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Citizen Sam to the Rescue

Closing the funding gap in Philadelphia’s public schools: A proposal

Citizen Sam to the Rescue

Closing the funding gap in Philadelphia’s public schools: A proposal

Editor’s Note: If you’re like us, you’re feeling more than a little underwhelmed by the substance of this mayor’s race. The candidates appear to be doing the math of turnout instead of debating solutions to our most pressing problems. Enter three-time mayoral candidate turned documentary filmmaker Sam Katz. He’s unveiled a new website—Citizensam.net—and he’s written an important, in-depth policy paper that focuses on bold solutions for our school funding crisis and advances an overarching philosophy for city government. We felt it was important enough to share in its entirety and we’ve invited Katz to amplify on these ideas in a Citizen Speaks event. Stay tuned.

March 12, 2015 For decades, Philadelphia’s public school system has confronted a massive resource gap.[1] Services, programs, staffing and educational supports afforded students in wealthier school districts have often not been available to students who attend Philadelphia public schools. SRC Commissioner Bill Green recently observed, “The fundamental problem with the district is that we can’t get anyone to invest in us, because we can’t get anyone to believe that if they give us the money, we will be successful. That seems to be the number one impediment to resources.” From my perspective, this assessment is absolutely correct.

Surely, money isn’t the only thing that matters in preparing kids to become critical thinkers, capable of competing for jobs and living self-sufficient lives and building a foundation for good citizenship. But if money didn’t matter, would the parents in Lower Merion, Council Rock and Radnor be spending so much more of it to educate their children?

This proposal argues for modifying tax policy and using publicly-owned assets to narrow the resource gap in public education. It recognizes the critical role in resource acquisition of corporate and foundation philanthropy. And it argues for changing our long held practice of depending on the State to solve this issue. Moreover, this approach says Philadelphia owns its schools, that Philadelphia’s leadership—political, civic, clergy, labor (notably the PFT who are essential to the coalition that can make this plan happen) and business—has to evidence the will to exercise that ownership, and must finally accept that closing the educational resource gap starts at home.

Since the 1960s, political leaders have argued that Harrisburg needs to do more. But our experience has more often been disappointing, even when the City has enjoyed significant influence in State government, which it certainly does not today. Yes, Harrisburg needs to do more. The fight for a funding formula that recognizes the poverty-wealth disparity and for legislation that addresses the deficits created from student transfers to charter schools are both critical intergovernmental issues. But I would argue our chances of doing better improve dramatically only by demonstrating that closing the educational resource gap is this city’s top priority. We do more first! We show Harrisburg the money! We evidence our commitment. We act like parents and take care of what our kids need.

I believe the place to start is with local tax policy and not tax rate increases. The local tax base is the principal source of funding all government services of which, by far, the single largest is public education.[2] In response to the fact that our tax system has a significant deterrent to job creation and economic growth, we’ve implemented numerous breaks and transactional fixes to stimulate the city’s economy. To address that, policies to stimulate investment have been layered into the City’s tax regime. These multiple tax policies and practices inadvertently contribute to the educational resource gap. Every tax subsidy that drives one economic activity takes a bite out of revenue that would otherwise flow to schools. We have always formed the policy question around jobs and development. Now it is time we asked the question, can public education meet the needs of its students with fewer resources so that other economic interests can accomplish more?

The second element of the strategy to address the school funding gap should focus on the municipal pension crisis. A recent PICA staff report[3] frames the issue effectively. Philadelphia’s hugely underfunded municipal pension system (a $5 billion unfunded liability in a pension system only 47 percent funded) is an enormous risk for employees, retirees and taxpayers. It is also a major problem for closing the educational resource gap.

The financial and budgetary dots between the pension crisis and public education all connect. Here’s how.

The City treats that massive unfunded pension liability like mortgage debt. The annual costs to pay off the debt approximate $464 million. There is only one-way, long term, to address this crisis and that is to infuse the pension system with capital. In doing so, lowering the appropriations to amortize unfunded liabilities will enable the City to address both the pension crisis and school-funding gap, simultaneously.

