Tax Planning Seminar 2012

Report
Business Tax Reform:
While Change is Underway, Work
Remains to be Done
Leveling the playing field for key business sectors +
Helping small businesses +
Encouraging entrepreneurship =>
Increased economic activity
Job creation
Growth
Fall 2012
The Broader Context
 The multiple levers policy-makers can pull that impact
the business climate in Philadelphia and the city’s
economic competitiveness include:
 Tax burden: business income and receipts tax (BIRT),
wage tax, real estate tax, use and occupancy tax, etc.
 Cost of government/services provided: the “value
proposition” offered to citizens and businesses
 Efficiency of government: ease of accessing services
and information, use of technology, complexity of
regulatory structure, “one-stop-shopping” orientation
2
The Broader Context
City Council is pursuing efforts on multiple fronts:

Tax burden:
 Passed legislation removing property assessment function from
Board of Revision of Taxes (BRT) and transferring it to a new Office
of Property Assessment as necessary first step to making property
assessment and taxation system accurate, equitable, and
predictable.

Cost of government/services provided:
 “Freshman 15” – innovative reform proposals that have saved the
city over $50M/year.
 Legislation requiring “program-based budgeting” so citizens and
policy-makers know the cost of providing particular city services,
goals/metrics for each service, and how well the city is performing.

Efficiency of government:
 Legislation requiring an electronic option for all city-related
interactions/transactions (e.g., completing forms, license and
permit applications, service requests, payment of bills, taxes, fees,
and fines).
3
Context Re Business Tax Policy


The City’s business tax – previously termed the “business
privilege tax” (BPT) and now called the “business income and
receipts tax” (BIRT) – consists of two parts:

Gross receipts tax: low-rate (0.1415%) and applied to sales in
Philadelphia

Net income tax: high-rate (6.45%) and applied to the business
income of Philadelphia-based businesses
Although the net income tax portion of the BIRT is a primary
factor in Philadelphia’s ranking on comparative charts as a
very high business tax location . . .
Corporate
net income
taxes
Federal
State
City
Total
Tax rate
35%
9.9%
6.45%
51.35%
4
Context Re Business Tax Policy


. . . prior tax reform initiatives focused on eliminating the gross
receipts tax for reasons including:

the critique that the gross receipts tax was not tied to “ability to
pay” (begging the question of whether local tax policy should
subsidize non-profitable firms, which, in theory, cannot survive for
long regardless of their tax burden);

the sense that it would be “easier” to get rid of the lower-revenue
gross receipts tax; and

the absence of an econometric estimate of the supply-side effect
of eliminating the net income tax.
However, new analysis re how the gross receipts vs. net
income tax burden is distributed between taxpayers indicates
that eliminating the net income tax should have a more
important positive impact on Philadelphia’s economy than
eliminating the gross receipts tax.
5
High-Rate Net Income Tax Creates a
“Profitability Penalty” for Local Businesses

There is broad consensus that the 6.45% net income tax is a
major disincentive for many businesses to locate in city.

Leaders of publicly traded companies may have a fiduciary duty
to not incur high levels of tax. The net income tax creates a
significant barrier to such companies locating in Philadelphia.

Even home-grown companies – such as biopharma and
technology start-ups incubated at the Science Center – are
encouraged by their VC investors to move out of the City, often
to the Route 202 corridor, once they hit profitability.

When engaged in business planning, smart businesses look more
closely at revenue than expenses and plan over a multi-year
time horizon – with the goal of maximizing profits.

Shifting to a gross receipts-only business tax encourages
economic growth by removing the “profitability penalty”
placed on Philadelphia-based businesses by the net income tax.
6
Current Tax Structure Puts Philadelphia
Businesses at a Competitive Disadvantage
 The current business tax structure puts Philadelphia businesses at a competitive
disadvantage.
 Philadelphia businesses have to pay the net income tax, but most out-of-city
companies either aren’t subject to the net income tax or can use tax planning
strategies to avoid paying it.
Business Location
Sales Location
Under current tax structure
Philadelphia business
Philadelphia
.001415 gross receipts tax +
6.45% net income tax
Non-Philadelphia Business
Philadelphia
.001415 gross receipts tax
Philadelphia business
Outside-of-Philadelphia
6.45% net income tax
(apportioned)
Non-Philadelphia Business
Outside-of-Philadelphia
No BIRT
7
Net Income Tax Subject to Tax
Avoidance by Sophistical, Large Firms

In addition to the aforementioned structural issue, there a
multiple ways for sophisticated, large companies to avoid net
income tax liability.

