Shifty Or Nifty? The Proposed Business Privilege Tax Reform

December 6, 2010

(December 2010)  

I have been involved in the push for tax reform in Philadelphia for much of the past decade and half. Winning many reforms to improve Philadelphia's ability to attract and retain residents and jobs has been very gratifying for me. But, most gratifying is the fact that the long process of performing solid research, presenting compelling information, and pushing for change has fundamentally transformed the conventional wisdom about city tax policy.

Earlier tax-reform debates focused on whether the city could "afford" tax reform. Now, there is almost complete agreement that we must reduce the city's oppressive tax burden and make our taxes more rational. The debate centers on how to improve our tax structure and how quickly we can make it happen.

Into this fray step Councilmembers Maria Quinones Sanchez and Bill Green with a proposal to change the way we tax businesses in Philadelphia by eliminating the city's tax on business net income and making up the revenue hit to the budget by increasing the city's tax on business gross receipts. Given the city's ongoing financial crisis and a less-than-receptive Nutter administration, Councilmembers Sanchez and Green deserve a lot of credit for thinking creatively about what can be done given our budgetary constraints and for putting their energies and political capital into this effort.

I was asked to provide testimony on their legislation before City Council. You can link to read the full testimony. Here are the highlights.

Philadelphia Has A Tax Problem


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.

Tax Reform Has Helped


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 Proposal To Eliminate The Tax On Net Income Makes Great Sense


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.

So the question we must ask is: if we believe that good things (job creation, economic growth) will likely happen if we eliminate the tax on business net income and we know that bad things (job loss, economic contraction) will likely happen if we dramatically increase the tax on business gross receipts, is it worth it for the city's overall economic health and competitiveness to make the proposed shift?

Philadelphia needs to reduce its overall tax burden AND change its tax mix. While a tax structure that relies only on taxes on gross receipts would almost certainly be an improvement on the current structure which imposes taxes on both receipts and income, even if the tax shift is an overall winner for the city economy, many city residents could lose jobs and suffer economic dislocation during the transition.

I continue to believe that the Tax Reform Commission's recommendation to deliberately phase out the job-killing Business Privilege Tax (both its net income portion and its gross receipts portion) remains the best policy to pursue.