This post is part of a larger series.
So far, I’ve explored the numerous types of taxes, their rates, and how this might affect normal people in Philadelphia. Now I want to take a look at the following:
- Who has the power to tax, and to tax what;
- How taxes are created and implemented;
- Total tax revenues from the different taxes I examined; and
- My final conclusion about taxes in Philadelphia, in terms of whether, how, and to what extent they impact poverty and inequality in Philadelphia.
Okay, let’s dig in.
Who Has the Power to Tax, and to Tax What?
To answer this, I’ve taken a look at the Constitution or its equivalent at each level of government, as well as any particular laws that apply to taxation powers.
Article 1 of the Constitution gives Congress the power to raise revenue through laying and collecting taxes:
Article 1, Section 7: “All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills.”
Article 1, Section 8: “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States…”
However, the 10th Amendment further delegates powers to the states:
Amendment 10: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”
This includes powers of taxation and spending. The Constitution is very light on requirements in this regard for states. The only mention about this is that states cannot create taxes on exports (Article 1, Section 9), and that they cannot create duties on imports or exports (Article 1, Section 10).
This provides the legal framework for state governments to do just about anything that the Constitution does not prohibit, including creating tax laws.
Pennsylvania’s Constitution is similar to the US Constitution in that it doesn’t enumerate many rights and privileges of localities or prohibit many actions, leaving lots of power to local government. It is a bit more complicated at the local level, though. First, taxing and spending authority is explicitly given to the General Assembly, which is the state equivalent of Congress:
Article 3, Section 10: “All bills for raising revenue shall originate in the House of Representatives, but the Senate may propose amendments as in other bills.”
Article 3, Section 11: “The general appropriation bill shall embrace nothing but appropriations for the executive, legislative and judicial departments of the Commonwealth, for the public debt and for public schools. All other appropriations shall be made by separate bills, each embracing but one subject.”
However, Article 9, Section 2 allows for the creation of Home Rule Charters, which are effectively local constitutions that allow for almost total independent control of the local government. It states that, “A municipality which has a home rule charter may exercise any power or perform any function not denied by this Constitution, by its home rule charter or by the General Assembly at any time.”
There are only a couple of restrictions on taxation, which are enumerated in Section 8. The most significant is the “uniformity clause,” which states, “All taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax, and shall be levied and collected under general laws.” This is why Philadelphia can’t have different property tax rates for businesses and residents, among other things. The state also enumerates tax exemptions that it has the right to enact, and it claims the right to certain excise taxes, such as on fuels.
Philadelphia was the first municipality in Pennsylvania to create a home rule charter, which went into effect in 1952. This charter is constantly updated, and the full document can be found here.
In Article 1, the Home Rule Charter, the City of Philadelphia is granted broad powers to exercise complete legislative and administrative powers allowed under the law enabling home rule charters. The Charter notes that it leaves this statement vague into order to grant the broadest possible powers. Because of this, Philadelphia’s City Council can enact any laws to create, collect, and spend any kind of tax that isn’t prohibited by the state or federal constitutions or laws.
This already answers the second question I posed at the beginning regarding how taxes are created and implemented. The answer is this: every level of government can create a tax through legislation, so long as it doesn’t conflict with the laws or constitutions of higher levels of government. They can also collect the tax and spend it how they see fit through legislation.
There is one more complication, before we move on to the next section. You might be aware of the recent battles over the soda tax, which have brought to the surface the tensions between taxing powers between different levels of government. These tensions have existed for quite a while, most frequently over Philadelphia’s wage tax.
Much of this controversy stems from the Sterling Act of 1932. This law was passed during the Great Depression to give Philadelphia broad powers to tax anything the state could tax, so long as the tax doesn’t conflict with or overlap with existing state laws. State laws take precedence in these cases, but Philadelphia can still pass taxes on top of existing state taxes with permission from the state. This is the case for the wage tax, cigarette tax, and various other specialty taxes.