And the third element is philanthropy and private investment. Not so long ago a sizable level of community philanthropy was invested in public education. Rather, we need to engage philanthropy and private capital in supporting public educational initiatives beyond what is afforded by the District’s operating budget. [4] There was a time when public schools had powerful and supportive allies in the private sector, both corporate and philanthropic. The civic and business community was organized to help schools. Today, although there are uncoordinated important initiatives[5], one would be hard pressed to identify a similar sense of broad community spirit that supports strengthening schools. Public finance, including additional taxes on property, sales and cigarettes, has generated important allies, but private financial support for public schools remains in a deficit position.

Each of these strategies—modifying tax policy, addressing the pension crisis head on and developing a private philanthropic investment plan—collectively could help Philadelphia narrow the school resource gap. Once underway, our messaging to Harrisburg will entirely change and should strengthen the prospects for more financial support from the Commonwealth, as partner. The Wolf Administration has outlined a very ambitious program to increase educational spending. Exactly how much incremental state funding will materialize will be known once the FY16 Commonwealth budget is approved (presumably by June 30th). The challenge has been and will continue to be persuading the General Assembly.

If citizens and our elected leaders considered the following, Philadelphia could make a significant dent in closing the educational funding gap.

Tax Policy. Can Philadelphia’s schools afford to forego tax revenues to enable higher education and hospitals among other non-profit enterprises to remain tax-exempt for real estate tax purposes? Is the trade-off in tax revenue to continue 100% 10-year tax abatement sustainable for schools? Should we be examining other tax incentives that incent private companies to locate to special zones or utilize other tax incented financing? Can tax collection and enforcement practices be accelerated to drive more funding to education? Can we continue to engage in a policy of transactional economic subsidy when one of the clear impacts creates so much inequity for the school kids of our city?

What needs to change?

First, we need to change the policy of tax exemption for most non-profits. Religious institutions, K-12 schools, social service agencies and others that address at risk constituencies should continue to be exempt from real estate taxes. Obviously, this is complicated, but there are enough wise people to make it work. Whether we assess the value of land and improvements so that “eds and meds” pay a rate that becomes a PILOT (payment in lieu of tax) or follow the proposal made by Council President Clarke for a partnership approach is a matter for study and debate. Boston, a city of 645,000, roughly 41% the size of Philadelphia, collected $25.9 million in PILOT payments (plus non-cash “community benefits”) in FY2014.[6] Philadelphia should have a target between $45-50 million annually in new tax revenue to flow from this source. It may be wise to step up to these funding levels in a scaled manner.  Clearly, some important research has been conducted in support of opposition to PILOTs [7].  There is no argument that area hospitals and universities add greatly to the city’s vitality. But it is equally true that the population that lives here creates the market and corresponding revenue streams for services supplied by the area health care institutions. Similarly, the cultural life, infrastructure and transportation services, diverse neighborhoods and communities make Philadelphia a magnet for faculty, administrators, researchers, physicians and students of area universities and medical centers. There are real costs to make a community great and real sacrifices that also have to be made. It is time for current property tax exemption to be fixed.

Next, we need to re-examine the tax abatement, tax incentive districts and opportunity zones, tax increment financing, and other site and project specific mechanisms designed and implemented when Philadelphia’s economy was in the tank and there was a pressing need to address job loss and economic decline. Most studies that have been done to explore the impacts of these tax incentives have found them to be extremely important and effective. None of these studies have ever evaluated the impact of these tax subsidies on public education resources. It is obvious that if the question was asked from the perspective of public education funding, researchers might have different answers regarding whether or not these incentive arrangements should be implemented, what their structure might look like and how long they should remain in place. For example the ten-year property tax abatement might be valuable to create affordable and low-income housing outside of the “gentrification zone.” But within the widening Philadelphia zone of gentrification, real estate is red hot. The studies that have concluded the value of tax abatement seem to assign extremely high correlation between abated taxes and development/investment decisions.[8] Financially, the loss of these revenue streams in the future matter to school finance. Over the past decade, property tax abatements would have generated $44.2 million for the School District.[9] I’m not arguing for the elimination of tax abatement or the other programs intended to incent re-location and economic development but I am convinced that too much value is assigned to real estate expansion and tax incentives. There may be good reasons to continue to use them selectively. But these should be predicated on today’s market conditions and should focus on locations and construction sectors experiencing disinvestment. Far too often, tax policy stays in force well beyond its useful life. So it is time that all of these practices come under close scrutiny and that the mechanisms, terms and longevity be re-calibrated to current market conditions and real needs.

