CITY

OF

PHILADELPHIA

CITY COUNCIL
OFFICE OF THE PRESIDENT
DARRELL L CLARKE
PRESIDENT
ROOM 494, CITY HALL
Philadelphia, PA 19107
(2151 686-2070
Fax No, (215) 5633162

June 25, 2015

COUNCILMAN - 5TH DISTRICT

The Honorable John Taylor

214 Ryan Office Building
P. 0. Box 202177
Harrisburg, PA 17120-2177

Dear Representative Taylor:

I am writing with some sense of urgency to let you know my position on a matter
of great concern to me, and about which there may be some confusion.
First, I enthusiastically support an amendment to the Pennsylvania Constitution
that would authorize the General Assembly to permit Philadelphia to tax residential real
property and commercial real property at different rates.
Second, I do not support the drastic modification proposed by a group of business
leaders (the "Job Growth Coalition") that would cap at 15% the maximum by which the
commercial rate could exceed the residential rate; and require that other local taxes be
reduced by the amount attributable to the difference in the two rates. This wholly
unnecessary modification could jeopardize the fiscal well-being of our municipal
government; if implemented, Council simply could not risk moving forward with dual
rates.
My support for dual real estate tax rates dates back to the fall of 2012, when
Council was wrestling with AVI, the "Actual Value Initiative"-- Philadelphia's historic
effort to reassess every property at its fair market value. Council's analysis revealed that
AVI would result in a massive shift in the relative share of real estate taxes from
commercial propetties to residential properties.

To provide relief to homeowners, we came to Hanisburg with a package of

proposals. And we were heard. Thanks to legislation subsequently enacted by the General
Assembly, we mitigated the impact of AVI on long-term owner-occupants whose home
values had skyrocketed as a result of gentrification, and we gained additional authority to
collect delinquent property taxes.
Those measures alone, however, could not shift the allocation of taxes to the
extent needed, so at the same time we also proposed an amendment to the Pennsylvania
Constitution to permit dual real estate tax rates, knowing that such an amendment could
take several years to enact.
I continue to believe that such an amendment would be extraordinarily helpful. It
would allow us to allocate in a fair way the burden between homeowners and commercial
property. Many local jurisdictions, including those in our neighboring states ofNew York
and Ohio, have the authority to set tax rates on different classes of properties. Having the
same authority in Philadelphia would allow us to implement responsible tax measures
strategically designed to strengthen and grow our City while enabling businesses to
compete successfully in the region and around the world.
In response to our request, at least three bills have since been introduced that
would accomplish our goal: House Bill No. 389 of the Session of 2013 proposed a
Constitutional amendment providing that the General Assembly may authorize local
taxing authorities in counties of the first class "to impose a rate of taxation on residential
real property that is different from a rate of taxation on commercial real property."
House Bill No. 1693 of the Session of 2013 used the same language I have quoted but
extended the amendment to cover all local taxing authorities, not just those in
Philadelphia. Finally, House Bill No. 584 of the Session of2015 is identical to HB 1693.
The language in those bills that I have quoted is consistent with my position. I
would also support authorization for more than two rates, as is sometimes the case in
other jurisdictions. For example, the District of Columbia defines five separate classes of
real estate, each taxed at a different rate (residential; business properties assessed at $3
million or less; business properties assessed at more than $3 million; vacant property; and
blighted property).
The Job Growth Coalition, on the other hand, while endorsing a higher
commercial real estate tax rate than the residential rate for Philadelphia, only does so if at
the same time, Council would have to reduce the rates of other local taxes -- mainly the

