Philadelphia's Toxic Tax – And It's NOT the Wage Tax
July 27, 2017
Alison Burdo, Digital Producer, Philadelphia Business Journal
Philadelphia businesses have a profitability problem.
And local political and economic experts say it is thanks to the city’s tax structure, which puts a substantial burden on the exact sectors that are expected to drive Philadelphia’s future.
“BIRT,” groaned Alison Perelman, seemingly exhausted by the lack of urgency to change the city’s Business Income and Receipts Tax and the long-standing knowledge of the limitations it creates.
“There is a profitability penalty,” explained the executive director of Philadelphia 3.0, a nonprofit focused on political reform.
The burden created by one piece of BIRT is the key culprit behind the inhospitable business environment, she says, and the best place to start to address change that betters the city’s reputation.
“At a minimum,” she said, “we should absolutely be focusing on the net income portion of BIRT.”
The net income tax applies to just under a third of the city’s approximately 96,000 registered businesses. Those 31,000 enterprises pay 6.35 percent on their taxable net income, or the profits made that are attributable to activities within Philadelphia.
In tax year 2015, the most recent year data is available, BIRT generated $397 million in total revenue. Net income accounts for $293 million of that figure, or almost 74 percent of the total.
A Pew Charitable Trusts analysis issued in August 2016 shows that of the nation’s 30 largest cities, Philadelphia is one of just six to impose this type of tax.
It is the only city where businesses incur both net income and gross receipts taxes.
“When you look at who those other cities are, we don’t have the inherent competitive advantages that those cities have,” Perelman said.
Columbus, Ohio, and Portland, Oregon are among the six cities with a net income tax, according to Pew. But neither is an ideal comparison to Philadelphia in terms of demographics and geography, Perelman said. Detroit also has one, but “from a tax perspective, you don’t want to have much in common with Detroit,” she said.
The final cities to make up the six are Washington, D.C. and New York.
“Wall Street and [the Capitol] aren’t here,” Perelman said. “We aren’t robust enough to demand those sort of taxes from folks who are mobile and don’t need to be here.”
Job growth in Philadelphia has improved in recent years – running counter to the perceived unwelcoming business culture.
The city increased the total number of nonfarm jobs by 2.3 percent from 2016 to 2017, according to a May report from the Bureau of Labor Statistics. That puts overall job growth ahead of the 1.5 percent increase seen around the country.
Upon closer inspection, however, the BLS data shows the growth rate in professional and business services for Philadelphia is 2.6 percent, compared with the national rate of 3.1 percent.
In a longer view, the BLS data also shows Philadelphia trails 25 of the nation’s largest metros in annual growth in private wage and salary jobs, according to a January 2017 report from the Center City District. In Philadelphia, those jobs increased by 1.1 percent between 2010 and 2015, behind the national average of 2.2 percent and the rates seen in other East Coast metros like New York (3.1 percent), Boston (2.6 percent), Washington, D.C. (2.5 percent) and Baltimore (1.6 percent.)
“You can celebrate; we are finally seeing job growth. But we have to really keep in mind that job creation growth when compared to peer cities,” said Josh Sevin, acting executive director of the Economy League of Greater Philadelphia. “We are lagging significantly.”
Others say the financial impact of the net income tax on private industry is not the sole source behind Philadelphia’s struggles to grow its economy, but when combined with the gross receipts tax and the cumbersome and complicated paperwork needed to stay on the up-and-up in Philadelphia, a reputation is formed that scares off companies.
“It is certainly confusing and puts an unfriendly business posture to people who aren’t from here,” said Michael Pestronk, CEO of Philadelphia-based Post Brothers.
The characterization is warranted, according to Jane Scaccetti, CEO and shareholder of Drucker & Scaccetti, a Center City accounting firm. “You shouldn’t underestimate the frustration level and the costs associated with these taxes,” she said.
The process to file tax forms is an “administrative nightmare,” described Scaccetti.
Rosalind Sutch, a Drucker & Scaccetti shareholder, said the amount of paperwork, and in particular the way net income tax is calculated on the forms, isn’t sensible for business owners.
For instance, the Revenue Department mandates businesses submit an estimated BIRT payment for the following tax year that is the same exact amount as what’s currently owed.
“They basically have to double pay their tax in that year. That can be a big cash flow burden for a startup,” Sutch said.
Although that may sound like it would only be a strain in a firm’s first year, Sutch said the practical implications of this process can cause concerns throughout the lifetime of a business. “Say they know they are closing their business in the next year,” she suggested. Or a contract anomaly results in an incredibly profitable year – one the company knows it won’t replicate any time soon.
Scaccetti’s and Sutch’s criticisms resonate with City Councilman at-Large Allan Domb, who plans to address BIRT after tackling the recovery of $882 million in delinquent property related taxes, according to July 2016 estimates, and inefficiencies in local government to shore up more cash.
“The net income portion of BIRT, we need to figure out how to get that to zero in the next 15 years,” Domb said, although he admits that it is a steep hill to climb.
“At the end of the day, we can’t keep taxing, taxing, taxing,” Domb said. “We have to find efficiencies through technology. That is how your government gets healthier.”
According to Perelman, Pestronk and other business group leaders, lessening BIRT’s impact is not only a way to generate more funds, it also will lead to a healthier job growth rate.
“When we are smart, we can move to a faster growth trajectory,” Sevin said.
The smart move, according to the Economy League and 14 other groups that make up the Philadelphia Jobs Growth Coalition, is the legislation sponsored by State Rep. John Taylor (R- Philadelphia).
