Three times in the past 10 years, voters in Arkansas City have approved a sales tax meant to benefit South Central Kansas Medical Center.

But not all of the funds generated by those voter-approved taxes have gone to the medical center.

More than $1.5 million over the past decade has been deposited into the city’s general fund, which pays for basic city services such as police and fire, the upkeep of parks, and street maintenance.

City and elected officials are taking steps to change that, and possibly to pay back money meant for the medical center that never came its way over the past 10 years.

At issue is a complex and largely unknown tax called the compensating use tax. Created in the 1930s, the tax is meant to protect Kansas businesses from unfair competition with out-of-state vendors who sell goods tax-free. 

Out-of-state businesses are supposed to collect the tax on purchases made by local residents. Those funds are sent to the state for distribution to cities.

The compensating tax in years past didn’t amount to much. But with the boom in Internet sales, that revenue stream is growing, reaching a total of $350,000 in 2018 in Ark City when the sales tax for the hospital was 1.5 percent.

Ark City seems to be alone among municipalities in Kansas that handled the compensating tax the way it has — dumping the money into its general fund.

City Commissioner Kanyon Gingher said she contacted officials of 83 cities who told her that their compensating tax is combined with local sales tax revenue and spent on a specific use, not for other purposes.

The CourierTraveler contacted several cities, including several that Gingher did, and confirmed that to to be the case.

What happened?

Concern over how the compensating tax was being spent in Ark City surfaced this spring as city officials studied refinancing the bonds used to finance the new hospital, they said. 

In a June interview, City Manager Nick Hernandez said he could not explain why the compensating tax funds weren’t made available to the hospital, except that when he took over in 2011, he continued the previous practice of putting that money into the general fund.

“We never thought about it,” he said. “It was just the way it was done back then, and the way it (was) always done forward.”

At a recent city commission work session, though, Hernandez elaborated. He said the compensating tax came up in April when city officials started discussing the plan to refinance the bonds.

City treasurer Jennifer Waggoner brought him a sheet that showed the sales tax and compensating use tax. Hernandez said he noticed a discrepancy, and she told him that the use tax goes into the general fund.

“I said we need to bring this up because every community I’ve been in, it was always one —  sales and compensating use tax was always combined,” Hernandez told commissioners.

The city manager shouldered some of the blame for the money not going to the hospital.

“A mistake was made,” he said. “I’m part of the problem, I’ve got a solution. It may not be perfect, but I think it’s the best for both entities.”

Steve Archer was city manager in 2008 when voters first approved a sales tax for a new hospital.

Reached by phone this week, Archer said that at the time the use tax generated was very small compared to the full scope of the project (about $28 million plus interest).

Archer estimated the use tax was about $10,000 a year back then. (Figures provided by the city put the amount at $43,513 in 2009, the first full year of the tax).

“It should have been going to the hospital all the time,” Archer acknowledged, “but it just got overlooked.”

Mayor Jay Warren is the only elected official remaining from that time period. He took some responsibility for the use-tax problem.

“If you are going to accuse yourself, I’ve got to accuse myself,” Warren said after Hernandez’s comments. “I got elected in 2008, just when that whole thing started. Maybe I should have known about it, but I didn’t.”

Hernandez said that once the issue was raised this spring, city officials contacted the State of Kansas, the city auditor, and the city bond counsel for an opinion.

The state advised that the use tax should go to the purpose that generated it, Hernandez said, but that there was no legal requirement to do so.

City finance director Kathy Cornwell was not with the city when the hospital was first built, but she said there was a lot of turnover at the city and the hospital at that time, making research on the issue difficult.

“I think it goes back to: Was anything done illegally? No. Could it have been done differently? Yes,” Cornwell said in an interview.

The fix

To make things right, Hernandez has proposed a number of steps to ensure the compensating tax revenue ends up benefiting the hospital. 

The amount generated from 2009 through Dec. 31, 2018 is $1,427,000, nearly the same amount the city loaned the hospital from 2015-2016, when the hospital could not make its debt payments.

Forgiving that $1,313,000 loan would leave a difference of $114,000, but that could be considered a wash because the city took on the hospital’s debt, Hernandez suggests.

As for compensating tax generated this year, Hernandez recommends applying that estimated $300,000 to the debt payment for the hospital. 

The city considered just handing it over to the medical center, but that would affect the city’s projected revenue figures already built into the debt refinancing, Hernandez said.

Going forward, the city recommends applying a portion of the use tax to the debt payments for the hospital on a sliding scale that would reach 50 percent in 2024.

The rest of the use tax revenue, Hernandez recommends, could be given to the hospital for general use.

In addition, the hospital would get reimbursed $266,000 for the special assessments it has paid for water, sewer, stormwater and streets in the Patterson Park subdivision where the new medical center was built.

“If you go back far enough, according to word of mouth, the city was always suppose to pay the special assessment,” Hernandez told commissioners last week.

These actions will require formal votes by city commissioners, all of whom said they were not aware of the compensating use tax issue until it came up this year.

“I’m happy with his suggestion of what we need to do, and it should make everyone happy,” Commissioner Duane Oestmann said.

Gingher said she still wants to review everything.

“I think what has to happen is that this needs to be best for the taxpayers,” she said. “The hospital is what we want in our community. It’s necessary.”

Warren, the mayor, said the big thing is that the hospital doesn’t have to worry about the debt anymore because the city is handling that now.

The refinancing completed earlier this month will save taxpayers about $11 million over the life of the bonds, which will be paid off earlier.

Warren said the use tax is going to be given back to the hospital. “That’s where it needs to go.”

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