Wage Tax and Business Income and Receipts Tax- by an amount equal to the estimated
yield from the differential in the two real estate tax rates.
Again, I do not support that proposal. The Coalition has portrayed the proposal as
"revenue neutral" to the City in the first years of the program, and then as "strongly
revenue positive," based on certain assumptions. I have come to believe that that
portrayal is deeply flawed.
Shmily after I met with representatives of the Coalition, I asked the past long-time
head of Council's Technical Staff, Rick Auerbach, to evaluate the Coalition's proposal
and underlying work product. I am enclosing a copy of Mr. Auerbach's report (without
supporting spreadsheets, which I can provide upon request).
The bottom line is this:
The Coalition's math did not add up. Initial assumptions were erroneous. I quote:
"As the following table shows, under this apples-to-apples analysis, the Coalition's
proposal is in fact strongly revenue-negative to the City in years 3-10, and thereafter."
Correcting for the faulty initial assumptions, Mr. Auerbach found that, by the end of year
10, rather than a net revenue gain of$66 million, there would be a net revenue loss of$91
million.
The report also noted deficiencies in the Coalition's "elasticity" estimates - that
is, how a change in a given tax rate would affect the base of that tax. For example, the
Coalition evidently assumed that an increase in the real estate tax rate would have no
impact on the real estate tax base, despite the generally held consensus that increases in
real estate tax rates tend to depress real estate tax values. As a result, the Coalition's
projections overstate real estate tax collections if the commercial real estate tax rate were
increased.
I also asked Mr. Auerbach to evaluate the specific language of the Coalition's
proposal as then provided to me. The Coalition proposed amending the Pennsylvania
Constitution to provide that the General Assembly may, by law:
(vii) Permit a city of the first class to impose taxes on real estate usedfor
business purposes at a tax rate that exceeds the tax rate applicable to other real
estate provided that the rate applicable to other real estate shall not vary by more
than 15% from the rate applicable to real estate used for business purposes and
provided that the General Assembly requires the city of the first class to reduce
the aggregate revenues from other taxes imposed on businesses and any wage &

net profits tax by the amount of any real estate tax revenues attributable to the
variance.
I understand the Coalition may since have modified its proposal: the limitations
would remain, but instead of being in the Constitution itself, the General Assembly
would impose them. Nevertheless, the Coalition's proposed language is deeply troubling.
For example, the proposal seems to treat the real estate taxes in Philadelphia as a
single tax, with a single rate (1.34% at the time the proposal was issued). As you know,
however, this percentage in fact reflects the sum of two completely separate rates: one
that supports the City's municipal government; and one that supports the School District.
Why does this matter? As Mr. Auerbach explains:
"If any portion of the proceeds of an increase real estate tax on businesses goes to
the School District, then the proposal, while revenue neutral to taxpayers as a
whole, would be revenue positive for the School District and revenue negative for
the City. That is because the required concomitant reduction of wage, net profits,
and business taxes must all be taken on the "City" side, at least as long as Act 46
precludes reductions in School taxes." (Emphasis added.)
There are more problems and ambiguities; here are selected examples:

Who would decide, and by what method, how much revenue an increase of the
business real estate tax would generate, so that the City would know how much to
reduce the other taxes? Who would decide, and by what method, the revenue
reduction that would result from cutting the wage tax or the BIRT by a given
percentage?

The Coalition assumes that cuts to tax rates will increase the tax base and thereby
increase tax revenues. Must these "base growth" effects be considered in deciding
how much to reduce other taxes? If so, the City might be required to make even
larger cuts to other tax rates, since a given tax rate reduction will, under the
Coalition's assumptions, increase the relevant tax base and therefore have less of
a revenue-reducing effect. Could the City use a methodology that ignores the
"base growth" effects?

Could already-scheduled cuts in the BIRT or Wage Tax that are in the City's
Five-Year-Plan be considered as "offsetting" tax cuts to balance out a future
increase in business real estate taxes, or would only "additional" BIRT cuts
satisfy the requirement?

Would all rates have to be adjusted before the start of a fiscal year? If so, what
happens if the City's estimates prove to be wrong? Would the City be required to
make additional cuts in future years to remedy any "shortfall" in prior year tax
cutting measures. If a taxpayer challenged tax rates as not in compliance, would a
court defer to the City's calculations, or would it decide itself what method to
use?

None of these questions is answered by the Coalition's proposal. They do serve,

however, to underscore the risks inherent in that proposal.
In the end, even the language concerning the 15% cap is flawed: For example, the
wording of the amendment, by stating that the residential rate may vary by no more than
15% from the business rate, would as a mathematical matter permit the business rate to
be as much as 17.6% higher than the residential rate. (With a residential rate of 0. 85 and a
business rate of 1.00, the ratio of the business rate to the residential rate would be
1.00/.85 = 117.6%. In other words, the business rate would be 17.6% higher.) And, of
course, the 15% figure is itself arbitrary.
In closing, let me emphasize that I am a fiscal conservative. I believe in
"squeezing every nickel" and raising taxes only as a last resort, when all other options
have been exhausted. I have voted for and supported multiple reductions in local business
and wage taxes with the goal of growing our local economy. I have only reluctantly voted
to increase tax rates for the benefit of our financially distressed School District.
I do support the gradual reduction of business and wage taxes, much as the
Coalition does, and I greatly appreciate the Coalition's willingness even to consider a
higher tax rate on commercial properties. That said, the Coalition's proposal to connect
mandatory tax reductions to the separate idea of bifurcated real estate tax rates is poorly
conceived, and I cannot endorse it.
I would be happy to discuss this matter with you at your convenience.
Sincerely,

