(Photo by Flickr user Justin Wolfe, used under a Creative Commons license)
Here’s a secret sign that an entrepreneur in Philadelphia today is serious, motivated and smart. She doesn’t give a damn about the city’s tax structure. But that doesn’t mean she shouldn’t.
Sure, there will be no parades this Saturday to celebrate the historic 75th anniversary of the oft-maligned city wage tax, introduced in 1939 as an innovative and rational approach for a very different Philadelphia.
And nobody with enough of an economics background to muster a conversation at a cocktail party would defend the particularly maddening local tax portfolio Philadelphia remains stuck on.
But for all the white papers, op-eds and panel discussions, the city’s tax structure, while most certainly flawed, is not a hindrance for starting a company. The messy tax policy, which prominently includes a local income tax, is a hindrance for bigger companies to stay.
"It seemed like a good idea at the time."
That means that the city wage tax may likely be the single most important — and addressable — public policy issue facing Philadelphia today.
This is a report on why tax reform is necessary (no, it isn’t because of small business growth), how we became so in need of it and why change will come, if the right balance of pressure is applied in the coming mayoral election.
When the city’s first wage tax of 1.5 percent was first approved by City Council with a 17-3 vote on Dec. 13, 1939, Philadelphia was the first municipality in the country to have its own income tax, according to a landmark 1999 report [PDF] from the Economy League of Greater Philadelphia — city of firsts, indeed. A local income tax was seen as an innovative experiment for an industrial city to temporarily shoulder the lasting detriments of the Great Depression.
(The city wage tax is like any other income tax, a percentage that is taken from taxable income to pay for services. In Philadelphia’s case, there is a slightly higher rate, 3.92 percent for residents, who presumably consume more city services, and a slightly lower rate for non-residents, 3.4912 percent, who commute into the city to work.)
“It seemed like a good idea at the time,” said David Thornburgh, now CEO of the Committee of Seventy. “This is how you pay for public services in a place and at a time when people are dependent on employment that has fixed, relatively immobile assets, like railroads.” Back in 1999, he was leading the Economy League and is a longtime follower of city policy. (He’s who first tipped us off to the impending anniversary.)
"It’s not that Philadelphia taxes too much, rather it taxes the wrong things."
For decades now, though, the tax’s logic has been lost. Because, as the saying goes, you ought to tax what you don’t want or what can’t move (buildings, not businesses). Workers of today are highly mobile, and, in truth, Philadelphia’s property taxes are likely lower than they ought to be — which doesn’t help commercial real estate rates that are cheap enough to suppress new development.
Two-thirds of municipal tax revenue in Philadelphia comes from taxing “highly mobile” wages and profits, according to a January report [PDF] from the Center City District (CCD). For contrast, in New York City and Washington, D.C., that figure is closer to one-third. Just 17 percent of Philadelphia tax income is from property taxes, compared to more than 40 percent and 36 percent in NYC and D.C., respectively.
“So it’s not that Philadelphia taxes too much, rather it taxes the wrong things,” read the CCD report.
Since 1970, employment in New York City, Boston and D.C. has grown by double digits. In Philadelphia, the total has declined by nearly a quarter.
“The city lost something like 300,000 jobs from the 1960s to the 1990s. We attribute about half of that job loss to the consistent increase in wage tax rates,” said Wharton finance professor and longtime Philadelphia tax analyst Bob Inman. “It was really a primary contributor to the city’s decline.”
For most Americans, and certainly most economists, taxing wages (and other business activities) so heavily at the local level is a strange proposition.
“In [the late 1960s], for the first time, the city took more from the wage tax than property tax,” said Thornburgh. “That’s when we crossed the line, and things were beginning to flame.”
In the 1960s and 1970s, as population began to decline and, with it, property tax revenue sank, the James Tate and Frank Rizzo administrations consistently chose to increase the wage tax, seeing it as a choice to protect homeowners.
