Local Government Mandates—Reasonable Reimbursement Methodology

Through a complex, often convoluted, process that has engendered much discussion and disagreement over the years, the state must reimburse local governments for their activities to implement certain state mandates. State law requires the Commission on State Mandates (CSM) to determine whether new state laws, executive orders, or regulations affecting local governments create state-reimbursable mandates. Generally, local governments may submit claims for state mandate payment based on one of two methods: (1) claiming of actual costs or (2) a reasonable reimbursement methodology (RRM). A budget trailer bill proposal from the administration would change the requirements for developing an RRM. We recommend the Legislature reject this proposal and perhaps consider targeted alternatives.

Background

Mandate Determination and Payment

Constitution Requires the State to Reimburse Local Governments for Mandated Activities. In 1979, voters passed Proposition 4, which added a requirement to the California Constitution that local governments be reimbursed for new programs or higher levels of service that the state imposes on them. Local governments include counties, cities, local educational agencies (LEAs) such as school districts, and special districts. Historically, the state often deferred reimbursement. Proposition 1A (2004), which applies to non-education-related mandates, amended the Constitution to require the state to either (1) pay most mandate reimbursements in the annual budget act or (2) or suspend or repeal the mandate(s).

Complex Process. Under law, CSM determines whether a state requirement qualifies as a reimbursable mandate. The CSM adopts “Parameters and Guidelines” that list the specific activities that are reimbursable. The State Controller’s Office (SCO) then issues claiming instructions for local governments. The claiming instructions tell local governments how to file for reimbursement for the mandated activities with the State Controller.

Options for Mandate Reimbursements. Once CSM has adopted Parameters and Guidelines, local governments can submit claims for reimbursement based on the actual costs of the required activities. Alternatively, the CSM can adopt a Reasonable Reimbursement Methodology (RRM). The Legislature created the RRM process in 2004 with the intent to streamline the documentation and reporting process for mandates. An RRM allows local governments to be reimbursed based on general allocation formulas or other approximations of costs, rather than detailed documentation of actual costs. Currently, there are 58 active education mandates and 22 active local government mandates for which the CSM has adopted Parameters and Guidelines. Of these, six mandates—Habitual Truants, Graduation Requirements, Behavioral Intervention Plans, Immunization Records (Pertussis), Peace Officers Procedural Bill of Rights, and Municipal Stormwater and Urban Runoff Discharge—use an RRM. (Currently, there is ongoing litigation regarding the stormwater mandate. As a result, this mandate is neither funded nor suspended.) For education-related mandates, there is a third option—block grants—which we describe later.

Process to Adopt or Reject Proposed RRMs. The Department of Finance (DOF), SCO, affected local governments, or an interested party (for instance a local government association) may propose an RRM. Generally, when an RRM is proposed, the CSM cannot modify it. Rather, state law directs the CSM to adopt or reject the proposal. To be adopted by the CSM an RRM must meet certain conditions described below. (If there are multiple RRM proposals for a particular mandate, the CSM must determine which of the proposals best fits these conditions.) In particular, an RRM must:

Use cost information from one of the following: (1) a representative sample of eligible claimants, (2) information provided by local government associations, or (3) other projections of local costs;
Consider the variation in costs among local governments to implement the mandate in a cost-efficient manner; and
Be consistent with the mandated activities identified in the CSM’s Parameters and Guidelines.

Once an RRM is submitted to the CSM for consideration, DOF, SCO, or affected local governments may file comments with the CSM. These comments are part of the administrative record and may outline the parties’ support or opposition to the proposal. The parties may submit comments again after the CSM releases a proposed RRM decision. In addition, DOF, SCO, and local governments may request an informal conference on any matter pending with the CSM. An informal conference provides another opportunity for discussing issues before the CSM, including the adoption or rejection of an RRM. Parties may challenge a CSM decision, including adoption of an RRM, in court if they believe it is not supported by substantial evidence. A court may direct the CSM to re-hear the issue.

Funding for New Mandates Considered in State Budget. Typically, within one year of local governments submitting claims for reimbursement, the CSM prepares a statewide cost estimate based on the claims or the RRM. After the cost estimate is prepared, mandates are considered for funding in the state budget. As noted earlier, Proposition 1A (2004) requires the Legislature to fund, suspend, or repeal non-education-related mandates. Suspending mandates relieves local governments of performing the mandate for one year, while repealing a mandate permanently eliminates it.

Education Mandates Now Funded Through Two Block Grants. In 2012-13, the state created two education mandates block grants—one for all active K-12 mandates and one for all active community college mandates. The block grants are an alternative mechanism for LEAs to seek mandate reimbursement. Instead of submitting detailed claims on an ongoing basis listing how much was spent on each mandated activity or using specific RRMs for specific mandates, LEAs can choose to receive funding for all mandated activities through the block grants. As of 2015-16, almost all LEAs are participating in the block grants. (Those LEAs not opting to participate in the block grants continue to submit claims to the Controller for reimbursement at a later date.)

Audits of Mandate Claims

SCO Has Discretion to Audit Claims and Reduce Reimbursements. State law authorizes SCO to audit any mandate claim within three years of reimbursement. Generally, SCO identifies claims to audit based on certain criteria, such as the size of the claim, the variance in claimed costs, and prior audit experience. When auditing a claim or RRM, the Controller reviews whether the local government’s claim for reimbursement follows the Parameters and Guidelines set out by the CSM. SCO also verifies the information provided by the local government is accurate and sufficient to support the reimbursement. If the local government claimed reimbursement for activities not included in the Parameters and Guidelines or did not provide sufficient evidence for the claim, SCO may reduce the reimbursement. In addition, the Controller’s Office is authorized to reduce reimbursement claims if it deems a claim excessive or unreasonable. Of the six active RRMs, SCO typically did not audit associated claims.

