Report of the
Center City Residents Association
Committee on Taxation

Introduction

As residents of Center City we say that the value of living here outweighs the costs for us. Otherwise, we would move to the suburbs. By making this choice, we choose to share our prosperity with others by paying for schools and social services that we do not use and cope with services below the standards set by the suburbs. We make this choice because of the pleasure we derive from city living.

Too many residents and businesses in the metropolitan area have said that the city is a bad value and have moved out or chosen to never move in. This has led to a long period of population decline, which has averaged 10,000 per year over the last 50 years. Since 1990, there has been no net growth in city jobs. The recent history is one of economic stagnation interspersed with periods of economic decline while the suburbs have continued to grow.

Some like to argue that people who move out have "abandoned" the city. Yet, the phrase "pursuit of happiness" was penned here, and too many people are leaving to pursue happiness elsewhere. The city has to make itself a better value for more people who have the choice of where to live.

Resolved: For the city to prosper and have the resources to provide for its most needy citizens, it has to make itself a good value for businesses and people who pay more in taxes than they cost in services.

City Taxes

The main cost driving away businesses and people is taxes. Taxes are a boring subject except on the day we write the checks. Currently, the city brings in about $1.3 billion in wage taxes, more than $350 million in real estate taxes, nearly $300 million in business taxes, and about $250 million in other taxes. This is nearly $1,500 per capita. We have to ask are we as citizens getting full value for the cost? Those who have voted with their feet say no.

Taxes and tax rates should be changed with an eye towards how the alterations affect the city's economy and city functions. Economists have been thinking and writing about taxes for years. They ask questions about efficiency, equity, and economic distortion. Efficient taxes are cheap to collect relative to revenue. Equitable taxes meet some criteria for fairness. All taxes distort economic activity and incur economic costs beyond the revenue collected. The goal is to choose a method of taxation that distorts behavior the least. We address these topics in order since all of the aspects of the city's ongoing tax debate address one or more of these questions.

Tax Efficiency

Efficiency measures the net yield of a tax. For example, the real-estate transfer tax is efficient. Since all sales must be registered and the transactions price is clear, no special effort is necessary to collect the tax, and, unless the buyers and sellers resort to side payments, it is hard to distort the price at which real estate is sold, with the possible exception of some commercial, office and industrial properties. In this case compliance is high and collection costs low.

The personal-property tax was a failure on efficiency. For most households, the cost to the city for processing the forms was greater than the money received and compliance was hard to monitor. The school income tax is also inefficient because it depends on peoples' honesty in filling out the forms and requires a separate mailing to all citizens with a low yield from most. The Business Privilege Tax for business is not efficient because large firms can move business out of the city through simple accounting measures. Given the nature of the tax forms, for most businesses, the cost to the city of printing (on very high quality paper) and mailing is a large proportion of the take. Getting compliance from many businesses is difficult because cheating is easy through simple measures, such as maintaining a Post Office box in the suburbs. A corporate sales tax in the city is much more efficient.

Having taxes where compliance is hard to maintain creates a culture of cheating and criminality that sets a bad tone for government. Taxes with high collection costs waste taxpayers' money.

Resolved: The city should have a more efficient tax system, eliminate low-yielding, nuisance taxes, redesign existing taxes to be more efficient and reduce the number of forms and dates for the payment of individual taxes.

Tax Equity

Equity is necessary because people have a sense of fairness, and once that is violated, we get the divisiveness of class conflict. What the fair share of taxes should be is a necessary part of the political discussion. At the federal level, the top 5% in income pay 40% of the taxes. Any further tax cuts at the federal level are naturally aimed at the higher income levels. On the flip side, lower-income voters take no economic responsibility for the costs of programs they demand. When they have to pay, their positions change radically. We see this with the Medicare drug benefit that Congress passed several years ago. It was repealed the following year after the Medicare recipients found out they had to pay for it.

The residents of Center City pay a disproportionately large portion of the taxes the city collects while being a small portion of the population. Furthermore, these people generally make fewer demands for expensive city services. The city needs neighborhoods on which it profits to cover the costs of the poorer neighborhoods. However, by taking too much revenue from these neighborhoods, the city aggravates its value gap and residents leave because they feel unfairly treated.