“They said, ‘We’ll tax those people coming in from Newtown or Media for work,'” said Thornburgh. “Of course, it had the opposite effect: the higher the wage tax, the lower the property value because you’re depressing demand.”
The wage tax grew as high as 4.96 percent, where it stayed from 1985 until the mid-1990s. Then Mayor Ed Rendell came to City Hall.
WHERE IS THE WAGE TAX NOW?
Today, 20 years after Rendell first announced plans for annual, modest cuts to the wage tax — his “very, very small” cut in 1996 memorably saved the average Philadelphia family $5 — there is no planned reduction in the city wage tax for fiscal year 2015.
Today's startup CEOs see the wage tax as a non-issue.
Every other year, from Rendell through his successor John Street to Michael Nutter, save for a recession-blamed hiatus, the wage tax has been steadily knocked down. From that high of 4.96 percent, the city wage tax for a Philadelphia resident now sits at 3.92 percent.
“The clear goal here [in City Hall] is to reduce business taxes,” said Tilhaun Afessa, the Philadelphia Revenue Department’s director of policy.
Maintaining that consistent schedule of reductions took effort.
Lacking a consistent schedule for its reduction is a great concern — and could be a great opportunity, experts say.
“We have lost the complete certainty that Philadelphia is becoming more competitive,” said Paul Levy, the Center City District CEO and longtime local tax reform advocate. The mayor must set the agenda but the city’s legislative arm has to build policy, he said.
Someone has to take up the mantle in City Council — David Oh has shown interest, as has former resident legislative tax policy wonk Bill Green’s replacement, Ed Neilson, in his own way. But while City Hall has taken measured steps toward readjusting its tax policy, “New Philadelphia” has largely gone about getting business done and re-making the regional reputation of the City of Philadelphia.
Though there were still more than twice as many college-educated 25-34-year-olds living in the region’s suburbs in 2012 than in Philadelphia city, according to American Community Survey data provided by the Center City District, the rate of growth of this demographic between 2008 to 2012 was 60 percent in the city and less than 8 percent for the suburbs.
WHAT THE ENTREPRENEURS SAY
When serial entrepreneur Lucinda Duncalfe moved the headquarters of her healthy food delivery service Real Food Works from Montgomery County to Chinatown, it was clear that the residency requirements of the investment she got from the city-backed StartUp PHL Seed Fund had a role. But Duncalfe said it was at least as much about attracting younger talent, part of a far larger trend.
"Building companies is all about the people. Recruiting is the main determinant of location decisions."
This summer, she left her startup to become CEO of Monetate, a B2B ecommerce optimization company that is one of the region’s larger, more celebrated early-stage tech businesses. Since its beginning, Monetate has been a fashionable anchor of the suburban Conshohocken business community, so Duncalfe has surely addressed the city wage tax in her location choices.
“Building companies is all about the people. Recruiting is the main determinant of location decisions — along with the CEO’s home address,” she said. “In the past, that equation tilted strongly to the [Philadelphia] suburbs. A big piece of that was the wage tax, or at least the perception of the wage tax.”
But people attracted to the stressful, fast-changing, high-risk (and potentially well-paying) tech startup environment aren’t likely only optimizing for taxes, Duncalfe said. Rather, they’re looking for “meaningful, interesting work in an open environment.”
“So I don’t believe that the wage tax was ever really the key determinant in where people wanted to work, nor therefore in companies’ location decisions,” she said. “[In the past] the overarching anti-city sentiment was the real issue, and the wage tax was one of hundreds of reasons for it. Today the balance is shifting from [the] suburbs to the city for cultural reasons, as sentiment has shifted.
Fewer than 1 in 5 Philly-area startup CEOs listed tax policy as a leading challenge.
“Now the city is hot,” Duncalfe added. “The wage tax and overall difficulty of doing business in the city are things that you put on a list of negatives when you’re deciding where to locate, but they’re overwhelmed by other considerations.”
