The next mayor will be the executive of a city with the second highest municipal tax burden in the nation. Thank you Bridgeport, Connecticut. You kept us from the crown in 2014.
It does not have to be this way.
And if a growing coalition of civic, business, and labor leaders have their way, we will change direction and create jobs. This is not just good news for businesses but also for residents and everyday workers.
Led by Paul Levy from the Center City District and Jerry Sweeney, the CEO of Brandywine Realty Trust, the group also includes the African American and Hispanic Chambers of Commerce. Some private sector labor unions are flirting with being on board, too.
They have quietly been making the case to a broad group of political and civic leaders that it is time to turn the page on our existing tax structure. If we do so, there just may be a substantial payoff for the city: Jobs.
Of course, when you cut taxes to make a city more competitive new revenue does not appear overnight. But Levy, Sweeney and the other civic leaders have done their homework and figured out how to pay for the inevitable short-term gaps in revenue that come with tax reform. It boils down to this: Raise rates on some things as we lower them on others. Remember tax reform in Philadelphia was never only about lower rates; it’s also about re-balancing the source of revenue.
Paul Levy, Jerry Sweeney and other civic and business leaders have a plan for reforming our tax structure and growing jobs. This is real leadership. We are not used to this.
And how’s this for a surprise: These leaders think parts of the business community – commercial and industrial real estate owners – should take the lead by paying more right off the bat to make up for the shortfall. This is real leadership. We are not used to this. So I suggest we take it seriously.
More on their strategy below but let’s first briefly recall how we got here.
Philly boxed itself into a corner in the second half of the twentieth century by raising taxes on wages and business while keeping rates low on residential and commercial real estate. This happened at precisely the time that we made the mistake of thinking the future would be an extension of the present. Maybe it’s human nature. As Nassim Taleb warns us in the Black Swan, we give a high priority to what we know, and a low priority to what we don’t. If you go back to policy conversations in the 60’s and 70’s it is plain to see his point.
In the Philadelphia Comprehensive Plan of 1960 (prepared before the 1960 census was completed), we projected city population would expand to around 2.5 million (by 1980) from its base of 2.1 million in 1950.
We missed by a mere 35 percent.
Serious policymakers in the 1960’s and 1970’s still thought labor-intensive manufacturing (except textiles which had already largely disappeared), could still flourish in the city. Not so much it turned out.
As two tax commissions and countless experts note, over-taxing what can move and under-taxing what cannot is a bad idea. Today, our tax policies reflect a time when the city held the dominant economic position in the region. We never adjusted old policies to the new reality.
The only city that draws as much of its tax base from wages as we do is Detroit. This is not the comparison we want.
The wage tax reached its high water mark in 1991 (4.96 percent), the year the city was 27 days away from not being able to meet payroll, bond agencies were downgrading us to junk status, and the state organized a rescue through a new authority (PICA).
But just as Philadelphia’s yellow fever crisis of 1793 famously gave rise to the first municipal water department and a park system to protect the water supply, so, too, was the fiscal crisis of 1991 an opportunity to learn and improve as a city. Better practices were put in place regarding planning and budgeting. Today we have mandatory, sophisticated five-year projections that lay out the risk factors that could derail solvency. For my money, the state oversight board PICA needs to stay around and it needs to have even more power to unearth those risk factors.
But better financial management policies need to be accompanied by changing what got us where we are in the first place. Making budgets is not the same thing as making structural changes.
Instead, we’ve had a piecemeal approach to taxation. Given the overwhelming evidence that a high wage tax was a job killer, the city began to incrementally reduce the tax in 1996. During the past three administrations wage tax reductions have continued. The reductions were actually highest during the Street administration and the lowest during the Nutter administration. In total, three administrations have collectively shaved about 1 percent from the high water 4.9 percent base.
There have also been small reductions in the gross portion of the business income receipts tax in the past several years. At the same time, the needs of the school district have added taxes and fees on real estate and consumer goods.
Wage tax reductions slowed during the Nutter administration due to concerns about the national recession’s impact on city revenue, a reasonable concern. And, to his credit, Mayor Nutter took on other aspects of the tax system, most notably the entrenched bureaucracy at the Bureau of Revision of Taxes, insisting on the actual value initiative for residential and commercial real estate. It was a gutsy move that others had been happy to demagogue.
