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Business Tax Reform: While Change is Underway, Work Remains to be Done Leveling the playing field for key business sectors + Helping small businesses +

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Presentation on theme: "Business Tax Reform: While Change is Underway, Work Remains to be Done Leveling the playing field for key business sectors + Helping small businesses +"— Presentation transcript:

1 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

2 2 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

3 3 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).

4 4 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 FederalStateCityTotal Tax rate35%9.9%6.45%51.35%

5 5 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.

6 6 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.

7 7 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 LocationSales Location Under current tax structure Philadelphia businessPhiladelphia.001415 gross receipts tax + 6.45% net income tax Non-Philadelphia Business Philadelphia.001415 gross receipts tax Philadelphia businessOutside-of-Philadelphia 6.45% net income tax (apportioned) Non-Philadelphia Business Outside-of-PhiladelphiaNo BIRT

8 8 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.

9 9 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  The BIRT accounts for $3.67 (>93%) of this premium and, of that, the majority is due to the net income tax. 2 1.Paul Levy, “Can Tax Reform Get Traction in 2010? Overview of Task Force Recommendations on Tax Reform,” pg. 17. 2.Id. Detailed Analysis from 2005 of business tax impact on Class A tenants: 14% premium paid to locate in Center City vs. suburbs CostCenter CityPA suburbsDifferential (per SF) Inclusive Rent$25.85$26.93 U&O tax$1.30$0.00 BIRT$3.67$0.00 Employer-paid$30.82$26.93($3.89)

10 10 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.

11 11 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.

12 12 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.

13 13 Overview of Tax Rates under Proposed BIRT Reform Standard Business Income and Receipts Tax Rates Tax year(s)Gross receipts rateNet income rate 2008 to 20131.415 mills (0.1415%)6.45% 20142.208 mills (0.22%)5.16% 20153.002 mills (0.3%)3.87% 20163.796 mills (0.3796%)2.58% 20174.5578 mills (0.44%)1.29% 20185.2723 mills (0.527%)0.0% 20195.0649 mills (0.5065%)0.0% 20204.9414 mills (0.4914%)0.0% 20214.8209 mills (0.4821%)0.0%

14 14 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 Philadelphia- based 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

15 15 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 non- filers and those otherwise not in compliance  Produces a more stable revenue source

16 16 BIRT Reform Needed to Generate Economic Activity/Create Jobs  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. The Economic Perspective from Steve Mullin, former Commerce/Finance Dir.

17 17 BIRT Reform Needed to Generate Economic Activity/Create Jobs  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 [...].” The Economic Perspective from building owners, developers, and contractors who testified in support of the proposed business tax reform in late 2010.

18 18 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.

19 19 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.

20 20 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.

21 21 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 treatise 5 outlines the advantages of a gross receipts tax compared to a net income tax, which include:  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. 5.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.

22 22 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 21 st 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.Ohio Department of Taxation, “FAQs – Commercial Activity Tax” (available at http://www.tax.ohio.gov/faqs/CAT/cat.stm#1).http://www.tax.ohio.gov/faqs/CAT/cat.stm#1 7.Texas Comptroller of Public Accounts, “Franchise Tax Frequently Asked Questions” (available at http://www.onlinedetective.com/resource/view/59950). http://www.onlinedetective.com/resource/view/59950 8.Commission on the 21 st Century Economy, “Final Report” (available at http://www.cotce.ca.gov).http://www.cotce.ca.gov

23 23 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.Philadelphia Tax Reform Commission, “Final Report November 15, 2003 – Executive Summary,” pg. 2. 10.Mayor’s Task Force on Tax Policy & Economic Competitiveness in Philadelphia, “Thinking Beyond Today: A Path to Prosperity,” pg. 16.

24 24 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.

25 25 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 locationPhiladelphia businessNon-Philadelphia business Sales in Philadelphia001415 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

26 26 A Closer Look re the Need to Create a More Level Playing Field for Businesses Total Sales (avg. 2007-10) Current business tax costProjected business tax cost w/reform Based in Philadelphia (N) $19,197,770 $184,896 (7x more than non-city competitor) $101,748 Based outside Philadelphia (F) $18,609,322$26,332$98,629 Hospitality Sector Example (data from Greater Phila. Hotel Association)  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.

27 27 A Closer Look re the Need to Create a More Level Playing Field for Businesses Current Business Tax CostsBusiness Tax Costs Under Reform Philadelphia manufacturer $3,665.50 (23x more than non-Philly competitor)$530 Suburban manufacturer $141.50$530 Manufacturing Sector Example ($1M total sales; $100K sales in Phila.; $50K total profits = 5% margin)  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.

28 28 Why Manufacturing Matters to the City  A recent Green Economy Task Force report emphasized the importance of focusing on manufacturing 12 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).http://www.sbnphiladelphia.org/images/uploads/02-16-10_EIP_manufacturing.pdf

29 29 How the Proposal Creates a More Level Playing Field  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. Sales Location Business Location Under BIRT structure in 2018, per proposed reform Philadelphia sales Philadelphia business.00527 gross receipts tax Non-Philadelphia Business.00527 gross receipts tax Outside-of-city sales Philadelphia businessNo BIRT Non-Philadelphia BusinessNo BIRT

30 30 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.

31 31 Interim Solution re Creating a More Level Playing Field Philadelphia manufacturerSuburban 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 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:

32 32 A Closer Look re the Importance of Helping Small and Start-up Businesses  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.  FACT: The majority of businesses paying the business tax are small businesses.

33 33 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  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 14.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). 15.SBA Frequently Asked Questions (available at: http://web.sba.gov/faqs/faqIndexAll.cfm?areaid=24). 16.“The Small Business Economy,” pg. 10.

34 34 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).http://www.hks.harvard.edu/rappaport/downloads/policybriefs/entrepreneurs.pdf

35 35 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 income 18 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.

36 36 A Closer Look re Tax Relief for Small and Start-up 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%  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.  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.

37 37 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.

38 38 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%.

39 39 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 low- rate 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.

40 40 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 data- based 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.

41 41 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.

42 42 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.

43 43 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.

44 44 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 http:///www.greenforphiladelphia.com


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