The most common avoidance technique is the “Delaware
loophole,” whereby multistate and multinational corporations
reduce or eliminate their net income tax liability by shifting the
business income attributable to their Philadelphia operations to tax
havens, such as Delaware.

Closing such loopholes at the local level is extremely difficult
and recent efforts to address the “Delaware loophole” at the state
level have been unsuccessful.

Shifting to a gross receipts-only business tax would shut down
such tax avoidance techniques – thereby distributing the local tax
burden more equitably.
8
High-Rate Net Income Tax Distorts Rental
Rates for Center City Office Space

Due to Philadelphia-based taxes, the cost for tenants to locate in
Class A office space in Center City are $3.89/sf higher than for
comparable space in the suburbs.1
Detailed Analysis from 2005 of business tax impact on Class A tenants:
14% premium paid to locate in Center City vs. suburbs

1.
2.
Cost
Center City
PA suburbs
Inclusive Rent
$25.85
$26.93
U&O tax
$1.30
$0.00
BIRT
$3.67
$0.00
Employer-paid
$30.82
$26.93
Differential (per SF)
($3.89)
The BIRT accounts for $3.67 (>93%) of this premium and, of
that, the majority is due to the net income tax.2
Paul Levy, “Can Tax Reform Get Traction in 2010? Overview of Task Force Recommendations on Tax
Reform,” pg. 17.
Id.
9
High-Rate Net Income Tax Distorts Rental
Rates for Center City Office Space
 For larger partnerships (including law, accounting,
consulting, and financial advisory firms) with high profit
margins and thus high net income tax liability, the
business tax-related premium to locate in Center City is
$7.75/sf to $12.42/sf – a 30% to 40% premium.3
 With the elimination of the net income tax, the “economic
rent” for many Center City tenants – particularly the
professional services firms that occupy the majority of
Class A office space – will be reduced significantly.
 The BIRT-component of the economic rent for typical Class
A office space tenants should drop by over $3/sf and by
over $7/sf for large partnerships.
3.
Id., pg. 18.
10
High-Rate Net Income Tax Distorts Rental
Rates for Center City Office Space
 The proposed reform should increase demand for Class A
office space based on the projected positive supply-side
impact.
 By making the city a more attractive location for
profitable businesses – and no longer penalizing them for
their profitability – more of these firms should locate,
grow, and remain in the city, driving up demand for
office space.
 This higher demand (and, potentially, higher rents) will
help begin to address to current “cost barrier” to new
construction in Philadelphia.
11
Key Component of Proposed Reform:
Shift to Gross Receipts

Thus, the proposal is to eliminate the net income tax and raise
the gross receipts tax as follows:

A revenue-neutral, phased shift in the BIRT that, over a
five-year period, eliminates the net income tax.

The foregone net income tax revenue is made up by
increasing the gross receipts tax to 5.27 mills ($5.27 tax for
every $1,000 of receipts or approximately ½ of 1%).

Phasing in the shift over five years provides sufficient lead
time for businesses to engage in tax planning and adjust
their behavior in response to the changed rates.

The five-year phase-in also gives the City the ability to adjust
planned rate shifts, if needed.
12
Overview of Tax Rates under
Proposed BIRT Reform
Standard Business Income and Receipts Tax Rates
Tax year(s)
Gross receipts rate
Net income rate
2008 to 2013
1.415 mills (0.1415%)
6.45%
2014
2.208 mills (0.22%)
5.16%
2015
3.002 mills (0.3%)
3.87%
2016
3.796 mills (0.3796%)
2.58%
2017
4.5578 mills (0.44%)
1.29%
2018
5.2723 mills (0.527%)
0.0%
2019
5.0649 mills (0.5065%)
0.0%
2020
4.9414 mills (0.4914%)
0.0%
2021
4.8209 mills (0.4821%)
0.0%
13
Guiding Principles for Reform
This business tax reform proposal was designed to satisfy
three guiding principles:

