Tax reductions can work, experience here shows

Oct. 14, 2007
Chris Satullo
Inquirer columnist

Mike Schmidt called Philadelphia the town where you can experience the thrill of victory one day and the agony of reading about it in the papers the next.

For city politicians, the Phillies Hall of Famer's axiom has a corollary: Philadelphia is the town where you can cut people's taxes one day and have them yell at you for it the next.

Michael Nutter, Democratic nominee for mayor, got a taste of this quirky syndrome at a Great Expectations potluck dinner with voters in South Philadelphia a few weeks back.

While on City Council, Nutter led the charge to accelerate cuts in the hated wage tax; his platform pledges more trims in that levy and the job-killing "business privilege" tax.

Yet at the dinner, one civic activist, Freda Egnal, scolded him: "I question the premise that cutting taxes will result in more business. I find it surprising that someone running as a Democrat would take that position. Democrats have not typically been handmaidens of the Chamber of Commerce."

That comment explains a lot about why, even after years of alarms, Philadelphia retains the second-highest tax burden among major U.S. cities, trailing only New York.

Sure, people hate the wage tax; it still drives away residents and jobs.

But every such flight out of town only increases the percentage of remaining residents who form a stoutly pro-tax constituency: poor people who pay little in taxes but need much in city services, and the people (inside City Hall or in the nonprofit sector) who get paid to provide those services.

This group has a point: The 350,000 Philadelphians living in poverty need and deserve services - and the feds do less and less to help. So a heavy burden falls on the city.

Nutter, along with tax-cut advocacy groups such as Philadelphia Forward, responds that cutting the city's onerous tax burden is actually the best way to attract investment and jobs, which in turn will generate the tax revenues to pay for services.

But here in America's bluest city, where many treat George W. Bush and trickle-down economics as swear words, Egnal and a lot of others don't buy that pitch. To them, after the Bush era, the case is closed: Tax cuts always and everywhere are a plot of the rich against the poor.

This disagreement has been a flashpoint of city politics in this decade. Over that time, the city has dabbled enough in tax cutting to produce evidence to inform the debate.

This evidence gives Nutter and the rest of the tax-cutting proponents (including his Republican opponent, Al Taubenberger) plenty of reason to smile, but some cause for furrowed brows as well.

Cuts in the wage tax began under Ed Rendell; their pace accelerated after Nutter and a "briefcase brigade" of business leaders outflanked a reluctant Mayor Street on the issue.

The wage-tax rates - 4.96 percent for residents and 4.3125 percent for commuters when Rendell took office - have been whittled to 4.219 percent and 3.724 percent for this fiscal year. They are scheduled to keep shrinking through 2015, when the target rates are 3.826 percent and 3.534 percent.

First furrow in the brow: For all the political storms this tax nibbling had caused, it hasn't dramatically changed Philly's relative tax burden. A study this year by the Independent Budget Office of New York City looked at state and local tax burdens, relative to local wealth, in the nine biggest U.S. cities. Philadelphia's burden - $7.16 of taxes per $100 of gross taxable resources - was second only to the Big Apple's. Philly's business-tax burden was highest; its wage-tax hit was second-highest.

This underscores a point made by the city's Tax Reform Commission in its 2003 report: "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 overall high tax burden."

One element of the business-privilege tax is a levy on gross revenues without regard to profits. Why not just post signs at the city borders?: "Dreamers, entrepreneurs, biotech start-ups . . . KEEP OUT!"

The state and city have tried to counter this sorry situation by creating tax-free entrepreneurial zones, but those are patchwork fixes.

The city has been modestly reducing the business tax since 1995, too. Nutter wants to eliminate the gross-receipts levy within seven years. But that tax generates roughly $150 million a year. Can job growth spurred by tax cuts really replace all that revenue in the long run?

Many deep-blue Philadelphians doubt that, but recent evidence is more hopeful than most suspect. Despite the tax cuts this decade, city revenues have increased every year.

The record of another tax break, the real estate-tax abatement for new construction and renovation, is even more encouraging. The abatement, reinforcing other helpful trends in the housing market, helped attract new builders and new buyers to Philadelphia; new units built in the city increased sixfold from 1999 to 2006.

The newcomers who bought many of those units helped boost wage-tax receipts. Meanwhile, real estate-transfer taxes were the hidden hero of Philly's budget, rising from just below $80 million in 2001 to a roaring $236 million in 2006, before dipping this year.

Nutter wants to fiddle with the abatement, reducing its generosity in booming parts of town like Center City where such incentives may no longer be needed, and expanding it in other parts of town. Others worry that the onset of a national morgage/housing meltdown may not be a good time to tinker.

Despite this evidence of success, the abatement and tax cuts often were targets of scorn and cries of unfairness at Great Expectations forums. Even though city revenues have risen at a fair clip during this decade, many residents assume tax cuts were the culprit behind the service reductions that caused ritual budget-time squabbles at John Street's City Hall.

Actually, those spats had much more to do with political gamesmanship and the city's inability to rein in the Four Horsemen of the Fiscal Apocalypse: pensions, health care, prisons and debt service.

Those rampaging costs now pose the greatest obstacle to Nutter's tax-cutting promises. There is one other big worry, one possible windfall, and one complicating factor.

The worry is the national housing cooldown. It hasn't yet hit Philly hard. If it does, those helpful transfer-tax revenues will dip sharply.

The windfall is . . . shhhhh, hide the women and children . . . casino revenue. The city's share will be used to reduce the wage tax. Casinos are a radioactive topic in town, so few pols ever mention this. Estimates of the city share are unreliable, but in a best case, it could be enough to shave 0.4 of a percentage point off the wage-tax rate.

The complicating factor is property revaluation for tax purposes, which is overdue to eliminate gross inequities in assessments. Everyone in town seems to fear revaluation, even those who stand to benefit from it.

To allay concerns, the city must come up with a method to buffer taxpayers from huge year-over-year increases, such as basing tax bills on a rolling multiyear average of assessments.