In 2005, the State of Kansas and its 3,887 local governments collected $3 billion in property taxes and $2 billion in retail sales and use taxes. In addition, those governmental entities had $12 billion in bonded debt outstanding which represent claims on future revenues. This fiscal profile was the recent focus of several studies conducted through the Kansas Public Finance Center at Wichita State University.1
While the Spring 2006 issue of the Kansas Policy Review provided an overview to the recent history of state government revenues, expenditures and debt, the purpose of this current article is to size-up two major taxes relied upon by both the State of Kansas and its local governments: the property tax and the retail sales (and use) tax. Based on the tax principle that a broad tax base permits a low tax rate, the focus is on the extent of tax base erosion over time. To complement the earlier review of state debt, this article also examines local government debt. Together, these two articles serve as an overview to the fiscal profile of state and local finances in Kansas.
In 1995, the Governor’s Tax Equity Task Force recommended that all tax legislation be evaluated with several objectives in mind, including this one:
"Tax revision should not unduly erode the tax base. A broad tax base allows the lowest possible rate, while also enhancing compliance, public accept-ability, and the stability of the revenue source. But, there is a tendency to grant exemptions from a uniform or general treatment, and once granted they are hard to remove. It is poor public policy to erode the underlying tax base by granting unwarranted, gratuitous exemptions or exclusions. It is important to remove items from taxability, including but not limited to economic development incentives, only upon meeting rational, economically meritorious criteria. Further, all exemptions and exclusions should have a specified life, instead of an indefinite period" (page 12).Studies on the erosion of the property and sales taxes were conducted to determine the impact of deviations from their respective estimated tax base, and are reported here. While these studies pointed out the extent of erosion of these two important taxes, they did not recommend the removal of all exemptions or even particular ones. Rather, the focus was to suggest the need to periodically review each tax to ensure that it continues to reflect economic and fiscal goals.
In its beginning as a state, Kansas defined the property tax broadly. The Wyandotte Constitution of 1859 states: "The Legislature shall provide for a uniform and equal rate of assessment and taxation; but all property used exclusively for State, county, municipal, literary, educational, scientific, religious, benevolent, and charitable purposes, and personal property to the amount of at least two hundred dollars for each family, shall be exempted from taxation." These were the only Constitutional departures from a uniform and equal tax. Governor Thomas Carney, who served from 1863-1865, championed the constitutional ideal with his 1862 declaration: "Let all protected by the State share equally its burdens in proportion to their property." A relevant question is how well does the current Kansas property tax meet the "uniform and equal" standard?
Plotting the number (not the dollar value) of changes to the "uniform and equal" concept since 1859, as performed in Figure 1, reveals that most of the changes occurred in the last 25 years. From the few specified departures from uniform and equal assessment quoted from the Wyandotte Constitution, successful amendments to the Constitution’s finance and taxation article have occurred on only eight occasions concerning matters of property taxation. There were two amendments in 1924, one in 1964, 1974, and 1976 each, two in 1986, and one in 1992. The classification amendments of 1986 and 1992 are two of the most noteworthy changes. These amendments resulted in the current classification of residential property at 11.5 percent of appraised full market value while classifying commercial and industrial property at 25 percent of its value. When the eight amendments are examined in terms of who directly benefits from the Constitutional departures, the results reveal that 14 benefited business, 5 benefited agriculture, 3 benefited homeowners, and one benefited nonprofits.
In contrast to the infrequent and low number of Constitutional departures, Figure 1 also conveys that most of the property tax base changes represent statutory exemptions, including 20 benefiting business property, 17 benefiting agricultural property, and 15 benefiting the property of individuals. As shown, the sheer number of changes to the property tax has escalated in recent years.
A tax on property includes the value of real estate (that is land and improvements to land–such as buildings) and the value of personal property, both tangible and intangible. By definition, tangible property includes movable items such as machinery, equipment, inventory and even household goods and farm animals. Intangible property, by definition, includes investments (such as stocks, bonds and bank account balances) and even the value of intellectual property. The Kansas property tax excludes many of these items from taxation.