This change in approach reflects a policy of investing in human capital as well as in physical capital. Most experts argue that labor costs necessitate the abatement for new construction. If we could finally address the relative competitiveness of our convention center costs with labor, perhaps the time is right to negotiate construction labor agreements that will enable additional tax receipts to flow to education.[10] A recent column in the Philadelphia Daily News[11] reporting how much better the experience is for exhibitors at the Pennsylvania Convention Center creates a sense of optimism about a new collaboration with labor to tackle this issue in the interests of strengthening funding for schools.

Finally, the City needs to address the absurd and embarrassing performance of its tax collection system. Several years ago, this was made a top priority. There has been much progress to report on collecting current tax obligations.[12] Yet more than $1.2 billion of uncollected taxes and obligations due the City and School District remain outstanding. In excess of $820 million (68%) of this amount is owed in real estate, water and gas bills.[13] The underlying value of the real estate on which these delinquencies remain outstanding is in the billions of dollars. In view of this incredible disconnect, experts in the real estate market and professionals in the tax collection business believe that Philadelphia could realize between $250-$400 million in collected taxes on this unpaid delinquent inventory. There are simply no excuses for not aggressively taking the steps necessary to collect. Yes, this is complicated, but it is also the lowest hanging fruit. We need to make collecting collectible taxes a top revenue priority. This situation also needs to be cleaned up. Those delinquencies that are irrevocably uncollectible should be written off. A major initiative on this through tax lien sales, for example, could seed fund the educational endowment and kick-start private sector philanthropy. It would also send a powerful message to tax deadbeats that Philadelphia is no longer willing to look the other way when it comes to collecting delinquent payments. It is unlikely that the skills and enforcement culture is sufficiently present within City government to do this (or else it would have already been done). This may be an area where third party engagement, for example through wholesale tax lien sales and outsourced collection entities, could prove very fruitful.

Given that the City realizes no current revenue from tax exempt, tax abated, tax free zoned and tax delinquent properties, it would be smart to define a 10 year period during which all of the new revenue generated from reforms in these areas be dedicated solely to the School District. A goal of $75 million annually recurring locally generated funding—not requiring tax increases—is achievable.

Pensions. Reforming pensions is an important goal and the PICA report has offered some excellent recommendations.[14] The General Fund includes $687 million[15] in FY15 to fund our municipal retirement system, making it abundantly clear why we can’t adequately finance infrastructure, lower wage taxes or adequately support public education. Only one strategy will make a dent on this crisis and that is to infuse the pension fund with cash. Selling bonds is an inflexible funding tool and the capital markets are skittish about this option that, if widely exercised, could flood the markets. Relying on annual appropriations has undermined our capacity to address other needs. Awaiting a federal or Commonwealth bailout is a pipe dream given that most state and municipal pension systems are deeply underwater. If you question that assertion one only needs to look at the situation in Pennsylvania where, combined, the State employees and teachers pension funds have a total unfunded liability of $50 billion,[16] and where State annual appropriations to retire that liability are woefully inadequate. [17]

What we can do to generate cash for the pension fund is look to resources the city owns. We can sell or otherwise monetize profitable operating assets, the businesses that Philadelphia simply does not need to be in. I have long supported the sale of PGW for precisely this purpose and reason. Perhaps City Council partnering with a new administration can structure an approach that will generate an infusion of cash from a public-private partnership.[18] We should all be agnostic about the legal structuring that enables monetizing these assets but we need to be purposeful in pursuing this. And we don’t need to own our gas business[19] anymore than we need to own our airport, our water business or the parking business. All of these can and will command excellent valuations in the municipal infrastructure marketplace and their sale or lease can generate the significant cash needed to address the pension problem. If these operating business are not municipally owned or operated, will we still turn our faucets on and get water, get gas to cook and heat, be able to fly in and out of PHL and find places to park our cars? Everyone knows the answer is that we most certainly will.

