Government & Politics

Johnson County faces ‘puzzling,’ ‘catastrophic’ threats of plunging revenues

Month after month, officials around Johnson County are watching the sales tax numbers come in, hoping they’ll improve.

It doesn’t make sense. The economy is humming, the tax base is growing and the unemployment rate is historically low. But in the most affluent county in Kansas, retail sales tax revenues — among the key sources of funding that cities use to function — is flatlining or even shrinking.

“It makes you go, OK, well what is going on here? And we don’t have an answer for it,” said Merriam City Administrator Chris Engel.

The mystery pervaded an Overland Park budget discussion earlier this month. “I don’t think anybody today can quite figure out what’s going on in Johnson County and the state of Kansas, when nationally, and internationally, economies are growing,” Bill Ebel, Overland Park’s city manager, told city council members. “I don’t mean to be worrisome, but it’s real and we’re watching it, and we need to see some positive movement.”

The uncertainty comes as local governments face a possible nosedive in another major revenue stream that is outside their control: property taxes.

The so-called “dark store theory” of commercial property valuation snaking its way through Kansas courts could lead to a loss of as much as 30% of property tax revenue, Ebel estimated.

Combined, this two-headed dragon threatens to ravage county and city budgets, forcing increased mill levies, cuts to school funding and delays or cancellations of spending on things like community projects or new police cars.

And there’s nothing Johnson County can do about it.

“We’re scratching our heads”

While Kansas’ overall tax collections grew just over 6% from last year, sales tax collections — which at $2.3 billion are the second largest revenue source behind only income taxes — actually decreased slightly, .27%.

Wyandotte County is down about 3% as a whole. Johnson County is down less than that, about 1%. But Overland Park, the county’s largest city, was down 6%, and some cities have seen decreases pushing 10%.

In Merriam, which relies on a revenue stream from car dealerships, sales tax yields have dropped 9.5% from last year, Engel said. Automotive sales have dropped about 5%.

The sales tax revenue numbers lag by a few months, so he said he’s watching carefully to see if summer sales numbers will improve.

“We’re scratching our heads, but we still have some time to make up for it,” Engel said. “This is what all of us in local government are telling ourselves with our fingers crossed.”

In the meantime, revenue officials have been trying to pinpoint the causes of sales tax declines.

“It’s kind of puzzling to everybody to figure out if it’s something economic going on in the state or if it’s the e-service type of business that people are going to every year,” said Steve Stotts, director of taxation at the Kansas Department of Revenue.

The most significant culprit is a change in consumer habits as people are more likely to skip a trip to Walmart and order from their laptop. But online sales alone can’t be responsible, Stotts said, as they’re a small piece of the retail pie.

Taxes on online sales grew by 6% last year, but they were still less than a fifth of overall retail sales taxes. It would also stand to reason that a trend toward online sales would affect other states, which hasn’t been the case. Missouri, for example, has seen about a 3% growth in sales tax, Department of Revenue data showed.

“The surrounding states all had much better growth than we did. That’s why we all are kind of confused about what’s going on,” Stotts said. He said that in April the state met with economists from universities and different agencies in Kansas, and the sales tax trend was “puzzling” to everyone.

Beyond online sales, two other main factors are squeezing governments’ bottom line, said Chris Kuehl, co-founder of Armada Corporate Intelligence, a Kansas firm specializing in economic forecasting.

First, millennials tend to be “experience buyers,” he said, preferring to pay for events, like concerts, going out to eat or travel, rather than spending more consistently on traditional retail as older buyers do. The public also seems to be spooked as fears of slowing economic growth have taken “a little bit of bloom off the rose.”

“Nationally, we’re seeing consumers continuing to spend, but they’re expressing a lot more trepidation,” Kuehl said. “We keep waiting for the other shoe to drop.”

Another possible reason is an overuse in tax incentives for new developments, he said. Future sales tax revenues are diverted to pay some construction costs. These incentives, he said, can quickly become leeches on sales tax collection.

“The deal was supposed to be that you would give a tax incentive to sort of an anchor attraction of some kind,” Keuhl said. “Then others would flock there and pay full taxes. That hasn’t happened as much as people hoped it would.”

Earlier this month, The Star analyzed the state’s Sales Tax Revenue or STAR bonds program and found that it lacks accountability and that projects don’t always follow the mission of drawing tourists and new revenue. Several of the STAR bond beneficiaries analyzed by The Star fell short of projections to the tune of tens of millions of dollars.