The current property tax base is increasingly focused on real estate instead of personal property, and specifically residential real estate instead of that owned by business, agricultural, or other owners. Of total assessed value, real estate comprised 44 percent of the property tax base in 1988 but increased to 65 percent in 2005. Residential real estate represented 22 percent of total assessed value in 1988 but almost doubled (40 percent) by 2005. It should not come as a shock that this movement to a residential real estate tax is being felt in the political environment as those residential owners equate with "voters" who demand relief.
One test of equality in the administration of the property tax is to compare the appraised value of property (that is the value estimated for tax purposes) to the actual value of the properties when sold. Figure 2 shows the ratio of sales value to appraised values for real estate in Kansas. In 1933 the law required that property be assessed at 100 percent of market value but the median ratio was only 86 percent. It declined rapidly to 20 percent in 1962. More recently, the state’s median real estate ratio is within acceptable boundaries–tax appraisals are within 96 percent of residential actual values. This positive result is due to changes brought about after the classification changes in 1986 and 1992, and especially Judge Bullock’s 1993 opinion on school finance that mandated statistical appraisal standards. The message here is that professional administration of the property tax promotes equity in the appraisal process.
Property taxes were originally intended to tax the stock of wealth, in essence all property–real and personal, tangible and intangible. The framers of the Kansas Constitution provided exemptions only for public, educational, and charitable purposes, plus a $200 exemption of personal property per family. A comprehensive property tax with few exemptions was believed to be the most equitable form of taxation. Estimating the property tax base without any exemptions or other legal deviations from market value is an exercise that permits the discussion to return to the original concept of an "ideal" property tax on all property, including the original constitutional exemptions. Although no previous attempt to estimate this total "theoretical" property tax base in Kansas could be found, a series of estimating assumptions generated an admittedly imprecise initial estimate.
Based on this estimating exercise, the Kansas constitution and statutes currently exempt or otherwise do not tax approximately 93 percent of the estimated total tax base, as shown in Figure 3. Taxing all property would encompass the following types of assets currently untaxed: the difference between full market value and the classification levels; the difference between agricultural use value and full market value; tangible personal property, including household goods, business inventories, and farm equipment and animals; and personal and business intangible personal property including bank account balances, securities holdings, and other intangible assets. In summary, Kansas taxes an estimated 7 percent of the total possible property tax base. Any future exemptions would aggravate this situation.
Several competing policy options arise from the property tax erosion study:
- Continue on the current path. This choice will undoubtedly make financing local government more difficult and will raise the burden on residential property. More significantly, this choice may eventually spark a taxpayer revolt that could lead to the kind of arbitrary tax or expenditure limitations that have hampered the provision of government services in California and many other states.
- "Clean up" the property tax laws and develop rational policy for exemptions and then examine all present and proposed exemptions in light of the policy. This approach has severe limitations since some needed changes would likely require constitutional amendments and any attempt to repeal existing statutory or constitutional exemptions would meet fierce opposition.
- Return toward "uniform and equal." Drafting and passing such an amendment would require the agreement of major interest groups and might require a commission or some kind of "mini" constitutional convention.
- Repeal all taxes on personal property and reconfigure local government and government functions so that local governments finance only property-related services from the property tax. For example, social services now funded with local property taxes would have to be financed by state revenues or other revenue sources.
- Authorize local government broader access to sales and income taxes. This choice might be done by consolidating small governments or by creating taxing districts that could more effectively levy in-come or sales taxes. More governmental functions, for example, schools, could be shifted to the state level.
The Retailers’ Sales Tax Act, passed by the 1937 session of the Kansas Legislature, imposed a tax at the rate of two percent on the gross receipts from retail sales of tangible personal property or from the furnishing of taxable services, on and after June 1, 1937. Currently, the state tax rate is 5.3 percent (in additional to local tax rates).