The Sterling Act creates the added restriction that Philadelphia’s taxes cannot overlap with existing state taxes. Soda company-backed court cases have alleged that the soda tax creates a double tax on the state’s existing sales tax, thus violating the Sterling Act (see this article, this article, or this article for more information). However, the state supreme court rejected this claim, since the tax is on the distribution of soda, and not the actual sale. Since the state does not already tax this, the court ruled that the soda tax is not in violation of the Sterling Act. However, the state could, at any time, pass a tax, license, or other law regarding soda that renders the soda tax illegal—as with all local taxes and laws.
So, Philadelphia has a surprising amount of independence over creating its own taxes. The state (and even New Jersey residents) have tried for decades to fight Philadelphia’s taxation powers tooth and nail over most of its taxes, but with no success. As long as Philadelphia’s taxes do not conflict with the constitutions or laws of the state or federal governments, Philadelphia can pass any tax the City Council legislates. The only caveat is that the tax cannot already exist at the state level, unless the City gets permission from the State through legislation.
Total Tax Revenues in Philadelphia
In a previous post, I discussed revenues and expenditures of the City over time, and I found that the City had about $13.8 billion in revenues in fiscal year 2017. Remember that this includes several agencies that the City manages directly, such as the School District of Philadelphia, or the Philadelphia Housing Authority. Only $4.9 billion of that revenue was taxes. Grants and contributions (state and federal dollars), charges for services (utilities, parking, etc.), and “other” constituted almost two-thirds of the City’s revenue.
Here is the most detailed breakdown I could find of revenue from each type of tax I covered earlier, as of fiscal year 2017:
Philadelphia Taxes Collected
Unfortunately, the Philadelphia Department of Revenue’s annual reports on revenue sources (2017 and 2018) provide conflicting and seemingly incomplete information. The same is true of the month-to-month revenue reports for 2017 (general fund and school district). This could simply be differences in accounting practices, subtle differences in what each is reporting on, or other reasons like this. I have contacted the department for clarity, but in the meantime, I will use the official audit of the City for fiscal year 2017. This provides less detail on each source, but we know it’s accurate.
Of all of the City’s revenues, the City’s own taxes only account for 35%. Keep in mind, the “grants and contributions” category largely comes from the state and federal governments, which comes from taxes. Unfortunately, we can’t see a great level of detail. We do know that the wage, earnings, and net profits taxes collectively make up almost half of the City’s tax revenue. However, all of the taxes provide significant portions.
State Taxes Collected
We can glean an almost complete picture of State taxes from the public reports that the PA Department of Revenue publishes. However, they do not report corporate taxes or other excise taxes paid from Philadelphia to the State. This could be zero, it could be $500 million if it’s in line with other proportions, or it could be much larger. I have requested this data, and I will update this when or if it becomes available. For now, here is a breakdown of all State revenue in fiscal year 2017 (from the FY 2018 Governor’s Budget), revenue by tax source (same source), and revenue by tax source from Philadelphia (from the 2018 Statistical Supplement to the Tax Compendium).
Pennsylvania’s General Fund, which is almost all of the State’s tax revenue (there is a little bit from the special funds), only amounts to 39% of the State’s total revenue. A huge portion comes from the federal government and special sources, like licensing and other fees. Of the General Fund’s revenue, sales and use taxes, personal income taxes, and corporation taxes make up the majority by far.
Philadelphia’s taxes paid to the State amount to at least 4.75% of the State’s tax revenue, and more likely closer to 6.5%. This is very surprising, considering that Philadelphia’s population is about 12% of Pennsylvania’s population, and Philadelphia’s GDP was 16% of Pennsylvania’s as of 2015. This is likely because Philadelphia’s household incomes are so much lower than the rest of the State’s, and much of the General Fund comes from personal income tax.