Real estate taxes have serious equity problems in the quality of the assessments. One need only look at the assessments of one's block at the website www.HallWatch.org. The Inquirer in its articles note that Center City residences have lower assessments relative to sales prices than the poorer neighborhoods.

Equity questions involve what is termed tax incidence. That is the jargon that describes which economic and social groups pay what. This is the essence of the social security debate-who pays in what and who gets out what. Most city taxes are nearly proportional with income. This is mostly true of the wage tax and people tend to own houses based on their ability to pay, or income. Investment income, which is left out of the wage tax, is captured by the school income tax. However, retirees escape the wage tax, as social security is not taxed. Thus, for almost all of the population of the city, outside of retirees and welfare recipients, people are taxed approximately proportionally to income.

Increases in real estate taxes tend to hit retirees harder. However, when looking at the total tax bill, the retirees who don't live in Center City probably pay proportionately less in taxes than working families with the same income.

Typically, incidence studies measure the costs too narrowly. For example, the biggest losers from high city taxes are the working poor. They pay large transportation and time costs in commutes to suburban jobs on mass transit. They cannot find jobs in the city because of the city's decline, and if they find jobs in the city, they are at lower pay than the equivalent jobs in the suburbs.

A properly framed study of the wage tax would show that it suffers from severe equity problems simply because middle and upper income people can and have chosen to move out of the city and take their jobs with them. Professionals who operate in a national job market can and do demand compensation for their wage taxes. So, even though they ostensibly pay the wage tax, the incidence is on the employer, not the employee. The union contract for teamsters has the same wage throughout the region. Consequently, the truck driver pays the full burden of the wage tax.

The equity distortions cannot be resolved by replacing the wage tax with a progressive income tax because that would encourage even more high-income people to leave the city, aggravating the city's economic problems.

To counter the problems created by high taxes, the city has engaged in special tax abatements for specific firms and locations. This has created a deeper sense of unfairness in the companies that do not have the special deals. Furthermore, the creation of enterprise zones has too often been a real estate deal rather than sound economic development. Well-crafted general abatements can stimulate economic activity. The emphasis is on generality and availability to all.

Resolved: The city's taxes have become unfair because of their magnitude. The city has responded to the consequent economic stagnation and decline by making special deals, in the guise of economic development, to politically favored individuals. The city should correct the fairness problem by ending special deals, improving real estate assessments, and looking to reduce the overall tax burden.

Economic Distortion from Taxes

People have responded to incentives caused by taxes for centuries. The house known as Mount Pleasant in Fairmount Park has no closets because real estate taxes were based on the number of rooms; closets were counted as rooms when the house was built. One of the biggest distortions in the federal tax system is the deductibility of the interest expense of mortgages. This has led to sprawl and serious over consumption of housing in this country.

The distortions of regional economic activity caused by taxes are stark. The city is the hole in the regional economic donut because of the wage tax. The offices and fast-food restaurants on City Avenue illustrate this. The offices with their higher-paying jobs are outside the city and the low-wage restaurants are inside. The hot spot for growth in the region is the Route 202 corridor. Many of those jobs would have developed and remained in the city if taxes had not gotten out of hand. All of the new office buildings in the region that were built within the past decade were in the suburbs and city rents are below suburban rents. The city's signature office tower, Liberty Place, recently sold for less than construction cost.

City taxes have distorted the pharmaceutical industry in the region. Notice that all of the basic medical research takes place in the city, at Penn, Temple, Jefferson, Fox Chase, Drexel, and Wistar. Mostly, this results from the city once being the major economic and population center of the region. It also results from a quirk of government research funding: wage taxes are costs that are covered by government research grants. All of the pharmaceutical research labs are located in the suburbs because the companies pay the wage tax and the researchers are highly paid. Because the researchers operate in a national job market, they would have to be compensated for the wage tax if located in the city.

We have the least efficient location pattern in the pharmaceutical industry of any region in the country. This is costing the entire region economic growth. Because biotechnology is a knowledge business, it is most efficient and grows best when researchers are clustered together and can talk. However, we have these tax-created divisions that slow the communication of ideas and cut into future growth.

