Don't hike city receipts tax
Modest cuts in one business levy would be wise, but raising another wouldn't be.
By Robert Inman
City Council members Bill Green and Maria Quinones-Sanchez are proposing to lower and eventually eliminate the tax on city firms' net income. They would compensate for the lost revenue by raising the tax on firms' sales to city residents and businesses, known as the gross-receipts tax. They are right about the need to begin reducing the net-income tax. Unfortunately, though, the second half of their proposal is likely to have significant adverse effects on the city economy and to saddle residents with even more of the tax burden.
My research on the economic consequences of Philadelphia taxes suggests that increasing the gross-receipts tax rate would reduce business activity in the city. In the case of small tax changes, the effect is small. But given a big change, adverse economic effects accumulate.
The Green-Sanchez proposal, up for a hearing today, would raise the gross-receipts rate by almost 300 percent over five years, from $1.415 to $5.30 per $1,000 of sales. This would be its highest rate in city history.
My research predicts that after those five years, city business activity would be about 15 percent lower than if the tax remained at its current level. Today's gross-receipts tax base - a measure of the overall Philadelphia economy - is $64.5 billion. The proposed Green-Sanchez increase would reduce it by about $9.4 billion.
There are 518,000 jobs in the city's economy, and the average worker manages or produces $124,000 in output. So cutting city output by $9.4 billion threatens 75,000 city jobs.
These estimates are based on my analysis of the city's economic performance over the past 38 years. Unfortunately, a comparable analysis of the net-income tax is impossible because there have not been sufficient changes in that rate. The Green-Sanchez proposal asks us to make this unappealing trade: an uncertain gain of jobs from cutting the net-income tax for a probable loss of 75,000 jobs from raising the gross-receipts tax.
Nor is there much to recommend the proposal from the perspective of economic fairness. Lowering the tax on net income helps firms that earn a lot of profit. Analyses by Econsult for Green and Sanchez and by the city Department of Revenue suggest that the big winners would be law firms, real estate firms, drug companies, accountants, and non-food retailers. The big losers would be construction firms, warehouses, insurance firms, hotels, business-service firms, health clinics, social-service providers, and professional sports teams.
But fairness isn't about businesses, whether in or outside the city; it's about citizens. How would they do? Unless they earn net business income, they would lose.
The gross-receipts tax is a sales tax. Any business in a competitive market must pass the cost of doing business on to consumers via higher prices. The gross-receipts tax is a cost of doing business: Though firms write the checks for taxes due, their customers really pay the levy through higher prices.
The Green-Sanchez proposal does include a $100,000 tax exemption, worth $530 to a typical business. Once sales exceed the exemption, however, the tax affects prices for all city customers.
When considering the economic fairness of any tax policy, we should focus on how it affects citizens as they earn income and pay for goods and services. The Green-Sanchez proposal helps lawyers, accountants, developers, and others with net business income. And it hurts some city workers by threatening their jobs and all the city's consumers through higher prices.
It is, however, right to suggest reducing the net-income tax. While we don't have good evidence to predict the economic effect of doing so, we can begin to learn through planned reductions over time. This is how the city has been lowering the wage and gross-receipts tax rates, and our economy has benefitted significantly over the past 15 years as a result.
As the city recovers from this recession, there will be an estimated $260 million in new tax revenue at current rates (even if the city sales tax returns to 1 percent). Let's allocate that to the restoration of necessary city services and planned reductions in the wage and gross-receipts taxes. But let's save some of this "recovery bonus" for systematic cuts in the net-income tax, too. Before we eliminate the tax, let's find out how much it might help the economy.
With demand still unpredictable, we shouldn't add uncertainty to business decision-making and city budgeting. The Green-Sanchez proposal would move us from a path of planned tax reductions over three mayoral administrations to an untested reallocation of the tax burden. But when the time is right, the city should adopt the valuable half of the proposal and begin a steady reduction of the net-income tax.