This post is part of a larger series.
Property Tax Reform
In a past post, I discussed the state of property taxes in Philadelphia. I found that property taxes are minimal for homeowners, and there are many programs in place to prevent displacement due to rising prices. However, there are still some reforms to residential property taxes and other real estate taxes that will help reduce poverty and inequality.
The first order of business is fixing the City’s value assessing system, which has been put on moratorium after substantial complaints of incorrect property values. This is a recent issue that is already being worked on. I cannot make any recommendations on how to improve this process, and instead I will focus on how to reform the tax system that utilizes whatever property values are settled upon.
Property taxes are already very low, at 1.3998% of the assessed value, including a full 1% discount for paying taxes early. Additionally, the programs such as the Homestead Exemption, LOOP, and those for elderly or veteran homeowners help to prevent displacement. These are all very good features for benefiting low-income households, and probably contribute to Philadelphia’s high homeownership rate, despite high poverty levels.
One reform that can be made is to introduce a tax surcharge for very high property values. This would effectively be a progressive tax on real estate, using the current tax rate as the lowest bracket and the Homestead Exemption as the standard deduction.
The issue with progressive property taxes as compared to progressive income taxes is that property value does not necessarily translate to ability to pay, which is the core motivation behind a progressive tax. However, if we begin the second bracket at a very high level, say $750,000, then we can realistically exclude any homeowners who would not be able to afford higher property taxes. This is because any dramatic increase in assessed value would make the increased value exempt under LOOP for long-time homeowners. Additionally, elderly homeowners who have been in their house for a long period and experience dramatic property value increases are likely to be exempt under State property tax exemptions. Therefore, these various tax relief programs are an essential component to introducing a progressive property tax, because we want to be sure that it is only higher-income households we are taxing.
Small, incremental surcharges can help raise significantly more revenue from households who can most afford it, while helping to discourage the production and use of luxury real estate that displaces people and businesses.
First, here is a breakdown of the value of all owner-occupied homes in Philadelphia as of 2017, according to the census:
Here we can see that the vast majority of homes have lower values. Homes above $750,000 only make up about 2% of all owner-occupied homes in Philadelphia, meaning that tax surcharges in this range will have a negligible impact on the population.
Unfortunately, there is no data available on the value of renter-occupied households. This is significant, since renters make up 51% of the population in Philadelphia, according to the census. There is also no data on the value of business real estate. We will have to work without this.
Here is a more detailed breakdown of the value of owner-occupied homes as of 2017. I’m going to use this to estimate the impact of my proposed tax surcharges. Although we do not have directly available data from the City on details of real estate tax collections, we do have the total—$1.28 billion in 2017. Keep in mind that this includes all properties, such as owner-occupied homes, renter-occupied homes, and businesses.
Assuming that every homeowner uses the Homestead Exemption (which they don’t), and that there are no other exemptions being applied, here is the minimum and the maximum possible tax revenue from each bracket of home values from the census. I calculated the minimum using the lower range within each bracket, and the maximum using the highest. Take a look below:
|Value of Home||Number of Homes||Minimum Tax Revenue||Maximum Tax Revenue|
|Less than $10,000||1,973||$ –||$ –|
|$10,000 to $14,999||946||$ –||$ –|
|$15,000 to $19,999||1,677||$ –||$ –|
|$20,000 to $24,999||876||$ –||$ –|
|$25,000 to $29,999||1,638||$ –||$ –|
|$30,000 to $34,999||1,977||$ –||$ –|
|$35,000 to $39,999||1,047||$ –||$ –|
|$40,000 to $49,999||7,379||$ –||$ 1,032,809.13|
|$50,000 to $59,999||7,608||$ 1,064,967.84||$ 2,129,829.18|
|$60,000 to $69,999||9,739||$ 2,726,530.44||$ 4,089,659.33|
|$70,000 to $79,999||12,668||$ 5,319,799.92||$ 7,092,889.23|
|$80,000 to $89,999||12,248||$ 6,857,900.16||$ 8,572,203.75|
|$90,000 to $99,999||12,885||$ 9,018,211.50||$ 10,821,673.44|
|$100,000 to $124,999||31,989||$ 26,866,921.32||$ 38,061,024.09|
|$125,000 to $149,999||24,943||$ 29,677,929.69||$ 38,406,383.39|
|$150,000 to $174,999||29,134||$ 44,859,950.52||$ 55,054,986.00|
|$175,000 to $199,999||24,131||$ 45,601,074.63||$ 54,045,380.29|
|$200,000 to $249,999||38,414||$ 86,035,067.52||$112,920,488.40|
|$250,000 to $299,999||21,213||$ 62,357,310.54||$ 77,203,992.30|
|$300,000 to $399,999||22,342||$ 81,313,262.16||$112,587,281.02|
|$400,000 to $499,999||11,611||$ 58,511,080.08||$ 74,763,995.35|
|$500,000 to $749,999||12,908||$ 83,115,644.64||$128,287,009.95|
|$750,000 to $999,999||3,363||$ 33,423,444.54||$ 45,192,215.96|
|$1,000,000 to $1,499,999||2,234||$ 30,020,670.72||$ 45,656,405.45|
|$1,500,000 to $1,999,999||983||$ 20,089,649.64||$ 26,969,652.88|
|$2,000,000 or more||937||$ 25,707,606.96||$ 65,055,984.96|
In sum, Philadelphia is collecting $652 million to $907 million in owner-occupied real estate taxes. The census reports that the aggregate value of owner-occupied homes in 2017 was $66,047,111,800, which would generate tax revenue of $896,531,470.98 if no exemptions are applied. Considering that many exemptions are likely to be applied, a number closer to the lower estimate of $652 million is more likely for owner-occupied real estate taxes. This fits with our knowledge that total real estate tax revenue was $1.28 billion, since renter-occupied and business real estate taxes are likely significant.
