Testimony Before City Council -- Business Privilege Tax Shift Proposal

Testimony before the Committee of the Whole
City Hall Room 400
Tuesday, December 30, 2010

Good morning Madam President and members of City Council.  Thank you for inviting me to speak before this Committee and thank you for continuing to focus on the need to reform the city's tax structure to improve Philadelphia's ability to attract and retain firms and families.

This is certainly not my first time to appear before this Council to talk about Philadelphia tax policy.  As the primary author of the 2001 City Controller's Office Tax Structure Analysis Report, a member and committee chair of the 2003 Tax Reform Commission, and citizen activist ever since, I have been happy to share my views on the need to make Philadelphia's tax structure more fair and less burdensome.

Philadelphia's tax problems remain threefold -- we tax too much, we tax the wrong stuff, and we tax unfairly.  Employers and residents in Philadelphia are burdened with high taxes when compared to surrounding suburbs and other cities.  The taxes we impose are unique to Philadelphia, which sets us apart in a bad way and hurts our ability to attract and retain jobs and residents.  The way our taxes are imposed provide some with an advantage and place others at a disadvantage.

Take our business taxes.  Please.

Fundamentally, most cities and localities do not tax business activities so it is rare indeed to even talk about local business taxes.  Where firms are taxed locally, it is much more common to tax receipts than it is to tax profits, which makes some intuitive sense as receipts are much more easily tracked and audited for local enforcement.  It is exceedingly rare for cities and other local jurisdictions to tax business income and it is unheard of -- except in Philadelphia -- to tax both receipts and income at the local level.

When the Tax Reform Commission considered this issue, we found that, compared to surrounding suburban jurisdictions and to the 20 largest American cities, the gross-receipts portion of
Philadelphia's Business Privilege Tax was four times the average rate in the largest American cities and between six and nine times the average suburban rate, depending on the industry.  The net-income portion was more than nine times the average rate in the largest American cities.  None of our surrounding suburban jurisdictions imposed such a tax.

Our perverse double tax on business activity is actually the result of many changes over time including efforts in the 1980s to move from a tax on the gross volume of business transacted in the city to our current structure that includes a tax on gross receipts as well as a tax on net income. 

As economic evidence of the negative effects of Philadelphia tax structure mounted and political pressure grew to reduce tax rates and reform the tax structure, we made serious strides toward improvement.  Since the mid-1990s we have focused tax-reduction efforts on the Wage Tax and the gross-receipts portion of the BPT, cutting the Wage Tax by about 20 percent and reducing the gross-receipts portion of the BPT by more than half. 

The results must be seen as successful as the gap between Philadelphia employment growth and U.S. employment growth dropped substantially after the City began its program of incremental tax reductions in 1996.  And, until the historic recession, tax revenues increased even as the tax rates decreased.

The questions of whether to continue (or re-start) the current path of tax reductions or alter our course or to adopt additional changes are ones that we have examined many times over the course of the last decade. 

When I led the City Controller's examination of the City's tax structure that culminated in the 2001 Tax Structure Analysis Report and when I sat on the Tax Reform Commission in 2003, we reached the same conclusions that I submit remain true today. 

It makes great sense to focus tax-reduction efforts on the net-income portion of the Business Privilege Tax.  The Tax Structure Analysis Report promoted additional reductions to the Wage Tax and the gross-receipts portion of the BPT, but its primary recommendation was a substantial reduction to the net-income portion of the BPT.  The Tax Reform Commission advocated additional Wage Tax cuts, but its fundamental recommendation in terms of business taxation was the complete phase out of both portions of the Business Privilege Tax.

In looking at the two portions of the BPT, there is a striking difference between how the two levies affect firms.  The gross-receipts portion is levied primarily on receipts generated by local sales -- a customer walks into a business and makes a purchase.  Thus, the tax is borne chiefly by businesses that cater to local demand and it can be argued that, because those businesses are mostly competing with other businesses that cater to local demand, the tax gets passed on to consumers.

By contrast, the burden of the net-income portion of the tax is based not only on local sales activity, but also on a firm's physical presence in Philadelphia.  Thus, a firm that may be serving no local demand -- that exports its goods to the world and has no real business reason to be in Philadelphia -- has a very powerful motivation to leave the city or never locate in the city because if it is in Philadelphia it is subject to a rather high tax on its net income; a tax its competitors do not pay. 

Over and over in my research, I encountered employers and investors in firms who spoke of the fact that the tax on net-income in effect made the city an unwelcome silent partner for many businesses.  Investors looking to recoup their investment and business owners looking to grow their business told us they had a fiduciary responsibility to move their firms from the city once they became profitable and subject to the tax on net-income.

The Tax Reform Commission concluded:

"Economic theory and econometric research strongly suggest that Philadelphia's peculiar combination of taxes is far more damaging to the economy than an alternative revenue structure would be. With its heavy reliance on those tax sources that are most likely to drive residents, jobs, and businesses from the city, Philadelphia compounds the problems created by its high overall tax burden."

Unfortunately, that conclusion remains true as Philadelphia still has so far to go in terms of making its tax structure more competitive with other cities and surrounding suburbs. 

Of course, the burden of taxation is only part of the overall equation that influences location decisions for residents and employers.  The quality of city services, the capability of our labor force, and a host of other issues both within and outside the city's control will also influence Philadelphia's economic fate. 

That should be no argument for inaction. 

Every day we continue to impose high taxes, every day we continue to levy taxes that are unlike those in competitor jurisdictions, and every day we continue to allow our taxes to remain unfair is a day we continue to miss out on the job growth and infusion of vitality our city so dearly needs.