What Proposition 26 Means for Your Utility

Every time a California utility sets a rate, adjusts a fee, or transfers funds to a city's general fund, it operates within a constitutional framework that most utility managers did not choose and many do not fully understand. That framework — anchored by Proposition 26, which voters approved in November 2010 — treats any charge imposed by a local government as a "tax" unless it fits within one of seven narrow exceptions. The consequences of falling outside those exceptions are severe: voter approval requirements that can delay or block essential revenue actions.

Proposition 26 was the third in a series of voter-driven fiscal reforms that began with Proposition 13 in 1978 and continued with Proposition 218 in 1996. Together, these three measures have created what is arguably the most constrained public utility finance environment in the United States. The practical effects, however, vary dramatically depending on whether the utility in question is a municipal electric provider, a community choice aggregator, or a water system.

The Legal Architecture

Proposition 26's genius — and its burden on utilities — lies in its definitional inversion. Rather than defining what is a tax, the initiative defines everything as a tax unless the government can prove otherwise. The local government bears the burden of demonstrating, by a preponderance of the evidence, that a charge fits within one of seven statutory exceptions. The most important of these for utilities is exception §1(e)(2): a charge for a specific government service provided directly to the payor that does not exceed reasonable costs.

This burden shift is consequential. Before Proposition 26, a challenger had to demonstrate that a fee was actually a tax. After Proposition 26, the government must prove its fee is not a tax. The difference is not merely procedural — it changes the economics of litigation and the standard of documentation that utilities must maintain.

Municipal Electric: The PILOT Question

For the approximately 40 California cities that operate municipal electric utilities, the central Proposition 26 question is deceptively simple: can the city continue to transfer money from the electric utility fund to the general fund? These transfers — variously structured as payments in lieu of taxes (PILOTs), percentage-of-revenue formulas, or surplus transfers — are a significant revenue source for many cities. They also represent the most frequently litigated Proposition 26 issue in the electric utility context.

The California Supreme Court's 2018 decision in Citizens for Fair REU Rates v. City of Redding provided qualified reassurance. The Court held that a PILOT is a cost to the utility — not an exaction imposed on ratepayers — and is therefore not subject to Proposition 26. However, the Court's reasoning relied on the fact that Redding's utility had sufficient non-rate revenue to cover the PILOT entirely. For cities where retail rates are the primary funding source for general fund transfers, the holding offers less comfort.

CCAs: Structurally Favored, Not Immune

Community Choice Aggregators occupy a structurally favorable position under Proposition 26 for three reasons. First, CCA generation charges fit squarely within the cost-of-service exception: they are charges for a specific service (electricity procurement) provided directly to the customer. Second, the opt-out mechanism available to CCA customers undermines the argument that charges are "imposed" by government — a key element of the tax definition. Third, CCA rates are not property-related fees, so they avoid Proposition 218's additional constraints entirely.

The vulnerability for CCAs lies not in their own rate-setting, but in the broader ecosystem of charges that appear on their customers' bills. CCA customers continue to pay IOU delivery charges, including a Franchise Fee Surcharge collected on behalf of cities. The Zolly v. City of Oakland decision (2022) established that franchise fees are subject to Proposition 26 even when negotiated through contract — creating potential exposure for the pass-through charges that appear on every CCA customer's bill.

Water Utilities: The Most Constrained Environment

Water and wastewater utilities face the most legally constrained rate-setting environment of any utility type in California. Unlike electric and gas service, water and sewer fees are subject to Proposition 218's property-related fee requirements, which mandate cost-of-service rate design, proportional cost allocation, a prohibition on using fee revenue for non-service purposes, and a majority-protest hearing process. Proposition 26 then layers additional constraints on top of this framework for any charges that fall outside Proposition 218's scope.

The combined effect is a rate-design environment in which conservation pricing, affordability programs, and infrastructure reserves must all be justified through the lens of cost-of-service. Tiered water rates must be supported by evidence that high-usage customers actually cost more to serve — not simply by a policy objective of discouraging consumption. Low-income discounts must be structured to avoid shifting costs disproportionately to other ratepayers. And stormwater programs, which lack a well-established tradition of user fees, face the most severe funding constraints of all.

What Comes Next

The legal landscape is not settling — it is actively shifting. The Taxpayer Protection Act, which would have dramatically expanded Proposition 26's reach, was removed from the 2024 ballot by the California Supreme Court as an unconstitutional revision. But similar proposals continue to circulate in the Legislature, including ACA 14, introduced in April 2025. Meanwhile, the Zolly case returns to trial court on remand, where the factual record developed will shape franchise fee law for years to come.

For utility decision-makers, the takeaway is operational: Proposition 26 compliance is not a one-time legal review. It is an ongoing obligation that requires current cost-of-service studies, documented transfer justifications, and rate structures that can withstand judicial scrutiny. The utilities that invest in this analytical infrastructure will be best positioned to defend their revenue actions — and to serve their customers — in the years ahead.

NewGen Strategies & Solutions is a utility regulatory and financial consulting firm serving electric, water, wastewater, and solid waste utilities nationwide.

© 2026 NewGen Strategies & Solutions, LLC. All rights reserved. This content is for informational purposes and does not constitute legal advice.