Figure 4 shows the cumulative number of statutory sales and use tax changes since the tax was first imposed. Since 1937 there have been 71 original exemptions and exclusions from the sales and use tax, 53 expansions in exemptions or exclusions, 20 restrictions in exemptions and exclusions, and 62 other changes in the sales and use tax statutes, for a total of 206 legislative enactment or changes in the Kansas sales and use tax statutes.
When adjusted for inflation, the total value of sales and use tax exemptions in 2005 is estimated to be twice the size of the present tax base. As shown in Figure 5, the most significant exclusion is for component parts and items consumed in the production process. This tax exemption is consistent with the aforementioned Governor’s Tax Equity Task Force statement because physical ingredients that comprise a product should not be taxed until the finished item is sold to the ultimate retail consumer. Otherwise, double taxation would occur because a tax would be collected on component parts (such as a gasoline tank purchased by a lawn mower manufacturer for installation in the mower) as well as a tax on the overall retail price paid by the ultimate consumer.
As a share of the overall personal income of Kansas residents (Figure 6), the sales and use tax base has declined over the past 60 years. This trend is repeated nationally as the retail sales tax, focused originally on purchase of manufactured goods (food as well as durable goods such as appliances), has failed to address the growth in the purchase of services (e.g., personal care, home care, and legal and accounting services).
Although the sales tax is generally perceived by many to be a broad-based tax on final consumption, generally it is neither broad-based nor limited to final household consumption. In practice, the tax applies to a number of purchases for use in production, such as machinery and equipment. Moreover, there are numerous exemptions embedded in state law. The Kansas retail sales and use tax does not tax approximately 76 percent of the estimated total tax base (Figure 7). Taxing all sales and use activity would require the removal of all existing exemptions in state law, taxing services broadly, and capturing remote sales through a more effective use tax. If all these changes occurred (which the study did not advocate), collections are estimated to increase by approximately 4.7 times the present annual sales and use tax amounts. In summary, Kansas taxes an estimated 24 percent of the total possible sales and use tax base. Any future exemptions would aggravate this situation.
Consistent with national over-views on the future of the retail sales and use tax,2 there are four policy options to address the erosion of retail sales and use taxes:
- Avoid proliferation of sales taxes on business inputs;
- Keep household purchases of tangible personal property inside the tax base;
- Bring household purchases of services into the tax base; and,
- Get Congress to help states en-force use taxes on remote sales.
Debt is not a bad word. However, too much debt can reduce money for current services and negatively influence a governmental jurisdiction’s ability to borrow at a low cost of capital. Essentially, debt is just a way to leverage future revenue flows. Erosion of the revenue base reduces debt security whether it concerns the property tax which backs ultimately all General Obligation bonds or the local sales tax which underpin many local budgets and associated debt.
As an overview of debt, Figure 8 compares changes in per capita amounts of State of Kansas debt to that of local government debt in the state.3 State debt increased an annual compound rate of 13.5 percent due mostly to $2 billion of debt (or one-half of the State’s $4 billion of debt) to implement two successive multi-year state transportation programs. In comparison, local government debt increased at a 7.5 percent compounded rate over the same period to almost $8 billion in 2005. It should be noted that a significant part of state debt is for capitalizing two revolving loan programs for local government water and wastewater improvement facilities that are obligations ultimately of those participating entities.
Figure 9 shows the growth in local government debt to almost $8 billion in 2005. All the items represent General Obligation debt (backed by the property tax) except for the item labeled Revenue Bonds (backed by an assortment of dedicated taxes and enterprise operations).4 Significant growth occurred in school debt, which increased from 19 percent of all local government debt in 1990 to 39 percent in 2005. In contrast, the city debt share decreased from 35 percent in 1990 to 29 percent in 2005. State policy has encouraged more local school debt by covering part of the yearly debt service.
City residents have to pay for the direct debt of that city and the overlapping debt of the county, school district, and other special districts. Figure 10 shows the percentage of total city area debt contributed by K-12 education and all other overlapping local governments (such as the county and assorted special districts) for selected Kansas cities.5 The difference between the bar and 100 percent represents the city’s own direct debt. This figure conveys that when these cities borrow money they have to contend with the burdens imposed by other local entities. Essentially, the debt boat of any single jurisdiction floats or sinks together with all entities sharing the same tax base.