In a growing city, real estate taxes do not distort economic activity because the value of real estate derives from the economic activity and the bulk of the price is in the premium value of the land, not the buildings or other improvements on the land. In a declining city real estate taxes create distortions because they reduce investment in existing structures and accelerate housing abandonment. Increasing real estate taxes does lower housing prices because people look at their cash flow when making housing choices. Paying higher taxes cuts down on the cash flow that can be put into the purchase price, reducing demand. In a growing city, this mostly lowers the land price. Philadelphia is not growing and faces high levels of abandonment.

A tax shock like the most recent one with our real estate taxes can be very disruptive. The Center City real estate market is softer than it would have been without the jump in assessments. Furthermore, the appropriately large press coverage has probably made people think twice about moving here and pushed others who live here over the edge to move out. This costs the city economic activity and revenues from other taxes. Because the increase was so extreme, the increase may actually lower revenues in the future by undercutting the desirability and value of Center City property. For example, when people in Center City make retirement choices and have lower incomes, they may have to move elsewhere.

The move to a land tax for real estate lessens the distortions associated with real estate taxes because it taxes the "economic rent" associated with land and not the economic activity that leads to building construction. This is important because it increases the cost to speculators of holding boarded-up properties in renovating neighborhoods and using prime commercial or office building sites for surface parking for extended periods of time. Furthermore, under a land value tax system, people would not pay an additional tax burden when they improve a derelict property.

The current business taxes distort economic behavior very seriously for companies that cannot evade them. The Business Privilege Tax includes a formula for allocating revenues and profits between in-city and outside-city activities based on the share of capital stock, revenue, and employment in the city. That is, this is a tax on jobs and economic activity in the city. A sales tax on revenues in the city has far fewer distortions.

A sales tax drives people to make expensive purchases outside the city, as long as the purchase cannot be traced. We see this better at the state level. Delaware advertises on highway billboards that it has no state sales tax. Notice that the bulk of the retail on 202 is in Delaware and not Pennsylvania. Pennsylvania does have clothing stores on 202 just north of the state line because there are no taxes on clothing here.

At low levels no tax creates serious distortions. This applies to the city sales tax at current levels. It takes time after taxes are raised for the distortions to appear. Some past Philadelphia mayors escaped the bulk of the economic consequences of their tax increases and left a burden on the city. Note that the city economy did not start growing in the 1990's until the tax cuts started and people believed they would continue, despite this being one of the highest-growth decades in the history of the nation. That Philadelphia has been one of the worst performing cities in the country, falling behind even Newark New Jersey, is a consequence of failed political leadership for several decades.

Taxes in the city are exorbitant. We can document cases where the combined wage and real estate taxes are 20% of the take-home pay of families. That is, these families work one day per week for the city. The calculations are simple. Most people actually see less than half of their gross paycheck. This makes the wage tax equal to 10% of their net. If their real-estate taxes are comparable to their wage taxes, the city's take doubles to 20% of a family's bottom line. There also has been a silent increase in wage taxes due to the shift from defined-benefit to defined-contribution pension plans and the rise of medical co-pays. What people put into their 401k plans is taxed by the city. Company payments into pension plans for employees are not taxed.

On a salary of $100,000 the wage taxes are around $4500. Since these are deductible from federal taxes, the net cost to a taxpayer is around $3000. This is a big number because the take home on $100k after all the deductions is around $50k. If this person were to move to a suburb with a 1% wage tax, the savings would be $2500 tax, or a 5% after-tax raise. Say the wage tax is reduced to 3% and the person has a choice of living in the city versus a suburb with a 1% wage tax. The gross tax savings from moving is $2000. After other tax effects, the net tax is $1333. This is a much smaller price than with current rates, and one that more (but not all) people would be willing to pay to live and work in the city.

The net gain from the wage tax is probably far less than the numbers reported. The city is constantly doing special deals on other taxes to preserve the wage tax revenues. This leads to further economic distortion because favored parties receive these breaks while businesses in general suffer. The most recent one in the news is with American Business Financial Services. They get $19 million in city subsidies for bringing 700 jobs into the city. Many of the large deals to retain or attract large employers involve some form of direct subsidy. However, the bulk of the jobs in the country are in small businesses that do not come in on the radar screen of economic development officials and these jobs gradually drift away.

Despite all of the taxes we have discussed, we have not covered all of the taxes in the city. Others include the gross receipts tax and the use and occupancy tax.