Encourage economic growth in Philadelphia:

Makes Philadelphia a more attractive location for new business
formation and investment

Removes the “profitability penalty” imposed on Philadelphiabased firms by the net income tax, eliminating an incentive for
companies to leave the city once profitable

Reduces the competitive disadvantage of Philadelphia companies
vs. their regional competitors selling in the same market – i.e.,
“levels the playing field”

Advantages growth sectors of the local economy
14
Guiding Principles for Reform


Achieve increased equity among business taxpayers:

Business tax burden more equitably allocated across businesses of
different sizes

Satisfies basic taxation principle: broad base/low rate >>>
narrow base/high rate

Provides a more viable “escape valve” for manufacturers,
wholesalers, and retailers
Create a more efficient tax system:

Simplifies the preparation of business tax returns, maximizing tax
compliance

Simplifies tax return auditing, freeing up resources to identify nonfilers and those otherwise not in compliance

Produces a more stable revenue source
15
BIRT Reform Needed to Generate
Economic Activity/Create Jobs
The Economic Perspective
from Steve Mullin, former Commerce/Finance Dir.
 Philadelphia has a chance to come out of the recession in a stronger relative
economic position than it has after past recessions. Adopting this new business
tax reform is the single best way to accomplish such an important goal.
 No longer would existing or potential businesses have to deal with a staggeringly
unattractive corporate income tax rate of 35% federal + 9.9% state + 6.45%
city = over 50%. There is no question that this income tax burden pushes
businesses – and jobs – out of the city.
 The real “winners” right now, and under the gross receipts tax elimination plan,
are those businesses that start, relocate, or expand outside of the city and the
real “losers” are those businesses and citizens remaining in the city with a
smaller economic and tax base than if some of that activity had occurred in the
city, as it would under the business tax reform.
 The BIRT reform will have an overall positive impact on the city’s economy
and spending, because the positive effect of the net income reduction will be
greater than the negative effect of the gross receipts increase.
16
BIRT Reform Needed to Generate
Economic Activity/Create Jobs
The Economic Perspective
from building owners, developers, and
contractors who testified in support of the proposed business tax reform in late 2010.
 Representatives from two of the largest commercial property owners in the
city testified that:

The high-rate net income tax is often the deciding factor for companies considering
locating in Philadelphia and results in these potential employers not coming to the city.

Eliminating the net income tax will make the city a more attractive location for
profitable businesses, result in more businesses/jobs moving to and staying in the city,
create more demand for office space, thereby increasing occupancy rates, driving up
rents, raising property values, and increasing commercial property tax revenue.
 The BIA, representing both residential developers and contractors, testified that
the proposed reform would result in increased development, generating jobs
and tax revenues:

“None of us will be proposing to build a new project unless we project a profit, and
consequently eliminating the net income tax will add substantially to the bottom
line of the project. Our industry is a catalyst to economic expansion. By starting new
projects, we create jobs [and] generate revenue [. . .].”
17
Encourages Economic Growth:
Likely Supply-side Impacts

Businesses always adjust their behavior to tax changes, so
considering the likely supply-side effects of the proposed reform is
important.

Previous studies suggest a positive supply-side effect of gross
receipts tax rate reductions, but only in isolation and while
holding the net income tax rate constant.

As the 2009 Task Force on Tax Policy commented: “Although
exact predictions are not possible, economic theory suggests that
reducing the net income portion . . . would have a positive impact
on job opportunities in the city.”4

The essential question, not previously asked or analyzed, is:
“What would have the bigger supply-side impact – reducing the
gross receipts tax or reducing the net income tax?”
4.
Mayor’s Task Force on Tax Policy & Economic Competitiveness in Philadelphia, “Thinking Beyond Today: A
Path to Prosperity,” pg. 18.
18
Encourages Economic Growth:
Likely Supply-side Impacts

Consideration of how the gross receipts and net income tax burdens are
distributed across local businesses suggest that eliminating the net income
tax should have a greater positive supply-side effect than eliminating
the gross receipts tax.

