The city plans to put a new tax on your drinking water, but some question whether it’s fair to low-income residents

photo by: Chris Conde

Lawrence City Hall is pictured in September 2018.

In many progressive circles, the most hated tax in the land is a sales tax on food.

Kansas is one of the few states that charges it, and opponents decry it as extremely regressive because it forces low-income people to pay tax on a product that is necessary for life.

But now questions are being raised whether Lawrence city commissioners — perhaps without much thought — are placing an equally regressive tax on the one product that may be even more essential than food. Commissioners are poised to place a new tax on water.

As part of the city’s proposed 2020 budget, a new 6% tax would affect every water bill in the city. The tax is in the recommended budget that is slated for final approval on Aug. 13.

But upon questioning, it wasn’t clear how much city commissioners had considered the new tax, which is just one of many initiatives in the proposed 2020 budget. As details emerged this week, some commissioners did express concern that the city may be creating a new type of regressive tax or, in other words, one that affects low-income residents more than higher income residents.

Continuing coverage

Aug. 5 — Can large pile of cash reduce Lawrence’s proposed water rate increases? City is unsure

“I think it does,” City Commissioner Stuart Boley said when asked whether he thought the new tax could become regressive. “Maybe I need to be paying more attention to it. To be honest with you, I haven’t had a great focus on this aspect of the budget.”

Commissioner Matthew Herbert also acknowledged the new tax hasn’t gotten much discussion. He said he may seek more explanation on some aspects of it before commissioners are set to approve the water/sewer rates later this month. He stopped short of saying he would oppose the tax but said there’s no denying it is significant.

“It is a 6% tax that will impact people’s lives,” Herbert said. “There is no sugar coating that.”

The tax

Technically, what city commissioners are set to impose is called a franchise fee. But city finance officials acknowledge it actually is a tax. And even more technically, the city is not actually imposing the franchise fee. That would be illegal under state law. A nonprofit utility like the city-owned water and sewer department is not subject to a franchise fee under state law. So, the city instead is proposing to require its own department to make a “payment in lieu of a franchise fee.”

The city has had a policy in place since about 2012 that allows it to impose a payment in lieu of a franchise fee. But the city has not been doing so. Rather, more nebulous transfers between city funds have been taking place. Proponents of the new tax say it will be more transparent than that system.

The new tax would work pretty simply. The city every year will take 6% of all the money paid by water and sewer customers and put it in the city’s general fund, which pays for everything from public safety to roads to commissioner salaries.

In that sense, it works a lot like a sales tax. When the water department makes a sale, it will have to give up 6% of that revenue. In 2020, that amounts to a little more than $3 million it will no longer get to keep. In time, that is expected to put upward pressure on water and sewer rates, which already are proposed to increase by 8% in 2020.

That’s partly because of how the tax is structured. Future rate increases will have to be larger in order to generate the same amount of money they do today. Currently, if the water department says it needs an extra $2.5 million to maintain water lines, it basically could increase rates by 5% to generate that $2.5 million. But in the future, the 6% tax will apply to the new revenue. The department would only net $2.35 million in new revenue after the tax is paid. To get the full $2.5 million it needs for water lines, it would need to increase rates by about 5.3% instead of the 5%.

The reason

Why do franchise fees even exist? It depends on who you ask. David Nickel, consumer counsel for the Citizens Utility Ratepayer Board — a state group that seeks to protect the interest of utility ratepayers — said they are commonly paid by for-profit utility companies. A big benefit they get in return is the city grants the utility an exclusive right to operate in the city. Westar, for instance, is the sole electricity provider throughout much of Lawrence. In addition, Nickel said, the franchise fee is a way to recognize the city is allowing a utility to use its rights-of-way to place equipment — think power poles — that are used by the utility to turn a profit for the company.

But that’s not exactly what is happening in the case of the city’s water and sewer department. The city’s water and sewer department is a non-profit entity. Unlike Westar, there are no shareholders who get a dividend check. The department is not using publicly-owned land to make a profit. It is just using it to provide a public service.

There are other rationales for a franchise fee, though. For example, the city has to maintain the rights of way to keep them usable. It makes sense that the entities using the rights-of-way help pay for some of that maintenance. If you put a strain on the rights-of-way, you should help pay to alleviate it.

The city, though, is not contending that the utility department puts $3 million worth of strain on the city’s rights-of-way each year, said Jeremy Willmoth, the city’s finance director. That is why the franchise fee actually is a tax and not a fee. Fees try to recoup the cost of a service. A tax simply aims to generate revenue for the city at a specific rate.