Resolved: The city should move from the current business tax structure to a revenue-neutral business sales tax on sales only within in the city. Furthermore, the city should simplify the tax structure and tax-forms for small businesses.

Resolved: When real-estate assessments soar, the city should immediately cut the millage rates to cushion the impact of the jump in assessments and to avoid shocking the real-estate market. Furthermore, the city should look seriously at a tax on the value of the land rather than the improvements.

Resolved: The wage tax is the major force driving jobs out of the city. When making policy choices, the absolutely first priority for the city should be reducing wage taxes as fast as possible.

City Expenditures

The other half of the tax equation is the value citizens get from tax expenditures. It is irresponsible to talk of cutting taxes while not maintaining overall budget discipline. This committee was not in a position to do a thorough assessment of city spending. That is the job of auditors with a fulltime staff.

The committee did hold meetings where experts in the city budgets illustrated ways in which the budget could be cut. Other experts pointed to rigidities that hinder budget flexibility that should be removed. Many of the expenditures by the city are discretionary and not necessarily in the long-run best interests of residents. Furthermore, the city needs to make a concerted effort to match the productivity increases of the private sector when delivering services. A good measure of a lack of overall productivity improvement is that despite dramatic technological improvements that have exponentially expanded private-sector productivity, the city has approximately the same number of employees now with a population of 1.5 million as it had when the population was over 2 million.

Policy Choices that Keep Taxes High

The city spends too much money on special real-estate-tax abatements when reductions in wage taxes would have a bigger economic benefit. Officials confuse the role of real estate in economic development: real estate expenditures and values derive from economic activity and do not cause economic activity.

The city made bad choices in subsidizing sports teams and a dysfunctional convention center, while taxing away real jobs for people who spend their earnings in the region. Currently, the taxpayers pay more than $10 million each year to subsidize the operation of the convention center, and the stadiums will cost taxpayers approximately $30 million per year for the next 30 years. The convention center should not be expanded until it is clear that the expansion will pay for itself.

It is important to demonstrate and provide value when spending other peoples' money. If the value is not there, the political process will continue to turn against urban programs in general. An example of a question that needs to be addressed is the value of the city's housing programs. Is there a net gain for the city or is the new subsidized construction just emptying out other neighborhoods and accelerating abandonment? How reasonable are the construction costs when compared to the private sector?

Resolved: The mayor and other political leaders in the city should manage all expenditures with a focus on cutting taxes. The city should engage in a broad program of productivity improvement drawing on expertise in the private sector.

Resolved: City leaders should make policy choices that avoid expenditures and reduce taxes for everyone not just selected individuals and corporations. Expenditures should be made only when they provide real, documented benefits.

The State's Responsibility

The state has a major role in city governance. Its oversight has kept in check some of the past excesses of city politicians. However, it can be a stumbling block to true reform now that the city has a real opportunity for tax reform. The experts testified that there is a serious concern that the legislature will use an attempt at reform to infuse the required legislation with its own agenda at the expense of the city. Congress has developed a mechanism for dealing with complex treaties like NAFTA. They pass legislation prior to negotiations to restrict the ability to attach amendments that alter the treaty. The state legislature should pass a similar law for dealing with city tax reform.

Resolved: The state legislature should be supportive of city tax reform by passing legislation now guaranteeing it will hold an up-or-down vote without amendments of a reform program designed by the city tax reform commission that is approved by City Council and the mayor and meets the constraints of the state constitution.

The state should not be an irresponsible party, undercutting responsible management of city activities. The new law requiring that mediators not take into account the health of city finances will force greater economic burdens on the city and is no different from the unfunded federal mandates imposed on states.

Resolved: The state legislature should immediately reverse its mandate that labor mediators not include the city's financial health when determining worker salaries.

Conclusion

As residents of Center City we are committed to a healthy city that provides for the well being of all of its residents. We do and are prepared to pay taxes that support the functioning of good government. However, over the past few decades the political leadership has chosen to tax its residents at the highest rate in the country while not delivering full value for the money received. This has led to massive population loss that continues even when other cities like Newark, New Jersey have been growing.

All responsible commentators who have examined the public policies and programs of the city, including those who participated in our public program, have said that taxes must be reduced to make this city competitive with its suburbs and other cities in this nation. When reasoned voices call for reasonable action, it is time for responsible decisions by city politicians.