DARRELL L. CLARKE
DLC/dmc
Enc.: Memorandum: Some Quantitative Issues Raised by the "Job Growth Proposal"
cc: Members of Council

MEMORANDUM
TO:

Hal Fichandler, Senior Legislative Advisor

FROM:

Rick Auerbach, Consultant

DATE:

September 9, 20 14

SUBJECT: Some Quantitative Issues Raised By the "Job Growth Proposal"

You have asked me to review the "Job Growth Proposal" submitted by The
Job Growth Coalition ("Coalition"). This memorandum sets forth some significant
issues I believe are raised by the quantitative analysis provided by the Coalition in
connection with its proposal to permit higher real estate tax rates on business
properties, with offsetting cuts to other taxes. 1 I will provide by separate
memorandum an analysis of some issues raised by the Coalition's proposed
language amending Article VIII, Section 2(b) of the Pennsylvania Constitution to
implement its proposal.
I. Spreadsheet is not an "apples to apples" analysis

The Coalition's spreadsheet attempts to estimate the revenue impact of an

increase in commercial real estate tax rates coupled with decreases to the rates of
the wage tax, net income tax, and net income portion of the business income and
receipts taxes ("BIRT"). The spreadsheet compares estimated revenues under those
proposed tax rates to "baseline" revenues under the current 5 Year Plan.
The current 5 Year Plan assumes certain reductions to the wage and net
income tax rate (those reductions have not yet been enacted into law). In
calculating "baseline" revenues, the Coalition's spreadsheet assumes that the wage
and net income tax rate will continue to decline through 2025 at the same rate that
wage and net income tax rates are planned to be cut during the last year of the 5
1

I previously sent you a draft of this memorandum in advance of your meeting with Econsult. Please note
that the earlier draft included some analysis based on the first spreadsheet sent to you by the Coalition,
rather than the revised spreadsheet the Coalition submitted, and some of the differences between this
memorandum and the earlier draft are explained by those revisions (for example, the tables on p. 3 and p.
4 contain different numbers because of the spreadsheet revisions submitted by the Coalition).

Year Plan (again, that planned cut in the fifth year of the Plan is subject to
enactment of legislation by Council). The "baseline" revenues also assume that the
rate of the net income portion ofthe BIRT will decline to 6% in 2023, and remain
at 6% thereafter (those rate reductions have been enacted into law, per The
Philadelphia Code, 19-2604(1)).
The spreadsheet then calculates the revenue impact of the Coalition's
proposed rates (the increase to commercial real estate taxes, coupled with greater
cuts to wage, net income, and BIRT). However, in calculating those revenues, the
spreadsheet does not use the same tax base as used in the 5 Year Plan. Instead, the
spreadsheet assumes that the proposed tax rate changes will have the effect of
growing jobs and businesses, which will mean an increase to the bases of the
various taxes. The spreadsheet includes a tab that shows the various "elasticity"
effects of each tax cut on all tax bases (in some cases, the spreadsheet assumes that
a cut in one tax will increase the base of a different tax; e.g., it assumes that a wage
tax cut will increase the real estate tax base).
Under these assumptions, the spreadsheet concludes that the growth of the
tax bases (and the increase in the commercial real estate tax rate) will more than
offset the cut in wage, net income, and BIRT rates. As stated on p. 8 of its "Job
Growth Proposal," the Coalition believes its proposal will be "strongly revenue
positive to City in years 3-1 0."
I do not believe the spreadsheet makes an apples-to-apples comparison of
the Coalition's proposal to the baseline. As noted above, the baseline 5 Year Plan
also assumes that cuts will be made to the rates of the wage tax, net income tax,
and net income portion of the BIRT. Under the Coalition's assumptions, such
already-assumed cuts will have the effect of increasing the tax base and therefore
increasing revenues. Those increased revenues should have been included in the
baseline against which the Coalition's proposal is compared.
I have attached to the email transmitting this memorandum to
spreadsheet ("EHA 9-9-2014 - Tax Shift Model Five Year Lag") that I
provides an apples-to-apples analysis. 2 It uses the same methodology
Coalition's spreadsheet, but applies the Coalition's "elasticity" model
2

you a
believe
as the
to the

That spreadsheet follows the same analysis as the spreadsheet I emailed to you with the earlier draft of
this memorandum, but it has been revised to include the other taxes the Coalition included in its revised
spreadsheet {parking, amusement, school income, and liquor taxes).