Instead of fixing tax policy, the city resorted to a hodgepodge of tax breaks for everything from technology companies to new residential construction. If tax breaks just move businesses from one part of the city to another, they do not work.
But this piecemeal approach has long been a part of our problem. By committing to wage tax reductions 15 years ago in the absence of addressing other parts of the tax code simultaneously, or by adjusting property values without more aggressively seeking added wage tax relief, we failed to present the broader picture to residents: the rebalancing of the whole system.
Instead of fixing tax policy, the city resorted to a hodgepodge of tax breaks for everything from technology companies to new residential construction to hotels, (where we use tax increment financing), and ultimately for large areas of the city through the state-aided KOIZ zones.
The tax zones and abatements are a way to indirectly deal with both uncompetitive public costs and also uncompetitive private building costs. If tax breaks just move businesses from one part of the city to another, they do not work. But when they encourage business growth and expansion or relocation to the city, they make the case for tax competitiveness.
Philadelphia is not alone in using tax credits to avoid the political pain of fixing the system (which is admittedly a daunting task). Think of tax reduction zones or abatements as work arounds.
Perhaps at one point there was little choice to do anything but pursue the work arounds, but now it makes more sense to have a tax structure that is economically competitive rather than a non-competitive system partially rectified by special incentives.
Special incentives create popular resentment and also distort market pricing. They are pro-business but not pro-market. The difference is critical. That is clearly the case with the residential construction tax abatement and the KOIZ zones.
Politicians are often comfortable with tax zones and incentives because they have some say in their distribution. A zone gets a ribbon cutting. But well functioning markets avoid the political calculus; they are largely self-organizing.
Today, our tax policies reflect a time when the city held the dominant economic position in the region. The only city that draws as much of its tax base from wages as we do is Detroit. This is not the comparison we want.
Philadelphia is indeed growing in many ways. We should not discount the good news of the past twenty years. Our downtown and university districts are hopping and every time you turn around we get more good news: an upcoming visit from the Pope, the 2016 Democratic National Convention, good national press on cultural amenities, restaurants, and so forth.
But it’s one half the story. We are the city with the highest poverty rate among the largest cities in America, a city that lost 25% of its employment base over the past fifty years, a city with underperforming schools, and a place with weak business formation infrastructure (number of startups, amount of venture capital, number of entrepreneurial growth companies versus slower growth small businesses).
Moreover, our new demographic growth is more of a population swap than broad-based: we are gaining newcomers without school age children in exchange for adults with school age kids. We are gaining more through births than new entrants. And, we are still losing adults in their prime earning age (35-55).
How long will the population swap continue, particularly in the absence of better job numbers? The answer isn’t clear, but there are reasons—based on demography and job location – to worry.
Today’s growth spurt is an opportunity and not an answer. The window has opened slightly and now we have to force it all the way open. Those that argue that costs do not matter because we are in some kind of a post-economic millennial utopia are reading from a very thin playbook.
It is true that some residents and businesses will pay higher costs to take advantage of certain urban advantages. Sometimes it depends on the type of business and where people are in their household lifecycle. Sometimes it is a matter of personal preference.
But in the long run, people are wary of paying too much if they can’t get services critical to their welfare—such as serviceable schools. Growing businesses do the math in terms of all their public and private costs.
We do not have to be the cheapest alternative, since we offer great amenities. But we have to be competitive for broader groups of residents and businesses if we want the next forty years to look better than the past forty years in terms of job growth.
Which brings us back to the new proposal. The jobs coalition wants commercial and industrial owners to pay more in real estate taxes to cover the cost of reducing wage and business taxes.
And they want to get the wage tax under 3 percent within the next ten years and cut the net income portion of the business tax in half during that same period.
It will take some doing to get this plan or anything like it done, because to decouple commercial and residential real estate rates we will need the state’s help in modifying tax uniformity rules.
But it is the right course of action. It won’t be easy politically, but it’s absolutely possible, if we elect leaders who are capable of striking big bargains.
What do you say, next mayor?