Federal Taxes Collected
The IRS publishes information about the federal government’s tax revenue and sources every year in their annual booklet. Here is 2017’s breakdown.
Federal taxes totaled almost $3 trillion in 2017. Note that this is net taxes, so it subtracts about $500 million in tax returns from gross tax revenue. The majority came from individual income taxes and employment taxes, and the employment taxes are the FICA taxes.
Unfortunately, the only level of detail available about Philadelphia’s tax contributions to the federal government are on personal income tax paid. There simply is no data set for the other categories, which I confirmed after inquiring with the IRS. They do also publish data at the state level, so we can try to compare this to Philadelphia’s personal income tax contribution to get an idea of how large Philadelphia’s total contribution might be.
Pennsylvania’s contribution in federal taxes was about $134 billion in 2017. The ratio of tax sources is almost exactly the same, with individual income taxes and related taxes comprising 87% of the total. The only difference is that the data source does not tell us how much of this is FICA taxes. However, if the ratio is about the same as at the federal level, FICA would be 37% of the 87%. Additionally, another source (cited below) tells us that PA paid $55 billion in federal income taxes in 2016. We can safely assume this figure increased slightly in 2017, to be about half of the total, which is exactly what we would expect.
2017 data on the county level is still not available. So, in 2016, Philadelphia’s contribution to the federal government in personal income taxes was $4,182,354,000. If the state and national level are reliable indicators of the ratio of each tax to the total, then Philadelphia likely paid:
Please note that this is only an estimate. I’ve based it on the ratios at the federal level.
Conclusion About Tax Revenues
The tax revenue that every level of government collects is overwhelmingly from personal income taxes of various types and employment taxes, like the FICA taxes. Surprisingly little tax is collected from businesses, excise taxes, or other special taxes. One exception is the sales and other consumption taxes on the State and local levels, which are smaller portions, but still significant. Therefore, individual wage earners, everyday consumers, and small business owners who rely on the profit of their business are bearing the brunt of our society’s tax obligations.
A key finding to note is that Philadelphia and Pennsylvania’s governments only rely partially on local taxes. About 60-65% comes from higher levels of government and other unique sources. Therefore, changes in tax revenue at the local level will have a smaller impact on these budgets, and by extension, the services these governments can offer. Changes in federal and state sources, on the other hand, have an enormous impact on Philadelphia’s government services.
In 2016, about $5.6 billion came from the State and federal governments. At the very minimum, we know that Philadelphia paid the State and federal governments $5,642,752,000. More likely, Philadelphia paid the State and federal governments upwards of $10,372,548,188. So, Philadelphia’s payments and receipts from these governments evens out with the most conservative estimate. With more realistic estimates, Philadelphia has a disproportionately high tax burden. This raises serious questions about our intentions behind our taxation system and who should be paying the most. For instance, Philadelphia is a county with one of the highest poverty rates in the State and country. While it is true that Philadelphia has some of the largest revenue generators and is a hub of economic activity, it is also true that it has an exceptionally high level of need. I argue that it should, therefore, receive a disproportionate amount of benefit in order to help remediate this inequality—but I will save this for further discussion in section three.
Final Conclusions on Taxes
The primary purpose of taxes should be to generate revenue to run programs that benefit the general welfare, particularly society’s most vulnerable. For instance, we collect taxes to provide quality public schools, roads, and a police force so that everybody benefits, regardless of family wealth or background. Taxes should also play a role in discouraging unwanted behaviors, such as how the vacant real estate tax discourages property owners from sitting on empty real estate for prolonged periods, or the cigarette tax discourages cigarette consumption. Finally, taxes should encourage certain kinds of behaviors, such as how federal tax deductions for homeowners make it easier to buy a home. All of this should be done while minimizing financial burden on society’s most vulnerable—hence bracketed taxes, progressive income taxes, and deductions or other rebates.