For instance, Overland Park issued $65 million in STAR bonds for its Prairiefire shopping center in 2012, and a balance of $64,860,000 remains. The Star found that the project has missed sales tax revenue projections over the last five years by $7 million.

In the 20-year history of STAR bonds, their use has quadrupled over the last decade compared to the first. In total, more than $230 million in sales tax revenue has gone to pay off the bonds, and another $465 million remains on those bonds.

“To the extent that those are increasing, then it could be a drain on state revenues,” Stotts, from the state, said.

Whatever the cause, the sales tax downtick is weighing on the minds of officials around Johnson County.

Both Engel of Merriam and Ebel of Overland Park said their cities are prepared to delay or cancel planned spending.

“Where we’re at right now,” Engel said, “we are simply very cautious, we are watching it, we’re questioning expenditures — are these things we need right now or can we wait until later in the year for them?”

“We, in Merriam, and I can only speak for Merriam, are not in crisis mode, but we are in caution mode. We want to be very mindful of what we are spending money on and when we spend that money.”

Customers flow in and out of Walmart, 7701 E. Frontage Road in Overland Park. Tammy Ljungblad

“A scenario that is catastrophic”

While the sales tax numbers are concerning, the potentially much larger threat for Johnson County — although less immediate — is to property taxes. They are the county’s largest single source of revenue, and a majority goes to schools.

The threat stems from ongoing disputes before the Kansas Board of Tax Appeals between Johnson County and large retailers like Bass Pro Shop, Target and Walmart. At stake could be the loss of as much as 30% of property taxes, Ebel estimated.

“That is a scenario that is catastrophic, in my opinion, to the city,” Ebel said.

So far, the retailers are winning. Last month, in the latest ruling, Walmart prevailed, with the board approving its methods. This case, and others, could still be appealed by the county all the way to the state Supreme Court, a process that could take years.

The county re-appraised the value of those stores in 2015 after one sold for far more than had been expected. The stores are challenging these valuations and asking the courts to endorse a different method of measuring value that would lower the appraisal. Lower valuations ultimately mean less tax collected.

At the heart of this dispute is whether a building becomes more valuable when it is operated by a large retailer. The corporations say that only the physical property itself should be included in a valuation, not any part of the business generated inside.

This valuation should be conducted with an assumption that the property would be vacated at a sale, said Linda Terrill, Walmart’s lawyer, the same method used for residential property.

“If you win the lottery on Monday, your house isn’t suddenly worth more on Tuesday,” she said.

Critics disparage the retailers’ argument as the “dark store” method.

The county argues that this method is “hypothetical” and “contrary to known facts,” ignoring such factors as number of customers and success of the business, which should increase the property value, said Ed Eilert, county chairman.

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Ed Eilert, Johnson County chairman File photo

“Apparently, (the Board of Tax Appeals) has endorsed and accepted that hypothetical valuation processes are appropriate. We don’t think they are,” he said. “And you can call it ‘dark store.’ The ‘dark store theory’ was that a big box retailer needs to be valued as though the store was empty — that they’re just brick and mortar — even though there may be thousands of customers that come through the door every day.”

If the stores’ argument holds up in further appeals, Eilert said, it’s possible their method could then spread to office buildings, shopping centers or even further.

“The question is: If it’s appropriate for those large retail stores, why isn’t it appropriate for small mom-and-pop shops?” he said. “And if commercial property can be valued on hypothetical conditions that are contrary to known facts, then why can’t residential property?”

That’s the “catastrophic” situation Ebel described to Overland Park officials. The city has already set aside a small amount of money to refund property taxes if needed, Ebel said, a situation he said is “more than likely.” But this small fund would not cover the fallout from a sudden loss of 30% of all property taxes.

“That is something I’m not quite sure how you would plan for,” Ebel said.

At the county level, more than half of property tax revenue goes to schools, so they would be hit hardest.

Stotts, from the Department of Revenue, said Johnson County would “obviously” be faced with raising mill levies.

The county is at the mercy of the courts — or Topeka.

“We are not the board of tax appeals,” Eilert said. “In my judgment, the courts could make a decision that could impact that. The Legislature could make a decision, and the governor could make a decision impacting that process. So that’s where it may be resolved.”

And the county is powerless against the loss of sales tax revenue. “We don’t know the exact answer yet,” Eilert said. “Hopefully it’s a one-off situation, but we don’t know.”

Asked about the combined effect of these two issues, Eilert laughed without mirth.

“It is what it is,” he said.

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