Early in 2011 we heard the story of the opera-singing couple Ailyn Perez and Stephen Costello, who met, studied, and made their names in Philadelphia but moved out of the city specifically on account of the 6.45 percent net income tax that is part of the city’s much maligned business privilege tax (BPT).      

Notably, Philadelphia is one of only five cities in the U.S. to impose a local tax on business income. The other four are New York and Washington, D.C. -- the financial and political capitals of the country, respectively -- Columbus, and Detroit, which should tell us all we need to know.  But there’s more:  Philadelphia is the only city to tax both business receipts and business income.

There has been much ado, appropriately, about the new-look City Council to be inaugurated in January:  we’ll have six new members (the most since 1992) and the majority of members will be serving their first or second term. This change bodes well for the body and the fresh ideas, perspective, and energy it will bring to doing the citizens’ business.  

It also bodes well for continued reform of BPT, which underwent historic changes already this fall thanks to a new approach to solving an old problem. This, along with redrafting the city’s outdated Zoning Code and reforming the city’s dysfunctional property assessment system, helps send the message that the city is open for business and will encourage, rather than impede, growth.

Before getting into the nuts and bolts of the new reforms, a brief overview of Philadelphia’s current BPT structure and its business landscape may be helpful.  

Broken in Two, Broken For All
The BPT consists of two parts:  the 0.1415% gross receipts tax (GRT) and the 6.45% net income tax (NIT). The low-rate GRT (fourteen cents on every $100 of sales) is paid by all businesses that make sales in Philadelphia – no matter where the business is based – on those local sales. The high-rate NIT ($6.45 on every $100 of net income) is paid primarily by businesses based in Philadelphia and applies even to their sales outside of the city, putting them at a competitive disadvantage when selling goods regionally, nationally, and globally.  

Clearly, the current BPT structure puts Philadelphia businesses at a competitive disadvantage:  local businesses have to pay the high-rate NIT, but most out-of-city companies making sales in the city either are not subject to it (because they do not have a sufficient connection to the city) or can use tax planning strategies to avoid paying it. What’s more, the high-rate NIT acts as a "profitability penalty," discouraging businesses from locating in the city in the first instance and, for those start-up ventures incubated here, staying in the city once they become profitable.  

The current BPT structure also stacks up the tax burden on small businesses, which constitute the majority of businesses in the city  and account for the majority of job growth.  In 2008, the 54,000 BPT filers with up to $100,000/year in sales paid the high-rate NIT on proportionally five times as much of their sales in the aggregate as the 2,200 BPT filers with $10M-$50M/year in sales. It seems unlikely that this is due to the small businesses being five times as profitable as multi-million dollar businesses. Far more likely, the larger firms are able to use tax planning strategies (such as out-of-state holding companies) to minimize their taxable income, opportunities generally not available to small business with one local base of operations.

More broadly, recent research highlights the importance of small businesses to economic growth. In a 2010 paper, Harvard professors reported their findings that "regional economic growth is highly correlated with an abundance of small firms' and “an abundance of small, independent firms is one of the best predictors of urban growth." Philadelphia has an abundance of small businesses, and thus is well-positioned to take advantage of this growth potential, but its business taxation policy – as embodied in the BPT – has disfavored these very businesses.  

Early Progress
Against this backdrop, Councilwoman Maria Quinones Sanchez and I have worked together over the past three years to bring about progressive tax reform that levels the playing field for Philadelphia businesses, helps small businesses, encourages entrepreneurship, and stimulates job-creation. This collaborative effort is starting to bear fruit.

Our overarching proposal was to eliminate the NIT – the only change that will truly level the playing field for Philadelphia businesses and eliminate the “profitability penalty' for locating in the city.  We initially proposed to accomplish this in a revenue-neutral way by increasing the low-rate GRT to off-set the loss of NIT revenue. This kind of game-changing reform requires the support of the administration and, unfortunately, the Nutter Administration opposed the change. 

We were able to reach agreement with the Administration on two, key interim reforms:

1.  Exempting the first $100,000 in business receipts from both the gross receipts and net income prongs of the BPT.  This across-the-board exclusion provides unprecedented tax relief for the city’s existing small businesses, which, as noted above, are both key to the City’s economic growth and paying more than their fair share under the current structure.

2.  Implementing single sales factor apportionment.  Under single sales factor apportionment, local businesses that sell tangible goods will no longer have to pay the NIT on their sales outside of the City. Export-based sectors including manufacturing and wholesaling will operate on a more level playing field when competing with businesses located outside of the City.  Based on analysis performed by the Revenue Department, in the aggregate, this reform will result in tax savings for Philadelphia-based businesses across all industries, including creative economy sectors.

These reforms stand in sharp contrast to what has been tax reform orthodoxy. Until this year, the city’s plan was to eliminate the low-rate GRT, which is paid by all business, wherever based, on their sales in Philadelphia. This so-called "reform" would have exacerbated the competitive disadvantage faced by Philadelphia-based businesses: out-of-City businesses making sales in the City would have not paid any BPT, while Philadelphia businesses would still have to pay a 6% NIT.  

Historic Tax Relief on the Way
The legislation passed this fall is an important first step in fundamentally changing the city’s BPT reform strategy. Our legislation will provide over $50M/year in tax relief for Philadelphia-based businesses -- a historic amount of tax relief.  The business tax burden on Philadelphia-based businesses in the aggregate will be reduced by 20%. Importantly, this relief is focused on the small businesses and Philadelphia-based industries that are particularly disadvantaged under the current BPT structure. By full implementation of our bill:

- Over 30,000 of the 90,000-plus current BPT filers will have no business tax liability whatsoever (i.e., $0 BPT and $0 net profits tax ).  This includes tens of thousands of freelancers and others working in the creative economy.

- An additional 25,000 filers will have $0 BPT liability.

- The business tax burden on micro-enterprises (those with under $100K per year in sales) will be reduced by 50%.

Significantly, the conversation has turned from the now discredited conventional wisdom to a data-based discussion of how best to achieve our policy priorities. But the only way to address this issue completely is to eliminate the net income tax, as proposed last year.  This would result in Philadelphia businesses having the same BPT costs as their competitors -- thereby creating a level playing field and removing the “profitability penalty' to locating in the city.

To maintain focus on the needed overall reform, I plan to re-introduce legislation to phase-out the NIT over ten years when the City Council begins its new term in January 2012.  

BILL GREEN is a City Councilman At-Large in the City of Philadelphia and a native Philadelphian. He is Chair of City Council's Labor and Civil Service Committee and lives in Chestnut Hill with his wife Margie and their two children.

FLYING GUEST is a recurring feature contributed by a Greater Philadelphian who is moving the region forward. For consideration, contact the editor.