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Other Budget Issues

Last Updated: 4/27/2011
Budget Issue: Davis-Dolwig cost allocation study
Program: State Water Project
Finding or Recommendation: Amend requested budget bill language to have the study instead focus on legal issues that need to be resolved before the Legislature can proceed with making needed policy reforms to the Davis-Dolwig Act
Further Detail

Proposal.  In a letter dated April 13, 2011, the Department of Finance (DOF) requests a one-time transfer of $34,000 from the Harbors and Watercraft Revolving Fund to the Department of Water Resources (DWR) to fund a portion of the cost of a new cost allocation study. The study would serve to reëstimate the benefits provided by the State Water Project (SWP) in terms of water supply and recreation to assist with the allocation of total SWP costs between these two purposes. This request follows from the recent conclusion of a previous statutorily required study that examined DWR’s methodology to calculate the state’s share of total SWP costs.

Davis-Dolwig History.  As described in our earlier report, “Funding Recreation at the State Water Project,” the Davis-Dolwig Act, passed in 1961, states the broad intent of the Legislature that SWP facilities be constructed “in a manner consistent with the full utilization of their potential for the enhancement of fish and wildlife and to meet recreational needs.”  The Act also specifies that the SWP contractors (water agencies contracting for the deliveries of SWP water) should not be charged for the costs incurred in meeting the requirements of the Act.  The DWR has historically used a cost-allocation methodology called Separable Costs-Remaining Benefits (SCRB) to calculate the state’s responsibility under Davis-Dolwig.  This methodology allocates "joint costs"–those costs that cannot be attributed solely to water supply or recreational purposes–on the basis of the proportion of the benefits provided by the SWP overall that are estimated to accrue to each purpose. 

LAO Policy Concerns and Recommendations Made in Past Years. We have raised concerns in the past (again, see “Funding Recreation at the State Water Project,” as well as our analyses of the 2009-10 and 2010-2011 Governor’s budgets) over DWR's practice of using SCRB to calculate the state’s share of SWP costs.  Most importantly, the practical implication of the use of this methodology (as implemented by DWR) is that DWR assigns cost responsibility to the state for aspects of SWP that lack any direct recreational component--to even including assiging to the state some of the costs of the study that is this subject of this budget request. Given the "off-budget" nature of SWP (the Legislature only approves SWP positions, not expenditures), the DWR has been able to pursue development of SWP projects without expressed legislative consent, later retroactively billing the Legislature and the state's purse for its estimate of the state's share of the costs of those projects. This runs up against, and potentially conflicts with, the Legislature's exclusive constitutional authority to set its expenditure priorities by making appropriations. As discussed below, we have made recommendations for policy reforms to the Davis-Dolwig Act to address this issue by providing a clearer, more limited definition of the state's funding obligation under the Act. A related issue concerns the department's practice of charging to the state's public purse some of the costs of meeting federal regulatory requirements at SWP facilities (specifically, requirements that mandate recreational improvements to be made at federally licensed hydroelectric facilities). Given that the Legislature has expressed its intent, in various contexts, that regulatory compliance costs should be borne by the beneficiaries of the regulated activity, we think that these regulatory mandated recreation costs should be borne fully by the SWP contractors.

We have previously offered three recommendations to address these issues. First, we have recommended that the Davis-Dolwig Act be amended to specify that only costs related to construction of recreation facilities at new SWP facilities are to be paid for by the state under the Act. Second, we have recommended that the Legislature specify that SWP is no longer to incur operational and maintenance costs for state recreation areas, or use SWP funds for these purposes. Finally, we also have recommended that the Legislature specify that any SWP recreation facilities that are to be developed or improved under a regulatory requirement shall not give rise to a state funding obligation under the Act.

Making Policy Reforms Has Been Difficult. The above reforms have not been enacted by the Legislature, in part due to legal issues that have been raised by DWR and DOF. Specifically, the administration has maintained that SCRB is required by various contracts and bond covenants that are in place, and that these constraints limit the Legislature’s ability to revise the Davis-Dolwig Act, as we have recommended, to set parameters for the state's funding obligation for recreational expenditures. While informal legal opinions provided to the Legislature on these legal issues suggest an alternative view, it is fair to say that these fundamental legal issues remain unresolved. Until resolved, it will likely be difficult to proceed with any meaningful Davis-Dolwig policy reform.

Previous Cost Allocation Study Did Not Address the Legal Issues. As noted above, the Finance Letter requests funds to perform a recalculation of the benefits that are inputs into the SCRB process used by DWR.  The 2010-11 Budget Act required DWR to hire an independent consultant to evaluate the cost allocation methodology DWR uses to calculate the state’s Davis-Dolwig funding obligation. The consultant's report recently concluded that while the manner in which DWR implemented the current methodology is acceptable, the estimates of water supply and recreational benefits from total project costs could be improved.  We have since raised concerns that the scope of the report was too narrow. Being constrained by the task list developed by DWR and by the expertise of the authors, the report fails to address the larger legal questions discussed above. For example, the report appeared to assume the administration’s position that the SCRB methodology is required, without having examined whether SCRB is in fact legally required, and if it is required, how to reconcile that requirement with the Legislature's constitutional autrhority to set its expenditure priorities and make appropriations.

Recommendation. In light of our concerns over the previous study, and given the unresolved legal issues that are impeding Davis-Dolwig policy reform, we consider the study as proposed in this budget request to be premature. The proposed effort may be worthwhile down the road, if some resolution can be reached on the legal issues surrounding SCRB.  It is worth noting that the results from reëstimating water supply and recreation benefits are likely to be utilized only if it were ultimately determined that SCRB is legally required. Therefore, in order to facilitate resolution of the legal questions we pose above, we recommend that an alternative study by an independent third-party contractor be conducted that specifically examines the legal questions we raise.  That third party should consist of, at a minimum, an academic with legal expertise, such as a University of California law professor.  Specifically, we recommend that existing SWP contracting authority be used fully to pay for the study, and that the proposed budget bill language be amended as follows:

“The Department of Water Resources shall allocate [an amount to be determined] in existing State Water Project (SWP) contracting authority for an independent third-party review to determine: (1) what legal constraints, if any, exist to proscribe the California Legislature’s ability to revise the Davis-Dolwig statute, with specific attention to the contracts signed by the department with the SWP contractors and to the SWP bond covenants; (2) whether such legal constraints conflcit with the Legislature's authority to make laws and to set its expenditure priorities through its constitutionally granted authority to make appropriations; (3) how any such legal conflicts can be reconciled; and (4) what options exist to resolve the issues. The Department of Water Resources shall submit the task list for the contractor to the Legislative Analyst's Office for its approval.  The contractor shall work in periodic consultation with the Legislative Analyst’s Office, the Department of Finance, and the Department of Water Resources when performing its analysis. The department shall submit this analysis to the budget committees, and relevant policy committees of both houses of the Legislature, no later than January 30, 2012.”