Based both on its review of multiple years of business tax returns and on
economic research, Econsult reached the following conclusions regarding
the likely supply-side impact of the proposed reform:



Growth of high-margin/profitable firms generates growth in low-margin/less
profitable firms, but not vice-versa.
Accordingly, City policy should encourage the high-margin group to grow –
thereby laying the foundation for a spillover growth effect on the low-margin
group.
The positive impact of the net income tax reduction on the high-margin group
likely will be greater than the negative impact of the gross receipts tax increase
on the low-margin group.
19
Encourages Economic Growth:
Likely Supply-side Impacts

While there will be firms whose taxes go up or down under the
reform in the short run, for many of the industries that may
experience a short-term increase in cost – such as large retailers
and non-local hoteliers – the overall positive impact on their
top line (i.e., revenues) should more than swamp any increase
in their above-the-line expenses, as the rate increase is so small
(about one-third of 1% or .0038) compared to now and could be
even less for those that can use the alternative method/rate.

The proposed rate changes reflect a conservative, zero-sum
rate change based on 2008 data – in other words, they do not
assume the positive supply-side effect the reform should
generate.

The expectation is that, rather than being zero-sum, the change
will be dynamic – having an overall positive impact on the
city’s economy and spending.
20
Proposed Reform is Consistent with
National Trend
 Shifting away from net income and toward gross receipts
tax is consistent with a developing national trend, as
states and localities move to receipts-based taxes and
attempt to spread the tax burden across more businesses.
 A leading tax policy treatise5 outlines the advantages of
a gross receipts tax compared to a net income tax,
which include:




5.
taxing all businesses, consistent the fact that all businesses
benefit from government services regardless of their
profitability or organizational form;
being simpler to implement;
dampening distortions, as a result of having a lower tax rate
applied to a broader base; and
providing more stable tax revenues.
Pogue, Thomas F., “The Gross Receipts Tax: A New Approach to Business Taxation?,” National Tax Journal, Vol.
LX, No. 4 (December 2007), pgs. 799-819.
21
Proposed Reform is Consistent with
National Trend

Examples of the trend toward receipts-based taxes include:

Ohio: Implemented a “Commercial Activity Tax” (an annual privilege tax
measured by gross receipts on in-state business activities) in 2005, with
five-year phase-in (to a 2.6 mill rate) and concurrent phase-out of
Corporate Income Tax.6

Texas: Implemented a “Margin Tax” on general gross receipts in 2007.7
Standard rate is 1%; qualifying wholesalers/retailers pay 0.5% (5 mills);
and businesses with under $10M/year in receipts pay 0.575% (5.75
mills).

California: State-charted “Commission on the 21st Century Economy”
recommended eliminating the state’s corporate income tax and sales and
use tax and replacing them with a business net receipts tax that would
tax a broad range of economic activities at a relatively low rate.8
6.
7.
8.
Ohio Department of Taxation, “FAQs – Commercial Activity Tax” (available at http://www.tax.ohio.gov/faqs/CAT/cat.stm#1).
Texas Comptroller of Public Accounts, “Franchise Tax Frequently Asked Questions” (available at
http://www.onlinedetective.com/resource/view/59950).
Commission on the 21st Century Economy, “Final Report” (available at http://www.cotce.ca.gov).
22
Proposed Reform is Consistent with Prior
Tax Reform Efforts

The proposed reform is designed to make Philadelphia more
economically competitive in the region – a primary goal of all
prior tax reform efforts.

Framing the issue, the 2003 Tax Reform Commission noted that
“businesses and residents can move within a region to avoid
paying high local taxes while still enjoying many of the region’s
benefits.”9

This analysis was echoed in the 2009 report of the Mayor’s Task
Force on Tax Policy and Economic Competitiveness, which observed
that “[t]ax savings from moving to a lower cost community in the
same region no longer means losing one’s labor force, customers, or
suppliers.”10

Accordingly, tax reform should be geared to attracting and
retaining profitable firms that can leave the city, and focus on
overall system efficiency and equitability – as the proposed BIRT
reform does.
9.
10.
Philadelphia Tax Reform Commission, “Final Report November 15, 2003 – Executive Summary,” pg. 2.
Mayor’s Task Force on Tax Policy & Economic Competitiveness in Philadelphia, “Thinking Beyond Today: A Path
to Prosperity,” pg. 16.
23
Proposed Reform is Consistent with Prior
Tax Reform Efforts
 In calling for modification of the net income tax
methodology, the 2003 Commission noted:

“Businesses that make sales in Philadelphia without locating
here benefit from the current formula, while businesses
maintaining buildings and employees in the city are
penalized.”11
 Eliminating the gross receipts tax rather than the net
income tax – as had been the tax reform orthodoxy until
the Green/Sanchez proposal – exacerbates the
competitive disadvantage of locating in Philadelphia.
 Only through the elimination of the net income tax –
which is borne disproportionately by Philadelphia-based
businesses – is the regional disincentive to locate and
grow in Philadelphia addressed.
11.
Philadelphia Tax Reform Commission, “Final Report November 15, 2003 – Executive Summary,” pg. 8.
24
A Closer Look re the Need to Create a
More Level Playing Field for Businesses
 PROBLEM: The traditional business tax structure puts Philadelphia-based
businesses at a competitive disadvantage.
 Philadelphia-based businesses had to pay the high-rate, 6.45% net
income tax both on their in-city and a portion of their out-of-city sales.
 Most of their non-Philadelphia competitors either weren’t subject to
the net income tax or could use tax planning strategies to avoid
paying it.
Sales location
Philadelphia business
Non-Philadelphia business
Sales in Philadelphia
001415 gross receipts tax +
6.45% net income tax
.001415 gross receipts tax;
no net income tax
Sales outside of
Philadelphia
6.45% net income tax
(apportioned)
No Philadelphia business tax
25
A Closer Look re the Need to Create a
More Level Playing Field for Businesses
Hospitality Sector Example
Total Sales
(avg. 2007-10)
Based in
Philadelphia (N)
Based outside
Philadelphia (F)
(data from Greater Phila. Hotel Association)
Current business tax cost
Projected business
tax cost w/reform
$19,197,770
$184,896 (7x more than
non-city competitor)
$101,748
$18,609,322
$26,332
$98,629
 Data provided by the hotel sector indicates that Philadelphia-based hotels are paying the net income
tax, while their non-city-based competitors are not.
 Based on this same industry data, Philadelphia-based hotels have 13% average profit margins, while
their non-Philadelphia-based competitors show $0 taxable income in Philadelphia. The hotel sector could not
explain this discrepancy at a City Council hearing on business tax reform.
 Philadelphia-based hotels tend to be union shops, paying their workers a living wage.
 By full phase-in, on an $150/night average room rate the total BIRT cost would be $0.80 (an increase of
$0.58 from the current business tax cost). The tax reform proposal would simplify passing this cost on.
 As hotel sector representatives acknowledged at a November 2010 hearing, no hotel customer is going
to stay in Conshohocken or Cherry Hill instead of Philadelphia to avoid a $0.80 charge.
26
A Closer Look re the Need to Create a
More Level Playing Field for Businesses
Manufacturing Sector Example
($1M total sales; $100K sales in Phila.; $50K total profits = 5% margin)
Current Business Tax Costs
Business Tax Costs Under Reform
Philadelphia
manufacturer
$3,665.50 (23x more than
non-Philly competitor)
$530
Suburban
manufacturer
$141.50
$530
 Manufacturers representing a range of business sizes and specialties testified
at a hearing in support of business tax reform in 2010.
 They described how the net income tax puts them at a competitive
disadvantage, and drives many manufacturers out of the city.
27
Why Manufacturing Matters to the City
 A recent Green Economy Task Force report emphasized the
importance of focusing on manufacturing12 in growing our
local economy:
 “Manufacturing is one of the strongest segments of
the Philadelphia economy in terms of jobs provided, taxes
contributed, and total economic output. The emergence
of the sustainability movement has created myriad
opportunities for further developing the sector . . . .
