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Philadelphia's Tax System Is Upside Down, And It's Hurting Everyone

In Philadelphia's business community, few things are easier to agree on than the fact that the city's tax system is broken.

The Philadelphia skyline

Everyone in real estate has their pet concern over property taxes — the 10-year abatement and inaccurate or inconsistent assessments chief among them — but the biggest issue is in what gets taxed, and how much.

“I think there is a general consensus in the business community that the tax structure in Philadelphia is in reverse, with an over-reliance on business taxes and an under-reliance on property taxes,” Center City District CEO Paul Levy said.

Nearly every major city in the U.S. gets the largest share of its tax revenue from property taxes, with much smaller shares coming from income and business taxes. Philadelphia operates in opposite fashion, deriving as much as 40% of its tax revenue from business taxes, Levy said.

“The balance of where we collect taxes from in Philly is exactly the opposite of what other major cities do,” JLL Research Director Lauren Gilchrist said.

How Philly Works Differently

There are two taxes that are generally referred to as "business taxes" in the city: the wage tax and the Business Incomes & Receipts Tax, or BIRT.

The wage tax is 3.8% of an individual's income if they live and/or work in the city, no matter what tax bracket they reside in. The BIRT takes 1.4% from a Philadelphia-based company's gross receipts and a separate 6.35% from its net income.

The wage tax is much more onerous than in the surrounding suburbs, leading business leaders to label them as a millstone hanging around the city's neck when it comes to recruiting companies. The median wage tax in the five closest counties in Pennsylvania is around 1%, according to Center City District research.

The BIRT has no direct counterpart in the suburbs, functioning to ensure businesses pay for more of a share of the city's revenue than individuals. City property tax rates are 33% lower than the median in the Pennsylvania suburbs, so the BIRT is needed to make up the shortfall.

Levy believes that if the BIRT were reduced, the effects would eventually go toward offsetting any lost revenue.

“If you lower wage and business taxes, [office tenants] are prepared to pay more rent," Levy said. "And if people pay more rent, the building's assessment goes up and the city gets more property taxes.”

Colliers International Vice President Elizabeth Morrow, JLL Research Director Lauren Gilchrist and Parkway Corp. Vice President Brian Berson

The fact that the lion's share of BIRT is tied to profits and not gross revenue means that it more heavily affects companies that are more profitable, as opposed to startups. That makes Philly a less attractive relocation prospect for established companies, and incentivizes growing businesses to move out when they mature, Levy and Gilchrist said.

Philadelphia's job growth numbers have lagged behind its counterparts in the 25 most populous cities in America for decades, and only in the last couple of years has it been able to close the gap somewhat. Three-quarters of the jobs that Philly has added since 2009 pay $35K or less per year, while 62% of jobs added nationally over that same time period pay between $35K and $100K per year, according to Center City District research.

“People think that all Center City jobs are for rich, white people, but a significant portion of jobs in Center City go to people with only a high school diploma," Gilchrist said. "So reducing BIRT and helping jobs to grow helps a broad-based group of people in Philly overall.” 

With Philly's suburbs functioning as a competing hub of jobs, as much as 40% of the city's residents who live outside of Greater Center City reverse commute to jobs outside city limits, Levy said.

A significant portion of those that have left the city for homes in the suburbs can be considered middle class, meaning their exodus is contributing to the deepening inequality between Center City and the outer neighborhoods, Levy added.

The Slow Pace Of Change

Levy and Brandywine Realty Trust CEO Jerry Sweeney led a coalition of business leaders in releasing a plan in 2015 that would have cut wage and BIRT taxes in Philly (Gilchrist contributed research for the plan). The trade-off would be raising taxes on commercial properties only — sparing low-income homeowners from bearing the brunt of the change. 

Raising taxes on one type of property and not others violates the state constitution's uniformity clause, and to amend it requires passage through both state houses in consecutive sessions, followed by a statewide referendum.

After state Rep. John Taylor introduced a bill based on the Levy/Sweeney plan in 2016, it failed to make it through both houses by the end of October's session, starting a three-year waiting period before anyone can try again. Taylor retired at the end of the session.

That makes the Philadelphia City Council the most likely source of change.

Philadelphia Department of Commerce Deputy Director Lauren Swartz, Center City District CEO Paul Levy and Nightingale Properties Vice President Brenton Hutchinson

At the local level, lowering the BIRT and wage taxes would have to correspond with one of two reactions: raising the property tax rate and/or adjusting the city budget to compensate, experts said. The former has been a nonstarter in recent years, and the latter has not been popular either. With the budget, the issue is more with perception than actual financial impact, according to Levy.

"[Funding a business tax cut] is still incredibly hard because of the poverty levels in the city," Levy said. "That sets up a huge challenge for council members: a choice between helping people in need and cutting business taxes. And that’s a false dichotomy.” 

Philadelphia ended the 2018 fiscal year with a $421M budget surplus, five times what it had initially projected. Higher-than-expected revenue from BIRT and wage taxes drove the surplus, which has been split between the city employees' pension fund, its rainy day fund, raising city employees' minimum wage and funding more affordable housing.

All of those expenditures are easier to sell to the heavily Democratic political base in the city than tax cuts for businesses, but Levy and Gilchrist both believe that the issue is more of perception than of actual effect.

“Fund some major projects [with a surplus], absolutely, but at what point is the city just collecting too much tax revenue?" Gilchrist said. "BIRT and wage taxes would be the natural thing to reduce, because they're seen as anti-competitive. But it’s a political decision.” 

Just as many individuals believe the 10-year tax abatement takes money away from the school district, only business leaders themselves seem to see lowering the business taxes as an investment in growth, Levy said. But with Philly in a period of economic expansion, it might not get easier than right now to make that investment.

When a downturn inevitably comes, every budget choice becomes more painful. Philadelphia's growth has lagged behind the national average, and lowering business taxes now would allow the city's economy to expand more in order to have a softer landing.

“The first real hurdle [for cutting business taxes] is the political psychology around whether or not we want job growth in Philadelphia," Gilchrist said. "We need to politically get to a point where we’re on the same page to believe that economic growth is necessary to the future of Philly and the future of those most marginalized.”