The bill, currently with the House Rules Committee, would amend the uniformity clause of the state’s Constitution to allow Philadelphia to adjust how it taxes real estate so commercial properties could potentially face a higher rate than residential parcels.
Any increase to commercial property taxes would be tied to a decrease in wage and net profits tax.
“We can drift away from being a job center,” Taylor said. “Or we can create a mold to combat the imbalance created in Philadelphia by the overreliance on business taxes.”
The legislation has support from the real estate industry. “You would be much better off and if you took all the money you get from BIRT and built it into the real estate taxes,” said Pestronk.
Often called the Sweeney-Levy plan, the bill also has the support of Brandywine Realty Trust, which is led by CEO Jerry Sweeney, and Pennsylvania Real Estate Investment Trust. Brandywine just announced a headquarters move to the city.
The Kenney Administration has backed the plan, and according to spokesman Mike Dunn, “we remain committed to supporting the Levy-Sweeney [plan] and its potential to make Philadelphia more competitive with other big cities when it comes to business attraction and job growth.” Dunn added that the Mayor’s Office is “open” to considering other proposals and is already taking steps – like continuing to lower the wage tax rate – to help.
Yet that willingness to entertain other options is partly why Philadelphia still falls behind other metros, Perelman said.
“There is a general consensus around the net income portion of BIRT becoming harmful to our economy, but there isn’t a general consensus … about how we should prioritize it with other tax issues in the city,” she said.
In recent months, the Philadelphia Beverage Tax, the ban-the-box law, and the wage equity law – currently on hold while under litigation, appear to have taken precedent over BIRT changes.
Like Perelman’s former boss, Center City District President Paul Levy has advocated for years for the city to shift away from its reliance on the corporate income tax. Careful not to dismiss the gravity of the other business legislation battles, Levy said BIRT reform is still among his top priorities.
“We always have to make sure the urgent doesn’t get in the way of the truly important,” he said.
Improving the business environment with these tax adjustments is the change needed for Philadelphia to get on par with job growth rates in comparable metros.
“You need to rely more on the real estate tax and less on these taxes on things that move – wages and business revenues,” Levy said.
Wage tax revenue for fiscal year 2017 already surpassed $1.7 million by the end of May, city data shows. It exceeded $1.5 million for the first time in 2015. Levy says the huge dependency on wage tax “puts us in a league with Detroit.”
To put a stop to comparisons with the beleaguered Midwest city – where decades of economic decline resulted in municipal bankruptcy in 2013, action on net income is needed sooner than later.
“We are starting to inch into that place where we already are with wage, where it is so big and brings in so much money that it almost feels like really meaningful change,” said Perelman, hesitating as she searched for the best description, “it’s not unaccomplishable, but an incredible challenge.”
Of the $293 million in city coffers thanks to net income in 2015, nearly half comes from two sectors, professional services ($94.2 million) and real estate ($48.4 million).
Tax credits and exemptions – Philadelphia has 21, more than any other major city with local business taxes, according to Pew – help entities in other industries skirt the net income tax.
Yet by giving nearly 65,000 businesses a pass on net income, the problem the tax creates is exasperated even more. “All these exemptions, which are all well meaning, has so narrowed the base that it just affects the office sector,” Levy said.
Stephen Mullin, president of Econsult Solutions, said by narrowing the impact to fewer companies, the city is deterring firms in the knowledge sectors even more.
“A large rate on a small base will cause that base to shrink even faster,” he explained. “It is a vicious cycle.”
It isn’t always a good look for politicians to back policies that draw more suits to the Central Business District– especially in historically blue-collar Philadelphia, once a manufacturing hub for the nation.
“But those are the jobs that help drive a 21st century economy,” Perelman argues.
Pestronk suggests the switch – relying more heavily on property taxes while cutting back on net income – simplifies the business tax structure, better aligning it with other East Coast cities.
And even with an increase in property taxes, he says, the overall cost of doing business in Philadelphia would still be lower than other major Mid-Atlantic metros.
“Unquestionably, we’d still be far below Washington D.C., New York and Boston,” he said.
Despite the added expense property taxes will bring, Mullin says flipping the burden spreads the tax across a broader base.
“I’d rather have 1 percent of a billion dollars than 10 percent of a million,” he said.
As Levy put it, a lower rate could be applied to the roughly 85,000 business-based properties in the city and bring in more dollars than the 6.35 percent net income tax rate since it applies to just 31,000 firms.
While lawyers continue to rack up fees in an attempt to overturn the soda tax and halt the wage equity law from going into effect, Levy and others continue to lobby behind the scenes in hopes the bill altering the uniformity clause gets through the legislature.
“Sometimes substantive change happens just below the surface,” Levy said.
The legislation, which already got approval from the General Assembly last year, must be approved in a second, consecutive session since it amends the Pennsylvania Constitution.
But recent property reassessments, which caused a jump for lots of commercial parcels, could make city leaders reluctant to support the bill.
Levy makes it clear, though, that the legislation – which could end up on the May primary ballot at the earliest – doesn’t force City Council to up commercial property tax rates.
“We created a tool they can use,” he said. “If they had the authority to do it, they could say, ‘We just had a lot of turmoil over reassessments, let’s wait a year.’”
Taylor, who acknowledges the bill won’t force anything if passed, said it is a way for state lawmakers representing Philadelphia to take action for their constituents.
“The city, to the naked eye, is a very vibrant place,” he said. “But 20 years from now, if we don’t have a core of job creation, people … jobs, they are going to go some place else.”