Fewer than one in five Philly-area tech startup CEOs Technical.ly surveyed last year listed tax policy as a leading challenge to their business. More cited access to capital (perhaps another over-blown challenge) and talent (nationwide a challenge). (Our second annual Technical.ly Startup CEO Survey is live, so please share your perspective today here.)
“Both lifestyle (commute, office space environment) and being able to recruit the best candidates have been the biggest drivers,” said Krupit of business location. For him, getting the best candidates has meant experienced technologists. “Since that comes with age, and with age comes family, meaning house and schools are important, [the suburbs have often been where my companies have been based]. That’s why it’s lifestyle, not tax.”
But he, too, acknowledges there appears to be a shift in where that talent is locating — even if by sheer quantity, as noted above, the well-populated suburbs are still fuller with young college graduates than the urban core.
That’s exactly where a different generation of tech startups is taking root in Philadelphia city. Apu Gupta, the CEO and founder of visual analytics firm Curalate, has never had any serious discussions about the city wage tax.
“It seems that much of the concern centers around the notion that the tax would dissuade talent from taking jobs in Philadelphia and that companies would suffer as a result,” he said. “For us, this has not been the case yet.”
That’s because the majority of the top flight designers, developers and creative talent that Curalate is angling to attract want to live in a dense, walkable urban core like Center City. The opportunity cost of Curalate’s growth and city livability trumps the wage tax again and again, he said.
Outspoken Germantown native Alex Urevick-Ackelsberg, cofounder and CEO of Center City Drupal dev firm Zivtech, sniffles at all the tax conversations, calling it “short-sighted” and “a silly issue.”
“People who care about wage taxes are already rich,” he said. “It doesn’t affect us, is barely a blip on our balance sheet and would not influence any of our decisions in the slightest.”
SmartyPal founder Prasanna Krishnan too said city taxes were “not a significant factor.” (She did say that when she was working years ago for Comcast with a group in Radnor, “some of my colleagues who lived in the suburbs were not keen” on their offices being relocated to Center City, since they’d have to pay the wage tax.)
"If you take all the tech startups together, I'm not sure they'd fill 100,000 square feet of commercial real estate."
Nearly 200 freelancers and small-firm entrepreneurs, among others, come through Old City coworking space Indy Hall. Rather than taxes themselves, there are far more common complaints among members about how confusing the business setup and compliance process can be in the city, said community manager Adam Teterus, who said he got behind in city taxes “because I straight up didn’t understand what to do.”
City taxes may certainly be “complicated and annoying,” said Indy Hall cofounder and frequent creative class voice Alex Hillman, “but the thing that people talk about far more often as a very real debate item for moving out of the city when they’d prefer to stay is the schools, as related to their kids.”
As Hillman wrote in an email: “I only ever hear tax issues as a justification for not doing something that they weren’t really going to do in the first place, a.k.a. the folks who are going to look for an excuse no matter what.”
That may be rational for the entrepreneurs themselves, but there’s a greater good to be thought of, said Levy, the Center City District CEO.
“I understand an entrepreneur, who looks at their laptop and sees a growing technology firm, not finding the importance [of tax policy],” said Levy. “For a company like Curalate, the competitive advantages [for hiring] in Philadelphia are strong, and the disadvantages are modest,” said Levy. “But we have not grown many big firms.”
Post-recession, there has been a national boom of sole-proprietorships, one-person operations that include freelance graphic designers and app developers, in addition to hair stylists and construction workers. From 1999 to 2011, the national average in growth was 52 percent, while Philadelphia’s increase was more than twice that, according to the CCD report. (This data point may explain why the city is ripe for coworking.)
While that’s positive in some ways, there might be some concern that Philadelphia’s rate is more in line with other struggling urban economies like Detroit and Baltimore than with D.C. or Boston.
The energy around the region’s tech community is unquestionably important, said Levy, for brand building and talent acquisition, but it won’t replace the city’s economy on its own.
“If you take all the tech startups together, I’m not sure they’d fill 100,000 square feet of commercial real estate,” said Levy. In total, Center City has 39.7 million.