"baseline" rates in order to adjust "baseline" revenues on an "apples to apples"

basis (those adjusted revenues are shown in the tabs with the "eha" label). The tab
labeled "eha - Total - apples" is a summary that compares the Coalition's
calculated net revenue change to what I believe is an appropriately adjusted net
revenue change. As the following table shows, under this apples-to-apples
analysis, the Coalition's proposal is in fact strongly revenue-negative to the City in
years 3-10, and thereafter:

2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035

Coalition's calculated net

revenue change (in millions)

Adjusted net revenue change - Elasticity applied

to baseline rates (in millions)

1
0
(0)
5
20
33
46
59
66

0
(2)
(9)
(16)
(20)
(31)
(48)
(66)
(91)
(119)
(115)
(113)
(112)
(113)
(117)
(121)
(124)
(128)
(133)

72

106
134
156
169
174
179
185
190
196
201

(137)

A second "apples-to-apples" approach would be to consider the "elasticity"

effects only with respect to the amount by which the Coalition's proposed tax cuts
exceed the tax cuts already in the 5 Year Plan (and as projected thereafter). This
would mean that in computing baseline revenues, the tax bases would grow as
projected in the 5 Year Plan, but would not grow further as a result of any
"elasticity" effects of the 5 Year Plan tax cuts, on the theory, perhaps, that those
effects are already built in to the tax base growth projections in the 5 Year Plan
(although I believe that in fact, the projected increases of the tax base shown in the

5 Year Plan are independent of tax rates). Under this approach, baseline revenues
would be the same as calculated by the Coalition, but the projected "elasticity"
effects would be smaller (since the percentage decreases from the 5 Year Plan rates
will be less than the percentage decreases the Coalition computed from the 2015
base rates).
I have followed this alternative approach in a second spreadsheet
("Alternative 9-9-2014 apples-to-apples method") attached to the email
transmitting this memorandum to you. 3 That spreadsheet is identical to the one sent
to you by the Coalition, with one exception. Under the "RE Wage BIRT" tab, the
chart entitled "Alternative Percentage Change in Rates" is adjusted to show the
percentage changes not from 20 15 rates, but from the rates in the 5 Year Plan, as
projected (i.e., what the Coalition calls the "baseline" rates). As shown in the
"Total" tab, under this method the Coalition's proposal is more or less revenue
neutral during the first two years, but increasingly revenue-negative thereafter:

2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030

Coalition's calculated net revenue

change (in millions)

Adjusted net revenue change - Elasticity

applied only to marginal rate cuts below
baseline rates (in millions)

0
(2)
(9)
(15)
(17)
(24)
(38)
(51)
(70)
(91)
(82)
(75)
(71)
(70)

0
0
5
20
33
46
59
66
72

106
134
!56
169
174

(72)

Again, that spreadsheet follows the same analysis as the similar spreadsheet I emailed to you with the
earlier draft of this memorandum, but has been revised in line with the Coalition's revised spreadsheet to
include parking, amusement, school income, and liquor taxes.

2031
2032
2033
2034
2035

2.

179
185
190
196
201

(74)
(77)

(79)
(82)
(85)

Elasticity error

The Coalition's spreadsheet includes a tab showing how a change in any

given tax rate will impact the base of each tax (the "elasticity" estimates). Some of
the impacts are "cross-effects"; for example, a cut in the wage tax, the Coalition
believes, will have the effect not just of increasing the wage tax base, but also the
real estate tax base.
The Coalition also assumes that "Net profits tax revenue will increase by 29
percent of the reduction in BIRT net income revenue due to lower tax rates
(reflecting the tax credit available to firms that pay both the NPT and BIRT)" (see
Coalition's "Assumptions of Tax Shift Revenue Model 8.18.14 (revised), p. 3).
However, if cuts to the tax credit result in a significant increase in net profit
tax revenue, that is in effect an increase in the rate of the net profit tax (certainly,
the economic effect on a taxpayer is the same whether rates are increased or credits
are reduced). That effective increase to the net profit tax rate should (following the
Coalition's analysis) result in a reduction to the net profit tax base. Accordingly,
the elasticity estimates for the net profit tax should include an entry under the
column entitled "BIRT NI rate." However, the Coalition's spreadsheet has a zero in
that column, both for the resident and non-resident net profit tax base.
The effect of this correction would be to lower the estimate of net income
tax revenue under the Coalition's proposal, but the exact amount would of course
depend on the elasticity estimate.
3.