We cannot wait to act: this historic opportunity will
pass us by if we do not move swiftly and cohesively to
improve the working environment for these valuable
businesses.”
12. Elliott Gold, Emerging Industries Project of Green Economy Task Force, “Redeveloping Local Sustainable Manufacturing Infrastructure in
Philadelphia,” pg. 42 (available at: http://www.sbnphiladelphia.org/images/uploads/02-16-10_EIP_manufacturing.pdf).
28
How the Proposal Creates a More
Level Playing Field
Sales Location
Business
Location
Philadelphia sales
Philadelphia
business
.00527 gross receipts tax
Non-Philadelphia
Business
.00527 gross receipts tax
Philadelphia
business
No BIRT
Outside-of-city
sales
Non-Philadelphia
Business
Under BIRT structure in
2018, per proposed reform
No BIRT
 Under the proposal, Philadelphia
businesses would compete on a level
playing field, having the same
business tax costs as their
competitors.
 On their sales in the city, Philadelphia
businesses and their competitors from
outside the city would pay the same
low gross receipts tax.
 On their sales outside of the city,
Philadelphia businesses would not
have to pay any business tax – just
like their competitors.
 The only guaranteed way to remove
the competitive disadvantage for local
businesses under the business tax is
to eliminate the net income tax.
29
Interim Solution re Creating a More
Level Playing Field
 While working for broader business tax reform, there was an
opportunity to provide immediate relief for some local business
sectors – including manufacturing – that are particularly
disadvantaged by the current business tax structure.
 PROPOSED INTERIM SOLUTION: Implement single sales
factor apportionment.
 Under single sales factor apportionment, local businesses that sell
tangible goods would no longer have to pay net income tax on their
sales outside of the City.
 Export-based sectors including manufacturing and wholesaling would
operate on a more level playing field when competing with
businesses located outside of the City for customers.
 Based on analysis performed by the Revenue Department, this
reform will result tax savings for Philadelphia-based businesses
across all industries, in the aggregate.
30
Interim Solution re Creating a More
Level Playing Field
Manufacturing Example: Single Sales Factor Apportionment
 Implementing single sales factor apportionment significantly lessens,
but does not eliminate, the competitive disadvantage imposed on
Philadelphia-based businesses by the current business tax structure.
 Consider the relative business tax burden on two manufacturing firms,
one based in Philly and one based in the suburbs, with the same sales
volume ($1M), local market sales ($100K), and profit margin (5%)
under the current tax structure vs. single sales factor apportionment:
Philadelphia manufacturer
Suburban manufacturer
Current business tax
costs
$3,665.50 (23x more than
non-Philly competitor)
$141.50
Business tax costs
with single sales
factor apportionment
$464 (still 3x more than
non-Philly competitor, but
significant savings versus
current policy)
$141.50
31
A Closer Look re the Importance of Helping
Small and Start-up Businesses
 FACT: The majority of businesses paying the business tax are small
businesses.
Percentage of BIRT Filers by
Business Size
17.5% =
over $1M in
receipts
59% = under
$100K in
receipts
23.5% =
$100K-$1M
in receipts
 Of the 90,000 business tax
filers in 2008, close to
75,000 (83% of the total)
were businesses with under
$1M/year in sales.
 As noted by renowned
Wharton Professor Robert
Inman, “small businesses
are the heart of the
Philadelphia economy.”13
13. Robert P. Inman, Ph.D., "Local Taxes and the Economic Future of Philadelphia: 2009 Report,” pg. 12.
32
Helping Small Businesses Encourages
Local Economic Growth