Consider this simple math. For every dollar transferred to reduce unfunded pension liability, the City can reduce its annual appropriation by 8 to 9 cents. For every billion dollars used to reduce the liability, annual appropriations would be reduced by $80 to $90 million. If PGW can generate $600 million net of funding for its employee pensions[20], pay off PGW debt and fund certain reserves, Water, Airport and Parking should be expected to yield at least an additional $2.2 to $2.6 billion in net proceeds.[21]

If the City’s pension fund experienced an infusion of $3 billion[22], 60 percent, or nearly $280 million would be cut from the $465 million cost of amortization unfunded liability. Take a sizable portion of those savings and dedicate it to schools and an additional $180 million to invest in the future of the children of this city would be available. The balance might be used to increase pension fund amortization, invest in much needed infrastructure or help enable wage tax reductions. Some have suggested that this strategy represents a one-time benefit. That is wrong. These amortization costs are recurring annually. These savings would materialize annually as well.

I recognize that opponents to these proposal will use politically charged messages like “privatization,” “threats to workers,” “higher utility rates,” “loss of development incentives,” “the great things that the largest non-profits do for the city,” and more. There are valid arguments and concerns to be considered, debated and addressed. The lease, sale or partnership of these services is a very difficult strategy, no doubt. There are many issues to be addressed with employees, their unions, regulation, rates and charges, legislation, the FAA, the PUC, etc. But when a community makes a huge commitment to invest in the education of its children and in its economic future, there is nothing but hard and complex choices to make. The alternative? Wait for Harrisburg to finally come through. And that is a bet we should not be willing to make.

Philanthropy. We ask much of the charitable institutions and philanthropic individuals of Greater Philadelphia. But it would be myopic to fail to observe that the charitable landscape has undergone an extraordinary transformation. The Annenberg Foundation has moved to California. The Pew Charitable Trust has re-defined its mission as a public charity. The Lenfest Foundation has donated much of its considerable resources. Harsh economic conditions have imposed great demands on a shrinking asset base of local charitable institutions. Certainly there are wonderful examples of generous giving, both institutional and individual, to support a variety of educational initiatives throughout the city. A read of the recent study commissioned by the William Penn Foundation[23] shed interesting light on the imbalance of charitable needs (in this instance in the arts) and the supply of philanthropic resources. It is likely that this imbalance is even more acute in basic education and other human service needs.

Philadelphia needs a massive endowment to generate significant annual income streams to enable the School District to take on important projects beyond the basics. These might include leadership development, professional development, after school programs, and a host of options too numerous to list here. To create such an endowment will require articulating a powerful vision and mission for public education, building confidence in the leadership team empowered to execute on that vision and a universal acceptance that a new level of community philanthropic responsibility is part of the equation. Only the investment income of such an endowment should be incorporated in educational budgets. Might it be possible to see that endowment grow to $1 billion over 10 years and provide supplemental support for schools in perpetuity? The city could kick start such an effort by dedicating the collections from its currently uncollected tax delinquencies. Earlier, I suggested that there might be as much as $400 million that could be generated (e.g. through a tax lien sale). Investing what is collected through aggressive initiatives in this endowment would send a powerful message and give such an initiative a much-needed launch.  If the use of the endowment earnings was driven by analytics of what really works, a successful marketing program should enable securing support for this endowment fund beyond the geographic confines of Greater Philadelphia.[24]

What is the rationale and how might the math work for such a dramatic change in priorities and funding? Anyone who has read this memorandum to this point is likely thinking about all of the reasons, obstacles and political factors that render this thinking impractical in Philadelphia. I’ve been here all my life and know that getting even little things done is a big deal. But this is a new time of bold thinking, optimism and demographic change. The momentum we’ve built is only sustainable if we bend the poverty curve. Will Philadelphia move towards a 35 percent rate of poverty or towards a 25 percent rate? The answer to that question will determine whether we can sustain a viable future for the city. If anyone knows of a way to do that aside from creating an educated workforce and citizenry, I’d love to hear it. But history shows that the path to success in every generation where poverty has afflicted any demographic group has been through education and opportunity.