Elasticity estimates for real estate tax base

The Coalition assumes that increases (or decreases) in the real estate tax rate
wiii have no impact on the real estate tax base (elasticity= 0). However, I believe
there is a consensus that increases in real estate taxes depress real estate values,
and decreases in real estate taxes increase real estate values. If that is correct, why
is the elasticity of the real estate tax base to real estate tax rates zero? If the correct
5

I
I

lI
I

Ii

I
:i,,

estimate of elasticity is some number less than zero, then the Coalition's
projections have overstated real estate tax collections under the scenario of an
increase in the commercial real estate tax rate.
Also, please note that the Coalition does assume that the real estate tax base
will be positively affected by cuts to the wage tax rate (elasticity= -.26). Whether
or not that is reasonable is beyond my expertise. However, it should be noted that a
significant portion of the positive revenue effects shown in the Coalition's
spreadsheet are due to the claim that the real estate tax base will increase with
decreases to the wage tax. In fact, without that claimed increase to the real estate
tax base, Coalition's proposal would be net revenue-negative through 2025
(without any other changes being made to the Coalition's own calculations), and at
least 69% of the net revenue gains the Coalition estimates after 2025 are due to the
real estate tax base increase. The last tab (labeled "Effect of r.e. elasticity") of the
"EHA 9-9-2014 Tax Shift Model Five Year Lag" spreadsheet supports those
conclusions. 4
4. Other issues
a.
The Coalition states that the "the proposed increase in commercial
real estate taxes occurs up-front in years one and two in the model, whereas the
reduction in wage and BIRT taxes occurs gradually over 10 years" ("Assumptions
of Tax Shift Revenue Model8.18.14 (revised), p. 1.).
However, it is important to remember that under the proposed Constitutional
language provided by the Coalition, any increase in commercial real estate taxes
resulting from the higher rate for business properties must be fully offset by
reductions to wage and BIRT taxes, including in years one and two. Therefore, the
additional tax cuts proposed by the Coalition after year two are greater than the
minimum tax cuts that would be needed to offset the higher commercial real estate
tax rate, which does not increase after year 2. 5 That is not to say whether or not
those additional tax cuts are good policy or not. However, policy makers should be
4

When I sent you the prior draft of this memorandum, I included this analysis in a separate spreadsheet,
rather than including it as part of the larger spreadsheet.

The prior draft of this memorandum (and accompanying spreadsheet) included a discussion as to
whether the Coalition's proposed rates met the Coalition's proposed Constitutional tax cutting
requirement. I deleted that material because I was not sure whether and how to handle the "elasticity"
effects in determining the revenue impact of proposed rate cuts.

aware that the Coalition's tax rate proposals should be considered in two
categories: (1) those rate reductions necessary to offset the proposed increase to
commercial real estate taxes, as required by the Coalition's proposed Constitutional
language; and (2) those additional rate cuts the Coalition believes would be
beneficial to the City's economic growth.
b.
I had a few comments on the text of the "Job Growth Proposal"
submitted by the Coalition:
i.
Page 4 (assuming the cover page is considered p. 1) shows the
"outflow" of workers from districts (by the way, please note that the "old" districts
are shown, i.e., the districts from which members were elected in 2011, but not the
new districts from which members will be elected in 2015). It says that 37% of the
workforce commutes outside the City, but that seems to be low, given the
generally higher totals shown for each district (the discrepancy might be because
there are fewer workers in those districts showing the higher percentages). In any
event, this is not really relevant to any of the Coalition's quantitative analysis.
Page 6 claims that the 5 Year Plan assumes job contraction
ii.
because the growth of wage tax receipts is assumed to be less than the growth of
wages. I'm not sure if that is correct. The 5 Year Plan also assumes cuts to the
wage tax rate, and that would mean that if employment is assumed to be stable,
wage tax receipts will grow by less than the rate of wage growth. Again, this is not
really relevant to any of the Coalition's quantitative analysis.
Page 8 states that the Coalition's plan is to permit the
commercial real estate tax rate to be 15% more than the residential rate. That
statement is in conflict with the Coalition's proposed Constitutional language on
p.9, which states the residential rate can vary by no more than 15% from the
commercial rate (which would mean that commercial rate could be about 17.6%
higher than residential; e.g., 1.0 commercial, .85 residential). The rates proposed
by the Coalition are 1.34 residential and 1.54 commercial. Under those rates, the
commercial rate varies from the residential rate by a little less than 15%, while the
residential rate varies from the commercial rate by about 13%. Please note that
assuming the residential rate is fixed at 1.34, then, under the Coalition's proposed
Constitutional language, the maximum commercial rate could be set as high as
1.34/.85, or a little more than 1.57.
111.