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California State Auditor Report Number : 2015-125

San Joaquin Valley Air Pollution Control District
To Cover Its Costs, It Recently Increased Permit Fees and Continues to Use Supplemental Revenue but Can Improve Consistency and Transparency for Certain Program Requirements



Our audit concerning the revenues and expenditures of the San Joaquin Valley Air Pollution Control District (district) and its implementation of certain program requirements revealed the following:

Results in Brief

The San Joaquin Valley Air Pollution Control District (district) adopts rules designed to meet the air quality standards for the San Joaquin Valley set by the U.S. Environmental Protection Agency related to stationary sources of pollution. To comply with federal and state law, the district has established a permitting system that requires every person or entity who operates a stationary source of air contaminants—that is, large, fixed, sources of air pollution, including power plants, refineries, and factories—to obtain a permit and pay a fee for that permit.

Our review found that the stationary source permit fees charged by the district are allowable and generate fee revenue less than its costs. From its permit fees, the district received an average of $17.6 million, or 39 percent of its annual average operating revenue, for fiscal years 2010–11 through 2014–15. However, this revenue alone is not sufficient to cover the district’s regulatory costs of inspection and review activities. To make up the difference, the district has other sources of revenue that it can lawfully use to supplement its permit fee revenue, including revenue from penalties, interest earned, and state and federal grants. For fiscal years 2010–11 through 2014–15, the district received an average of $8.3 million annually, part of which it used to supplement its permitting program. In addition, the district maintains an unassigned fund balance in its general fund that it drew from in fiscal years 2012–13 and 2013–14. The district maintained an unassigned fund balance of between $13.1 and $14.3 million for fiscal years 2010–11 through 2013–14, or roughly three months of operating expenses.

During its annual budget process, the district evaluates whether its current revenue from permit fees and other supplementary sources is sufficient to cover its operations. If the budget analysis indicates that budgeted expenditures will exceed projected revenue even after the district implements feasible cost-cutting measures, the district will consider increasing its fees. Based on its annual budget analysis in 2013, the district projected a shortfall of approximately $2 million for fiscal year 2014–15. The district later submitted a proposal to increase its permit fees, which its governing board adopted in April 2015. Specifically, the district enacted a fee increase of 4.8 percent for the majority of its permits for fiscal year 2015–16, with an additional increase of 4.4 percent for fiscal year 2016–17. Before these fee increases, the district had increased most of the permit fees by the same percentage (across the board) only two other times—in 1997 and 2008.

Legal requirements that apply to fees state that the district may not collect fees in excess of the costs to perform the related regulatory activity. Using the district’s fiscal year 2013–14 fee revenue, we estimated that the district’s revenue from each of its permit fees will continue to be 15 percent to 86 percent below the costs related to each respective regulatory activity after its most recent fee increase takes effect in fiscal year 2016–17. Therefore, to cover the costs of its operations, the district will need to use a portion of the other revenue it receives from penalties, interest earned, and state and federal grants. The district expects that the recent fee increases along with its continued operational streamlining will enable it to balance its costs and revenue.

Because of the role the district plays in issuing various stationary source permits, it can be named as a party in litigation under the California Environmental Quality Act (CEQA). Under CEQA regulations, two of the basic purposes are to inform individuals about potential, significant environmental effects of proposed activities and to identify ways that environmental damage can be avoided or significantly reduced. Under CEQA, a resident can bring a lawsuit if he or she believes those who are leading the project, or those who have some responsibility for the project, have not followed certain procedural requirements designed to protect the environment. To protect the district and its many regulated customers from the potential costs of CEQA litigation, the district requires certain permit applicants to provide the district additional financial security by signing an indemnification agreement and providing a letter of credit. An indemnification agreement is an agreement limiting the district’s financial liability. A letter of credit is issued by a bank that agrees to provide prompt payment on behalf of the permit applicant, if needed. The district’s published policy in place during our review specifies the circumstances under which permit applicants must provide indemnification agreements and letters of credit. However, this policy is inconsistent with the district’s internal methodology for indemnification agreements for permit applicants. Specifically, the district’s published policy focuses solely on the district’s level of responsibility in approving the project as the determining factor in whether to require indemnification, while its internal methodology contradicts the published policy in certain instances where the district believes the project is not of public concern.

Additionally, in practice the district uses discretion to make the final decision as to whether to require an indemnification agreement and a letter of credit, and it does not always follow the published policy or internal methodology. The district justifies its decision to deviate from its policy or methodology by noting that it needs to use discretion so as not to be overly burdensome to permit applicants. For example, district rules require a dairy to obtain a permit when it reduces the number of cattle at a site. If the district strictly followed its internal methodology, it would ask the dairy to sign an indemnification agreement, even though the change would reduce pollution and be unlikely to generate litigation. However, the district often did not document its rationale when it used discretion, with the result that we identified two similar projects for which the district made different decisions: it required an indemnification agreement and a letter of credit from one project and not the other. Without documenting its reasoning, the district cannot be fully transparent and demonstrate that it treats similar permit applicants consistently. After we discussed these concerns with the district, it published a revised policy in March 2016 indicating that the district will conduct a case-by-case analysis of whether to require an indemnification agreement or letter of credit, and it will document its reasoning. Finally, the district does not have an adequate system for requesting, maintaining, and tracking indemnification agreements and letters of credit. For one project, the district believed it had a letter of credit when it did not. For another project, the district did not request a new letter of credit to replace one that expired before the end of the agreed-upon time frame, causing the district to lose the protection it sought to obtain. Although our review revealed that the district requires these documents only from a few permit applicants, it is important for the district to ensure that the documents are in place if needed.


To ensure consistency between its published policy and its internal methodology so that permit applicants are aware of the district’s requirements and receive equal treatment, the district should update its internal methodology by July 2016 to contain equivalent information to reflect its revised published policy.

To make certain that it can demonstrate consistency and transparency in its decision-making process when it determines which permit applicants it requires to provide additional financial security, the district—after updating its guidance documents—should follow its revised published policy and updated internal methodology for requiring indemnification agreements and letters of credit.

To ensure that the district is adequately protected from the costs of litigation, it should develop a protocol to maintain all required legal documents accurately and to make sure that those documents remain in effect. By July 2016, the district should adopt such a protocol for management of its centralized system for requesting, tracking, storing, and following up on indemnification agreements and letters of credit.

Agency Comments

The district stated that based on the concerns raised and our recommendations, as well as its core values which call for continuous improvement and open and transparent processes, it revised its policy to clearly describe the case-by-case nature of its risk management decisions and to require documentation of those decisions.

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