This plan envisions $250 to $300 million annually in incremental locally generated funding, for public education. I’m convinced that rather than relying on any mayor’s political skills with Harrisburg, though certainly valuable, that Philadelphia propose a new bargain to leaders in the State capital, one in which we demonstrate a re-set of our priorities, that we want to be the nation’s leaders in educating our students. We need Harrisburg as a partner on many fronts. This time Philadelphia is taking the lead. We’re putting our money where our mouths are. We’re asking to match us to the maximum extent possible. I can’t predict what that might look like dollar wise. But consider that if that added $100 million in new state money to the $250 million in new municipal money and $50 million in private philanthropy, the School District of Philadelphia would have additional resources of $400 million, $4 billion over 10 years.

There is also the need for a public debate about delivering educational services, about public, charter, magnet, parochial, home, cyber and other schools and platforms through which our city’s children learn. That is a conversation for another moment and one I look forward to joining. But the compelling argument I am hopeful of making here is that by prioritizing in financial terms a major turnaround for today’s 230,000 (and growing) public school population with $400 million new dollars annually we would make a major “close the gap” move. The imagination ignites with what strong leadership, well supported politically, by parents and private interests and public officials, could mean for addressing this most pressing challenge.

In addition to moving the needle on the educational resource gap, this set of proposals would:

  • Fully fund the pensions of employees and retirees of the Gas Works, the Water Department, the Aviation Fund and the Parking Authority;
  • Eliminate the pension crisis confronting Philadelphia’s municipal employees, retirees and taxpayers;
  • Kick start a renewed level of civic, business, and philanthropic commitment to strengthening public education in the city;
  • Stimulate a debate about re-structuring tax incentivized economic development policies;
  • Start a conversation and (hopefully, a negotiation) about how to bring down the cost of labor in construction so as to free up abated and other incentivized tax allowances to become available for public schools;
  • Free up additional funds in the General Fund budget of the City to be used for infrastructure investment and wage tax relief;
  • Enable Philadelphia to demonstrate its renewed commitment to funding education;
  • Change the dynamic in our State government relationship; and
  • Enhance our self-image and global image as a 21st century city ready to address its educational and financial challenges.

Conclusion. This is an election year. A focus on polls, the horse race, media buys, independent expenditures, and negative campaigning often overwhelm issues. But campaigns can be highly valuable when they generate debate around our most important needs and concerns. The 2015 Mayoral campaign is our best opportunity to clarify the kind of city we want Philadelphia to be.

Philadelphia can no longer afford and should not be content with incrementalism. There are thousands of young people facing a fork in the road, students in failing schools and families with school age children and lots of choices.

We’re their parents, not just to our own kids and grandkids, but to all of the kids in this city. We, all of us, need to take care of their futures. We have important decisions to make, hard ones requiring serious sacrifices.

Time is not our children’s ally. Let’s focus on moving the needle and solving this deficiency.

I hope you’ll post your comments and reactions at www.citizensam.net and that you’ll talk to your network about these and other ideas.

Thanks for engaging.