It is not clear how many other cities charge their own utility department a franchise fee. It is not an issue that is widely tracked, although previous city reports did find examples, including Wichita and Columbia, Mo. But it is clear that cities can’t charge other nonprofit utilities such a fee. Johnson County WaterOne is an example of such a nonprofit utility. It provides water to 17 Johnson County cities, including Overland Park, Lenexa, and Shawnee. A spokeswoman for the water utility said state law prevents those cities from charging it a franchise fee, and it would be opposed to making any payment in lieu of franchise fees because of the impact it would have on water rates.

“Those dollars are precious because they come from our customers,” said Mandy Cawby, director of customer relations for WaterOne.

Willmoth said the real importance of the franchise fee in Lawrence is that if it didn’t exist, there would be more pressure on the city to raise its property tax rate to pay for basic city services funded by the general fund, particularly road maintenance.

“Without those franchise fees, the mill levy would have to be increased to make up the difference,” Willmoth said.

Punishing the poor?

Nickel, the ratepayer advocate, is not sure he likes that rationale. What makes a water bill the right way to alleviate property tax pressures?

“The people we want to most protect are low-income people,” Nickel said. “A lot of times low-income people don’t own their own property and won’t be subject to a property tax. But they will pay this fee.”

Nickel’s state office won’t be weighing in on the city’s water rate case. The ratepayers board only becomes involved in cases that go before state regulators, such as electric and natural gas rates. City water rates aren’t regulated by the state. City commissioners are in complete control of the rates. Herbert said the rising costs of the water and sewer service does concern him, but he’s also worried about having enough money to keep up with the cost of aging infrastructure.

The idea that a rising utility bill might make it more difficult for someone to stay in their home, though, is particularly bothersome, Herbert said.

“I’ve been saying for a long time that we oversimplify our affordable housing issue,” Herbert said. “We talk about putting people in affordable housing. We ought to also worry about helping people afford the house they are in.”

Nickel said he could understand why the city would want to charge its utility for some use of the right-of-way. The utility surely puts some strain on it. But a flat across-the-board tax creates a lot of issues to think about, he said.

“You always have to be mindful of what citizens you are impacting when you make any type of change like this,” Nickel said.

No increase?

Boley, Herbert and Mayor Lisa Larsen this week all acknowledged that the new 6% tax hasn’t gotten much discussion among commissioners. That may surprise some, given that a sales tax increase — which requires a citywide election — typically sparks months of debate.

But when you talk to city finance officials, they contend the new 6% tax won’t play into any increases in water/sewer bills — at least not in 2020. Yes, water/sewer rates are scheduled to increase by 8% in 2020, but city officials contend that is driven by infrastructure repair needs, not the new tax.

They make their case by pointing out that the city has been doing a de facto version of this tax for years, but in a way that they contend is less transparent. For many years, city-budget makers routinely have transferred money out of the water and sewer fund into the general fund. The city manager typically has decided the amount, although the City Commission could always overrule. Willmoth, the city’s finance director, said the 6% franchise fee is designed to simply take the place of the transfer that has historically been happening.

“From my perspective, instead of saying we just have a transfer from the utility, I really wanted to put some restraints on it,” Willmoth said. “I wanted to be able to say it would be limited to that amount.”

The new tax will create more certainty for budget makers. Everybody responsible for putting together the city’s water and sewer budget should know from Day 1 that the first 6% of the money the department collects is going to be used to pay the tax.

But the new tax has some significant differences from the current transfer policy. It basically will apply a tax of 6% to every new building project the water/sewer utility undertakes. To understand, consider the new sewage treatment plant the city has built in south Lawrence. It was an approximately $75 million project funded through the rates that Lawrence water and sewer customers pay. In order to fund that project over a number of years, the city needs to generate $75 million in new revenue (more, in reality, given that the project was debt financed, which comes with interest costs). But with the tax in place, the city will need to generate nearly $80 million in new revenue in order to net the $75 million needed to fund the plant.

With the transfer policy, the city manager had the discretion to decide that the sewer plant project, for example, shouldn’t require an additional transfer to be made to the general fund. The new system does remove some of that discretion, but establishes a cap at 6%.

As for the 6% rate, though, there doesn’t seem to have been any public discussion about whether that is the right rate to charge. It is higher than the franchise fees the city charges to private, for-profit utilities that operate in the city. Electric utilities pay a 5% rate and natural gas utilities pay a 3% rate, according to city documents.

Willmoth said he proposed the 6% rate because it produced a number roughly equal to what the city has made in transfers recently. Whether past transfer amounts, though, have been appropriate has been up for debate. A 2010 report by then-city auditor Michael Eglinski noted that the city had significantly increased its amount of transfers from utility funds to the general fund. Further, the report found that Lawrence had the highest percentage of money being transferred out of the utility funds of any comparable city studied in the report.

Lawrence no longer has the city auditor position, and the report has not been updated to show where Lawrence stands today.

City commissioners will have a hearing on the 2020 budget, including the utility rates, at their Tuesday evening meeting at City Hall.

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