Small Share of Claims Audited, But Large Share of Those Are Reduced. Last year, SCO issued roughly 130 audit reports related to mandate claims. Each audit report included an average of five local government reimbursement claims for particular mandates. Overall, this reflects an audit of roughly 1 percent of claims. In the 1 percent, or roughly 650 claims, audited, SCO identified errors in 60 percent of them. As a result, reimbursements to local governments were reduced by $170 million. While those claims audited were reduced by a significant amount, these reductions reflect a small share of the state’s mandate payments overall. Moreover, this error rate likely does not reflect the error rate across all claims as SCO targets audits based on the risk factors discussed above. (Notably, reductions to community college claims reflected over half of the total adjustments.) Each audit report, which typically is performed by one auditor, requires six months to one year to complete.

Commission Can Overturn Controller Reductions. If a local government believes SCO incorrectly reduced its reimbursement, the local government may appeal the decision to the CSM. To overturn a reduction, the CSM must find that SCO’s reduction was arbitrary, capricious, or did not have sufficient evidence to support a reduction.

Administration Proposal

Proposal Would Require Audit of Claims Used for RRM Proposals. The administration’s trailer bill proposal would require SCO to audit all reimbursement claims used in the development of any new RRM. The administration proposes this amendment based on its concern that the claims used to develop the Immunization Records (Pertussis) RRM overstated actual costs. The administration has voiced similar concerns for other mandates through written comments to the CSM in the past. (In some cases, the CSM rejected RRM proposals because the administration had expressed concerns they were not “cost efficient.”) As noted above, any RRM proposal must use cost information from one of three sources: a representative sample of eligible claimants, information provided by local government associations, or other projections of local costs. Under the administration’s proposal, if a proposed RRM uses cost information based on claims filed by local governments to the SCO, those claims would have to be audited before being used to develop a general allocation formula. An RRM developed through means other than claims data would not face this requirement.

LAO Assessment

RRM Process Intended to Streamline Reimbursements, But Seldom Used. The intent of the Legislature in establishing the RRM process was to reduce local governments’ burden of documenting actual mandate costs, as well as reduce the work of state officials in reviewing and paying associated claims. The RRM process also may provide an incentive to local governments to perform activities more efficiently because they are reimbursed at a fixed rate. Despite these possible advantages, the RRM process has been seldom used to date. In part, this may be because the state has suspended many mandates in recent years, thereby eliminating the need to develop RRMs in many cases.

Already Multiple Opportunities To Provide Input. Current law allows (1) multiple parties to submit RRM proposals for the same mandate, (2) parties to submit arguments for and against RRM proposals, and (3) any CSM decision to be challenged in court. The first opportunity allows the state an opportunity to counter local government proposals that may provide reimbursements in excess of those required by law. The second opportunity allows interested parties to provide input to the CSM if they believed the CSM should reject an RRM. The last opportunity—challenging a CSM decision in court—offers a fallback should any party disagree with the CSM’s final decision. Thus, there are several opportunities for DOF or other interested parties to weigh in on whether an RRM proposal meets the requirements of state law.

Proposal Could Significantly Increase Audits and Make RRMs More Burdensome. One possible source of cost information for an RRM is claims from a representative sample of eligible local governments. Given the variation in local governments’ size, responsibilities, and populations, a representative sample of claims could include information from dozens of local governments. Given that SCO currently audits roughly 650 claims per year, one RRM proposal including one year of claims from 65 local governments could increase the Controller’s workload by 10 percent. (Notably, the Immunizations Records [Pertussis] RRM included claims from roughly 150 school districts over multiple years.) Since each audit can take many months to complete, the proposed audit requirement likely would lengthen the process for developing an RRM. As a result, it could become more difficult for local governments to propose RRMs based on claims data in the future. Moreover, an increase in SCO’s audit workload potentially could strain that department’s resources in the future.

Recommendations

Recommend Rejecting Proposal to Audit All RRM Claims. While RRMs have been seldom used to date, we advise the Legislature to be cautious in considering actions that could make the process significantly less beneficial for local governments in the future. In future years, for example, the state may suspend fewer local government mandates than it does today, and this could provide an impetus for more RRM proposals. Based on this perspective, we recommend the Legislature reject the administration’s trailer bill proposal to require an audit of all claims used to develop an RRM. Imposing such an extensive audit requirement could reduce local governments’ use of the RRM process in the future and impose additional burdens on state auditing staff. We believe that significantly less onerous requirements could address some of the administration’s concerns.

Possible Alternatives to Administration’s Proposal. To address the administration’s concerns regarding potential overstatements of costs, the Legislature could consider targeted alternatives. For example, the Legislature could consider adding an audit requirement for a sample of the claims used for an RRM. In addition, the Legislature could require SCO to complete its audit of the sample of claims within a specific number of days after receiving an RRM proposal—perhaps 60 days. Alternatively, the Legislature could consider requiring the CSM to hold an informal conference with DOF and other interested parties prior to adopting an RRM. (Currently, informal conferences are held when requested by an interested party.)