While bond rating firms refrain from emphasizing one factor over all others, published research suggests that economic base diversification is one of the more important factors in determining a bond rating. Consider how vulnerable a one-industry town is relative to a city with a diverse local economy where no single taxpayer or industry can weaken a tax base. Figure 11 plots the relationship between total general obligation bonded debt per capita and tax base concentration measured by that city’s top ten property tax payers as a percentage of assessed value. The extreme lower left area in Figure 11, representing low debt per capita and a highly diverse economy, is occupied only by Overland Park, consistent with its status as the only triple-A credit among all cities in Kansas. The implication is that local economies experience lower public debt when there is a more diverse property tax base. Rich communities can afford issuing more debt but they do not do it. Capital markets are not a redistribution mechanism–the rich get richer.
There are several policy options based on the study of local debt:
- Monitor the growth because city and county credit ratings take into account the overlapping debt burden caused by school debt growth.
- Weigh tighter limits, but realize that tight limits reduce local flexibility and can negatively influence the cost of capital.
- Preserve bond security by realizing that sales and property tax erosion hurts debt collateral.
- Promote debt coordination of local governments sharing a tax base. Local governments in Johnson County use to do this through a voluntary Debt Management Advisory Council, but despite receiving national recognition for innovation it is no longer active.
- Enhance transparency though a "Truth in Borrowing" statement for every bond transaction similar to the disclosure on the property tax bills. However, any such initiative should not unduly restrict the borrowing decisions of locally elected officials or threaten the legality of bond transactions.
- Enable taxpayer comparison shopping. The State could compile detailed financial records on each lo-cal government, thereby promoting accountability by helping taxpayers vote with their feet if they are not satisfied with a local government and its finances.
The property tax base has evolved far from the "uniform and equal" concept suggested by the Kansas Constitution, inviting a taxpayer revolt. Yet, there is great virtue in local determination of the property tax rate and its linkage to locally determined services.
The sales tax is neither broad based nor limited to final consumption. It is not the solution for all difficulties. Equity is needed between the taxation of out-of-state purchases and those made on Main Street.
While the market continues to assess local debt as affordable, the growth in school debt affects city and county debt ratios with potential impact on borrowing cost. It suggests the need to improve debt coordination because the past growth rate is not sustainable over the long-run.
This series of studies issued by the Kansas Public Finance Center at Wichita State University provide an overview to the fiscal profile of state and local finance in Kansas.
1. All of this research was conducted by faculty members and public administration graduate research assistants affiliated with the Kansas Public Finance Center (KPFC) in the Hugo Wall School of Urban and Public Affairs at Wichita State University. Research projects on sales and property tax erosion and local debt were funded by the Kansas Department of Revenue on behalf of the Kansas Advisory Council on Intergovernmental Relations (KACIR). The full report on each topic, and the specific researchers responsible for that work, is available from the KPFC web page (hws.wichita.edu/KPF/reports-publications).
2. William F. Fox, "Can the State Sales Tax Survive a Future Like the Past?" In The Future of State Taxation, edited by David Brunori. Washington, DC: Urban Institute Press, 1998, 33-48.
3. Local debt is from the State Treasurer’s web page and state debt is from the State of Kansas 2005 Debt Affordability Report (available from the KPFC webpage).
4. Industrial Development Bonds are excluded from all tables because such debt is not the legal obligation of the governmental entity.
5. All Kansas cities that issued Comprehensive Annual Financial Reports and made them available for this research project.
Glenn W. Fisher is Professor Emeritus of Public Administration.
H. Edward Flentje is Professor and Director of the Hugo Wall School of Urban and Public Affairs.
W. Bartley Hildreth is Kansas Regents Distinguished Professor of Public Finance and Director, Kansas Public Finance Center.
John D. Wong is Professor in the Hugo Wall School of Urban and Public Affairs, all at Wichita State University.