In general, tax policy in Philadelphia has many positive features that achieve these goals. Philadelphia, like everywhere else, uses federal income taxes, which are bracketed and progressive. In addition, business taxes utilize several deductions and exemptions that make life a little bit easier for smaller businesses. Finally, there are also many tax programs to reduce burdens on lower-income homeowners, the elderly, or veterans.
However, Philadelphia’s taxes also have many negative features. The federal FICA taxes, state income, city income, city property, and city business taxes are all flat taxes. This puts a disproportionate burden on lower-income households even after rebates, deductions, and the federal progressive income tax. For instance, any wage or salary earner is going to pay more than 15% in flat taxes right off the bat, plus another 7% if they are self-employed (such as a business owner). Although most of this flat tax comes from the federal government, the City and State are not helping by tacking on another 7.9%. This makes life hard for the typical wage earner, who needs his whole paycheck just to make ends meet.
Business taxes have a similar story to wage taxes, since many of the taxes overlap. However, it is even harder for people to start small businesses because of additional flat taxes that are levied on every business. For instance, the City’s Use and Occupancy tax is a flat rate on the value of property occupied, regardless of the size of the business. While there is a deduction included, it is not likely to assist business owners significantly as property values increase, especially in gentrifying areas. Similarly, the Business Income and Receipts Tax has a deduction and some exemptions, but is still effectively a flat tax that contributes to business expenses. And, yet again, the City and State levy a flat income tax on businesses, and the federal government levies flat FICA taxes. This makes it disproportionately difficult to start and maintain a small business, which also hurts Philadelphia’s economy as a whole.
In terms of homeownership, although the City offers many benefits and rebates, all homeowners are still paying the same rate regardless of income. Additionally, new homes and renovations are receiving full tax rebates for ten years, regardless of the income of the occupant, size of the business, or the value of the property. This has led to immense tax benefits for wealthier citizens, while lower-income households are paying a flat tax.
In sum, Philadelphia’s taxes are in the right direction, but still have a lot of room for improvement. The tax structure can still be changed to provide significant relief for lower-income households and businesses, while increasing the tax burden on higher-income households and businesses.
The good news is that the City retains much of the power needed to implement these changes. No, the City of Philadelphia cannot change federal or state taxes, but it can do a lot even within its own tax structure to improve outcomes. I want to wait until the third section of Block to Block: Poverty and Inequality in Philadelphia to go into my proposed solutions, but for now I’ll give a brief outline:
- Increase the sizes of deductions on business taxes;
- Create a deduction that scales to filing status for income tax;
- Create bracketed, progressive business and household income taxes;
- Make the various homeowner deductions automatic, based on filing status, and scale deductions to filing status;
- Make property taxes for households and businesses bracketed and progressive based on household income or the size of the business;
- Build political pressure on the state to shift income taxes to a bracketed, progressive system with deductions;
- Build political pressure on the federal government to shift FICA to a bracketed, progressive system with deductions, including by eliminating the cap on taxable income;
- Create various tax incentives and disincentives to benefit lower-income households; and
- Repeal the 10-year tax abatement, to be replaced with a more deliberate policy to encourage construction of affordable housing.
Obviously, there is a lot to cover here. I will get into much more detail in the third section. One of the greatest challenges is that the city, state, and federal governments rely most heavily on the taxes outlined, which means that any reductions in rates to lower tax brackets could negatively impact tax revenues. However, it remains to be seen as to whether increases from higher brackets would make up for this. Additionally, the majority of tax revenue is in federal income and employment taxes. Reforming state and local taxes is therefore unlikely to have a serious negative impact on the state and local budgets. Regardless, I want to emphasize this point: if the primary purpose of taxes is to create programs to benefit the general welfare of the most vulnerable in our society, then it is self-defeating to tax those populations disproportionately in order to create those programs. However we finance these programs, it should not be through flat taxes that most significantly impact lower-income households.
Next, I’ll cover local politics and corruption, then American political culture, and then finally I can get to the third section.