[1] Among other resources that address the data on this point, see: (1); (2); (3); and (4)
[2] The combined City and School District budgets for FY15 total in excess of $7.1 billion. The School District will spend $2.6 billion or 36.6% of that total.
[3] Read more here.
[4] In the late 1990s, the Annenberg Foundation initiated Children Achieving that provided $50 million to the School District of Philadelphia. This project met with less than robust results. I am not making an argument for re-instituting that program; only that there was such a significantly resourced private initiative. For more information on that program, click here.
[5] For examples visit: (1); (2); (3) The Neubauer Family Foundation is funding a huge project to provide for school leader development for all three sectors of schools (will be called Philadelphia Leadership Academy).
[6] Boston received $25.9 million in PILOT contributions in fiscal year 2014, a 71.0% increase over what was previously paid under the prior PILOT program in fiscal year 2011. This amount represents 74.8 percent of the $34.6 million requested PILOT amount. In all, 49 private institutions from the educational, medical, and cultural sectors were identified as owning tax-exempt property valued in excess of the $15 million threshold established in the PILOT guidelines. Note that neither Harvard nor MIT are located in the city of Boston. Read more here.
[7] See Econsult Solutions report, The City of Philadelphia and its Higher Eds: Shared Goals, Shared Missions, Shared Results.
[8] See Kevin C. Gillen’s April 2013 report, Philadelphia’s Ten-Year Property Tax Abatement.
[9] The total value of taxes abated during this period (FY 2005 to FY 2014) according the City Revenue Department was $98.5 million of which $44.2 million would have been collected by the City assuming the real estate development of abated properties had occurred.
[10] Gillen’s report observes, “Philadelphia has the 4th highest cost of construction of any city in the country, which is also 25 percent above the average national cost.” (page 1)
[11] Read more here.
[12] As reported by the Pew Charitable Trusts here and here and here.
[13] Data acquired from Philadelphia’s Office of Property Assessment.
[14] I might not be totally objective. This research for that report was initiated while I chaired the PICA Board, on which I served from February 2011 to February 2014. A copy of that report is referenced above in footnote 3.
[15] This amount includes $92.2 million in normal costs (employer contributions), $464 million to amortize the unfunded liability and $131 million for debt service on the ill advised 1999 $1.2 billion of Pension Obligation Bonds. The amortization costs represent 10.9 percent of all General Fund spending. In FY03, these costs represented 2.9 percent of General Fund spending.
[16] Actuarial reports on the State Employee Retirement System’s unfunded liability at June 30, 2013 calculated that liability to be $17.9 billion. For the same date, the unfunded liability of the Pennsylvania School Employees Retirement System was $32.6 billion. There are more than a few actuaries who believe that both of these calculations understate the dimension of this liability and that the actual combined number exceeds $60 billion.
[17] Consider that with unfunded liability of $5 billion, Philadelphia appropriates $465 million to amortize its pension problems. Pennsylvania’s problem is 10 times larger while its amortization appropriates is only three times the amount that Philadelphia’ funds.
[18] See here for a discussion on what public private partnerships are and how they can work.
[19] Among the 25 largest cities in the U.S., Philadelphia, San Antonio and Memphis are the only ones that own their gas business.
[20] I think the best case for selling PGW is (unintentionally) presented in the report prepared for the Philadelphia City Council by Concentric Energy Advisors, Inc. in October 2014 and can be read here.
[21] Applying valuations to the Water, Aviation and Parking operating businesses of Philadelphia absent careful analysis is difficult guesswork. PGW and the Philadelphia Water Department are comparable in gross sales/revenues, approximating $650 to $700 million annually. There is significant upside in the water business versus gas. Historically net revenues after operations total approximately $240 million for Water and $120 million for PGW. Outstanding Water Revenue Bonds approximate $1.7 billion (read here, page 149) while Gas Works Revenue Bonds are slightly in excess of $1 billion (see, page 18). The Water business should generate $3.5 to $4 billion and could net the City in excess of $1 billion.  Aviation is harder to gauge since there have been no sales of major American airports. A Federal demonstration program granted Chicago the right to sell Midway Airport but that sale has not been executed, although the original plan called for a 99-year $2.5 billion lease. Perhaps PHL could seek to replace Midway in the Federal demonstration program. Major airports around the world have been fully or partially transferred to a variety of ownership groups each with varying levels of success. The sale of PHL and its Philadelphia Parking Authority garages, one of PPA’s major money generators, would likely need to be executed in tandem for the City to realize the full value of an airport sale. The sale of the Lisbon, Portugal airport was completed in 2013 for $4 billion (see more here). Finally, in conversations with a major investment banking firm several years ago, I was advised that a sale of the Philadelphia Parking Authority’s operating business and assets could generate between $300 to $400 million in net proceeds.
[22] Or alternatively, an endowment could be created, with the funds invested and the investment income used to cover the annual amortization expenses now paid to the Pension Fund by the General Fund.
[23] Reported by the Inquirer here.
[24] The widely touted $100 million investment that Facebook founder Mark Zuckerberg made in the Newark school system was largely considered a failure. Why that was and what lessons might be learned for schools districts like Philadelphia that seek significant philanthropic infusions was reported in an excellent article in the New Yorker and can be read here.

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