Although small businesses have been hard-hit by the recession,
historic trends suggest that these businesses will be key to
Philadelphia’s future growth.

Census Bureau data indicate that following both the 1990-91 and
the 2001 recessions:
 “Firms with fewer than 20 employees were the only
ones with positive net job growth; the larger category of
small businesses with fewer than 500 employees, as well as
large firms with 500 or more employees, both experienced
net employment losses.”14

14.
15.
16.
In the period between 1993 and 2008, small businesses
generated 64% of net new jobs,15 accounting for 60-80% of
net new jobs annually.16
Small Business Association (SBA), “The Small Business Economy 2009: A Report to the President,” pg. 9 (available at:
http://www.sba.gov/advo/research/sb_econ2009.pdf).
SBA Frequently Asked Questions (available at: http://web.sba.gov/faqs/faqIndexAll.cfm?areaid=24).
“The Small Business Economy,” pg. 10.
33
Helping Small Businesses Encourages
Local Economic Growth

Recent research highlights the importance of small
businesses to economic growth.

In a 2010 paper,17 Harvard professors reported their findings
that:
 “regional economic growth is highly correlated with an
abundance of small firms”
 “an abundance of small, independent firms is one of the best
predictors of urban growth”

While Philadelphia has an abundance of small businesses, and
thus is well-positioned to take advantage of this growth
potential, the City’s business taxation policy – as embodied in
the business tax – disfavors these same firms.
17. Edward Glaser and William Kerr, “What Makes a City Entrepreneurial?,” Rappaport Center/Taubman Center Policy Brief,
February 2010 (available at: http://www.hks.harvard.edu/rappaport/downloads/policybriefs/entrepreneurs.pdf).
34
A Closer Look re Tax Relief for Small
and Start-up Businesses
 PROBLEM: These same small businesses that are key to the
City’s economic growth are paying more than their fair share in
net income tax under the current structure.

These small businesses do not have sophisticated tax planning options
(such as out-of-state holding companies) to avoid paying the net income
tax, like many larger companies do.
 PROPOSED INTERIM SOLUTION: Exempt the first $100K in
business receipts from both the gross receipts and the net
income18 parts of the BIRT.
 The across-the-board $100K exclusion provides an important protection
for start-ups and encourages entrepreneurs.
 Including the net income tax in the $100K exclusion is an essential part
of how the reform helps small businesses, which have a
disproportionately high net income tax burden.
18. The legislation uses a pro rata formula to exempt from taxation net income that is attributable to a filer’s first $100,000 in
receipts.
35
A Closer Look re Tax Relief for Small
and Start-up Businesses
 This tax reform will result in significant tax savings for small businesses, including
start-up firms, which are an engine of job growth in Philadelphia.
 The change will make Philadelphia’s tax structure much more progressive by
targeting the tax relief toward small businesses.
Business tax filers
by business size
Business tax
costs in 2008
New business tax costs
(adjusted for reduced
credit vs. net profits tax)
% change
Up to 100K
$23,598,437
$11,351,528
-51.9%
>100k and <=250k
$18,871,922
$11,794,761
-37.5%
>250k and <=500k
$15,331,877
$12,216,790
-20.32%
>500k and <=1M
$17,145,471
$15,142,839
-11.68%
 Furthermore, due to the $100K exclusion, between approximately 55,000 of the
90,000 current business tax filers will owe $0 in business tax by full phase-in.
36
Targeted Tax Relief is on the Way!
 The Green/Sanchez’s business tax reform legislation passed in
late 2011 provides targeted tax relief focused on:
 Small businesses; and
 Philadelphia-based businesses
 By full-phase in, the legislation will provide almost $50M/year
in tax relief for Philadelphia-based businesses – significantly
more than was previously planned.
 Furthermore, the tax relief is focused on small businesses and
on Philadelphia-based industries, including manufacturing,
that are particularly disadvantaged under the current business
tax structure.
37
Targeted Tax Relief is on the Way!
 The Green/Sanchez bill provides targeted tax relief. By full
implementation:
 Over 30,000 of the 90,000+ current business tax filers will
have no business tax liability whatsoever (i.e., $0
business tax and $0 net profits tax).
 An additional 25,000 filers will have $0 business tax
liability.
 The business tax burden on micro-enterprises (those with
under $100K per year in sales) will be reduced by 50%.
 The business tax burden on Philadelphia-based
businesses will be reduced, in the aggregate, by 20%.
38
Phase-in Schedule for Tax Relief
 In recognition of ongoing pressure on the city’s finances, the tax
relief measures contained in the Green/Sanchez bill are being
phased in over a five-year period.
 The measures are being paid for, in part, by keeping the lowrate gross receipts tax at its current level (.001415) and slowing
planned reductions in the net income tax.
 The $100K exemption is being phased-in as follows:
 A $50K exemption will be available for 2014
 A $75K exemption will be available for 2015
 The full $100K exemption will be available for 2016 and
thereafter
 Single sales factor apportionment will be phased in starting in
2013 and will be fully in place by 2015.
39
So, What Comes Next?
 In recognition of the fact that meaningful fiscal reform should consider
both the revenue and the expenditure side of the ledger, City Council’s
Committee on Finance has been authorized to hold hearings to:

“examin[e] the current tax structure and cost of government in
the City of Philadelphia and how to reform both to increase the
City’s regional and national economic competiveness, stimulate job
growth, and attract and retain residents.”
 In preparation for these hearings, the Committee plans to engage
economists to help analyze the pros and cons of various tax reform
proposals, including those outlined above, in continuation of a databased approach to tax reform.
 The AVI discussion started this spring will resume. Council is still
awaiting information from the administration about the new assessed
property values under AVI. The lack of this information prevented AVI
from moving forward for 2013, as it is essential to Council determining
what relief measures – if any – are appropriate.
40
Important Issues Regarding the
Proposed “Mobile” to “Immobile” Shift
 A recent tax reform commission, and some in the business community,
have called for a shift from “mobile” to “immobile” tax bases.

This proposal would mean reducing or eliminating taxes on wages and businesses
(i.e., things that can move) and making up the revenue by increasing taxes on
real estate (i.e., things that cannot move).
 One argument offered in support of this proposal is that, compared to
other large cities, Philadelphia gets more of its tax revenue from wage
and business taxes and less of its tax revenue from real estate taxes.
This argument is complicated by issues including the following:
 The comparison cities have a higher real estate tax rate for
commercial/industrial properties than for residential properties. Philadelphia is
forbidden by state law from having differential real estate tax rates.
 Philadelphia already collects a greater percentage of its real estate tax revenue
from residents than many other large cities. This higher residential tax burden
will likely be further increased by the planned Actual Value Initiative (AVI) , which
may reduce real estate taxes paid by commercial/industrial properties by over
$100 million.
 The conventional wisdom that a homestead exemption can “buffer” the impact on
residents of increased reliance on real estate taxes for revenue has been called
into question by preliminary analysis of AVI.
41
Broader Reform Still Needed to
Completely Level the Playing Field
 Previously, the City’s business tax reform plan had been to
eliminate the low-rate gross receipts tax, which is paid by all
business wherever based on their sales in Philadelphia.
 This “reform” would have exacerbated the competitive
disadvantage for Philadelphia-based businesses.

It would mean that out-of-City businesses making sales in the City
would not have to pay any business tax, while Philadelphia
businesses would still have to pay a 6% net income tax.
 The Green/Sanchez legislation passed in 2011 was an important
first step in fundamentally changing the City’s business tax
reform strategy, but the only way to address this issue
completely is to eliminate the net income tax, as
Green/Sanchez proposed in 2010, and maintain revenue by
increasing the low-rate gross receipts tax.
42
Broader Reform Still Needed to
Completely Level the Playing Field
 The revenue-neutral Green/Sanchez proposal would result in
Philadelphia businesses having the same business tax costs as
their competitors – creating a level playing field.
 On their sales in the city, Philadelphia businesses and their competitors from
outside the city would pay the same low gross receipts tax of 5 cents
per $1,000 in sales.
 On their sales outside of the city, Philadelphia businesses would pay $0
business tax – just like their competitors.
 The Green/Sanchez proposal is consistent with the widely
accepted taxation principle of applying a low tax rate across a
broad base.
 The net income tax base is $4.5B, projected to grow to $4.9B by the end of
the current five-year plan.
 The current gross receipts tax base is $72B, projected to grow to $80B by
the end of the current five-year plan – more than 16 times greater than the
net income base.
43
What People Are Saying About the
Reform Proposal…
 “Changing the [BIRT] as the Council members have proposed won’t
solve the city’s economic problems . . . but it would be a big positive
step.”
Mark Zandi, Moody’s Analytics
 The proposals is “a thoughtful economic development impetus.”
David Perlman, Building Industry Association
 “The proposal would . . . help the manufacturing sector generally, laying
the foundation for additional job growth in Philadelphia.”
George Zauflik, CARDONE Industries, Inc.
 “It seems that I have been dealing with Philadelphia taxes forever and I
really want to see the City become more tax friendly. I am confident
[the BIRT reform] would streamline the tax preparation process for both
preparers and their clients, relieve a huge administrative burden off
the City, allow it to focus its resources where they have the most
impact, bring business to the City, and raise the image of
Philadelphia in the business community.”
John Kostenbauder, Accountant
44
http:///www.greenforphiladelphia.com

similar documents