepayers to recover enough revenue to amortize those facilities. As a secondary concern, they wouldn’t want a private competitor to use a system paid for by the public only to take customers away from the public provider, who would then be forced to raise rates for those still using the system.

“We have to restructure the incentives in this tax system so that the growth/productivity rate can keep up
with the changes
in population demographics.
And that’s certainly doable.”

And those are legitimate concerns. The desire of private sector providers to get into the system at the lowest possible cost is appropriate. The desire of public providers, who own those facilities, to protect their ratepayers is also appropriate. But the private providers want to calculate the immediate cost of moving one given unit of water through the system while the public providers want to calculate the total cost of every drop that moves through, whether public or private. Somewhere between those two is a fair market notion of incremental cost.

Businesses deal with incremental cost in various ways. They all have secondary opportunities outside their core business. Often, competitors will offer to rent or make a trade for access to another company’s facilities, especially when those facilities have excess capacity. While the cost of these deals may not fully amortize that equipment, there’s the obvious value of money on the table and the future ability to turn to the competitor in a similar situation.

The public sector needs to think more like the private sector—how can we make best use of this embedded investment in water transportation infrastructure? How can we get the highest possible return for ratepayers in the most creative way? The answer is not simply that “x” units of water means “x” units of transportation cost; the answer will vary according to the circumstances.

If water is moving from north to south, there will be one set of issues and one cost determination. If the customer is longstanding, the cost will be determined much differently. If the transfer is in dry years—where there’s excess capacity anyway—the answer will be different from a time when other water would have to be displaced from those facilities.

So once we get the players to accept the basic premise that any transaction involving the historical provider should provide incremental benefit to ratepayers, we’ll get an agreement. At this point, the parties have agreed that there are four types of transactions: totally new, unanticipated customers; totally new, but reasonably expected customers; existing customers with increasing demand or need for additional reliability; and existing customers with existing demands. The transportation costs for each customer group must be dealt with differently.

Extraordinarily well said, Senator. Let me move to the issue of State and local finance, if I could. You’re Chair of the Senate Budget Committee and have been an articulate advocate for repair of the State-local fiscal relationship. As someone who’s experienced on both sides of this issue, give our readers a feel of what the crux of the problem is and what the obstacles are to fixing what most agree is a dysfunctional system at present.

The greatest obstacle is the passage of time. This problem began 30 years ago as an unintended consequence of Proposition 13—the power to make decisions was transferred to the State, which diminished local governments’ capacity to identify and establish revenue streams of their own.

“One group [is]
talking about local gov’t finance,
another group … infrastructure, and a third group thinks the issue is … tax policy. But it’s all the same issue—whether they know it or not.”

The people responsible for raising money ultimately make the decisions, no matter what they say to the contrary. It’s like the proverbial college student—the only time you hear from them is when they need money. At times, being a State legislator in this era has felt just like that with respect to local governments. And that’s unhealthy from both a local and a State perspective.

We let 30 years go by without addressing a fundamentally flawed mechanism, and a lot of things happened—mostly, by the way, resulting from good intentions. There’s been 30 years of band-aids, beginning immediately after Prop. 13 when the Legislature bailed out local governments with what was then a large State surplus. Well, that surplus disappeared, revenues to the State shrank, and the State was no longer in a position to provide the backfill of revenue taken away by Prop. 13. The reaction from the local governments was perfectly justified—they couldn’t function on what was left. However, if the State hadn’t acted, we would have had schools shutting down.

So our first goal must be to return independence to local governments. But they must understand that with that independence and authority comes responsibility. Similarly, State government has to be prepared to relinquish some power and authority—which is a difficult thing to give up.

Now, those issues concern the power relationship; the financial relationship revolves around infrastructure needs. The State drastically reduced infrastructure financing during the ‘70s and ‘80s, and today, many local financial pressures come from infrastructure demands. One group says they’re talking about local government finance, another group says they’re meeting about infrastructure, and a third group thinks the issue is California tax policy. But it’s all the same issue—whether they know it or not. You can’t do local government financial reform without doing infrastructure reform. And you can’t do either without tax reform.

An irrational tax structure grew up in California in the aftermath of Prop. 13, and it’s never been comprehensively discussed in the context of providing the best yield to State and local governments with the lowest possible tax on citizens.

The most graphic example is the sales tax. Compared to other states, we have a very high sales tax, mostly because it hasn’t been deductible in our federal income tax since 1986. Right now, we’re shipping a quarter of our tax impact off to the federal government. It doesn’t take a rocket scientist to discover that we could get the same yield from 25% less in taxes by using other federally deductible tax revenues.

California got a huge head start in the ‘60s by aggressively investing in schools, water systems and transportation systems. Since that time, however, California has been among the lowest investors in all those areas. It’s no secret that we have a huge need to invest in infrastructure—education, water, sewage, transportation and telecommunications—if we expect sustained future growth. And to improve those things—which are necessary to operate an efficient economy—we need a tax structure that makes sense.

The business community has a great deal at stake. They understand the interactions and complexities associated with tax policy, the local-State relationship and the infrastructure problems. And I think they will be the key driving force in overcoming these hurdles.

In total, all the organs of government are actually spending less per capita today than they were 30 years ago, on adjusted terms. What’s different is that the portion of the population under 18 and below poverty is 150% higher. So a couple of things are working against each other here: One is a larger dependent poor population, which puts tremendous stress on counties, and educational resources particularly. And two is an economic growth rate not adequate to keep up. We have to restructure the incentives in this tax system so that the growth/productivity rate can keep up with the changes in population demographics. And that’s certainly doable.

Let me jump in and ask you about the trailer bill to the State budget that you sponsored. Can you recap what happened with that bill and what your expectations are with the tack you took?

The first component of the State government package was about $250 million of immediate local government assistance, mostly one-time moneys to be used for capital improvements, deferred maintenance, etc.

The second component was a series of actions tied to the successful passage of a constitutional amendment in November 2000. I expect that when we return from summer break, the Legislature will look earnestly at that amendment proposal. This will lead to interim hearings over the fall, and then a stretch-run between January and July aimed at putting that amendment on the ballot.

At this point, it’s difficult to say where the Legislature and the Governor might head and what the parameters will be. But in general, the bill will logically address three issues—tax reform, State-local government relationships and infrastructure.

Senator, let me draw this to a close with a more forward-looking question. You’ve had a fairly high profile on a number of issues, and you’ve recently said you’re leaning towards running for Secretary of State in 2002. What would you like to leave behind in your Legislature career that could be the platform for your statewide race for Secretary of State, if that’s what you pursue?

Everybody comes to this process with passion for something. I really believe in the democratic process, which is one reason I’m interested in running for Secretary of State. It’s important that people believe in their governing institutions.

As a legislator—whether people have agreed or disagreed on given issues—my aim has always been to maximize public participation and encourage people to see democratic institutions as places to resolve conflict, not engage in it. As Secretary of State, it would be my goal to improve people’s confidence in their electoral system. It’s extremely important that we make some fundamental changes to do this.

Hopefully, the heart of that message will have been established by my track record in the Legislature. Every work product I’ve engaged in has been conducted in a very open and public forum. Each has been businesslike, timely and functional. And that’s how I would like to see the Secretary of State’s office operate—with election processes themselves more open, inclusive, timely, functional and businesslike.

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