We need the law firms and large consulting firms and other established businesses that have accounting departments, he said. “Those people care very much about tax policy.”
“For entrepreneurs, they’re still evolving. They don’t know yet what they don’t know,” said Joe Grace, the director of policy for the Greater Philadelphia Chamber of Commerce, which, for the record, was responsible for the first draft of the city wage tax introduced in November 1932.
WHAT IS THE GOAL?
Given a challenge, it helps to point to a goal. The funny thing is that it appears that for so long the fight has been to get the wage tax reduced (as part of a broader approach to lessen the role of business taxes and increase the role of property taxes), that there doesn’t appear to be a single, consistent goal.
“I think that the most important thing is that the wage tax be reasonable, so that it can’t be used as an excuse for not locating downtown,” said Duncalfe, the entrepreneur and new CEO of Monetate. For her, the perception is at least as important as the actual rate. What is reasonable then? Well, of course, that’s quite relative.
Now is very much the time to come back to goal setting, as the mayoral primary begins its race toward May (which will likely choose the next Philadelphia mayor, in a city that leans overwhelmingly Democratic). Plans to influence the agenda are already being set — Technical.ly Philly, too, is involved in several soon-to-come initiatives.
Next month, the Chamber of Commerce is hosting a mayoral issue forum on business competitiveness in its Roadmap to Growth campaign that will include tax reform, including the wage tax.
Two Center City development leaders are preparing to return to a clever idea floated during the 2003 city Tax Reform Commission: two levels of property tax rates, one for residential and one for commercial real estate.
There's some momentum around smart tax reform. But will it be enough?
Backed by Levy, the Center City District leader, and Brandywine Realty CEO Jerry Sweeney, the plan proposes higher commercial real estate millage rates than residential in exchange for a more robust “dollar for dollar reduction in the city wage tax,” said Chamber policy director Grace. (The Chamber has not yet endorsed the idea but is looking at it very seriously, he said.)
The hope is that the average square-foot cost to rent commercial real estate would increase (thereby making new property development more lucrative) and the city could more rapidly transition away from the wage tax in exchange for property tax revenue while “never touching the political third rail that is increasing residential property tax,” said Levy.
The tax reform commission put the goal for the wage tax to be between two and three percent (again, today, it’s at 3.92 percent for a city resident). That’s a meaningful and reasonable mark, said Thornburgh, of Seventy. The Chamber does not have an official stance on where the wage tax should be, though it publicly champions its incremental reduction, Grace said.
That two to three percent range is a “competitive rate” said Wharton’s Inman. Though debate about increasing the speed of its reduction is healthy, a Wharton finance professor like Inman defends the slow and steady transition.
“It’s not this fantasy world where you lower tax rates and there is a flood of new business here. Lowering taxes does mean shorter-term lower revenues,” said Inman. “There’s a benefit to rate reductions, but it’s not an immediate response.”
That’s where people like Levy and Thornburgh say a one-time asset sale, like the Philadelphia Gas Works deal that was spiked by Council President Darrell Clarke, could serve a powerful role as transitional bridge.
“What we need from the next mayor’s tax policy is not just a means of collecting revenue to offer services,” said Levy. “We need a model of encouraging or discouraging growth. Tax policy is economic development.”
The two most pressing public policy issues facing Philadelphia are educating a labor force and tax policy to provide services while retaining business to employ that labor force, said Thornburgh of Seventy.
“We have to prioritize public policy issues by asking, ‘Is it worth doing and is it doable?'” he said. “Both are worth doing, but we’ve had a School Reform Commission for 15 years. Tax reform is far more doable.”
It has a clearer path forward. he said. Commit to clear, long-term reductions, find spending efficiencies and leverage a large asset sale to cover a faster transition that’s more in line with peer cities, he said.
“Do we want to celebrate the 100th anniversary of the wage tax?” said Thornburgh. “What will the city look like if we do?”