Next, let’s take a look at the impact of surcharge taxes. For the sake of example, I’m proposing an addition 0.5% on the amounts above $750,000, $1 million, $1.5 million, and $2 million. If we assume the minimum revenue possible, with the Homestead Exemption and no other exemptions, then we would have the following revenue:
This proposal would generate an additional $70 million each year. Note that this model assumes there are no houses worth more than $2 million in order to estimate the absolute minimum, so the actual total is likely to be larger.
Next, I’ve made the same estimates, but for the maximum possible revenue to give an idea of the possible range:
One key feature to note is that I was forced to pick a value for the 937 homes worth more than $2 million. I chose an average of $5 million, based on data from Zillow that lists the following number of homes per value range:
$2-2.999 million: 331
$3-3.999 million: 137
$4-4.999 million: 82
$5-5.999 million: 29
$6-6.999 million: 29
$7-7.999 million: 38
$8-8.999 million: 5
$9-9.999 million: 4
$10+ million: 125
With the number of results above $10 million, the average is likely to be much higher, but I chose $5 million as a conservative estimate.
With all of this considered, the maximum additional revenue I calculated is $243 million. Remember, this is just for owner-occupied real estate. This likely only accounts for about half of all property value in Philadelphia, so these reforms would likely generate even more revenue when accounting for all types of real estate.
With either the lower or the higher estimate, this proposal can generate considerable revenue for the City, all while not impacting 98% of homeowners who could least afford it, and while discouraging luxury real estate. Combined, this will help mitigate poverty and inequality by encouraging the development of cheaper property and generating more revenue.
There is no reason why we cannot have more tax brackets for values above $2 million. I only chose these brackets as examples based on data I have available. Somebody with far more rigorous data directly from the City’s tax collections could create more precise tax brackets, tax increases, and a greater number of tax brackets that cover the full range of properties in Philadelphia. There could also be parallel tax surcharge brackets for luxury rental properties on a per unit basis and for commercial properties. Again, this would have to be coupled with the tax exemptions and breaks for lower-income households to ensure that the tax does not impact low-income renters who live in property that is increasing in value.
For other examples of this kind of tax structure, see this report and this report. The first outlines a proposal for progressive property taxes in Canada. The second is an overview of property tax structures throughout the European Union, including several countries with progressive property taxes.
Tax breaks for lower-income households
There are already considerable tax breaks for homeowners, which is great. However, many people are unaware that they are eligible for these programs, and so they simply don’t take advantage of them. Several political offices have made it part of their goals to conduct outreach regarding these programs. But, why not simply make these programs automatically apply to households, much like the standard deduction for federal income taxes?
Since every homeowner is automatically eligible for the Homestead Exemption, this can easily be shifted to be part of lowering the taxable portion of the assessed value of a property automatically. Likewise, LOOP, the Disabled Veteran Real Estate Exemption, and the State’s elderly real estate tax exemption can all be applied automatically. The only difficulty is when a household is eligible for multiple programs that are mutually exclusive, such as LOOP and the Homestead Exemption. Therefore, perhaps it’s best for homeowners to claim a status for each kind of tax break, much like for federal taxes.
Additionally, we should implement a property tax break for all households who cannot afford to pay, instead of special types of households, like those with veterans. This is the same principle as with income taxes—those who can least afford to pay should pay less, and those who can most afford to pay should pay more. Those who cannot afford to pay at all should simply be exempt. We could introduce income guidelines like those that exist for the current veteran program.
It is also important to consider extending all of this to renter-occupied households. According to the census, renters in Philadelphia are 51% of residents, and they are far more cash-strapped. They have half the median household income of homeowners, and yet have higher housing costs. Because of this, more than half of renters are housing-cost-burdened, a term used by many banks and housing organizations that indicates a household will have to sacrifice other basic needs to keep a roof overhead. The threshold is housing costs above 30% of gross household income. Take a look at the data below:
|Median household income||$58,588||$24,686|
|Median monthly housing costs||$881||$969|
While the owner of the property may not need the tax break, giving this tax break can help enable landowners to lower rent or to refrain from raising rent. Anything that could reduce the impact of rent costs for lower-income residents will help mitigate the effects of poverty and inequality. Of course, there would have to be guidelines in place to ensure that the landlord is not taking advantage of the program and taking in the difference as profit.
I already covered how property taxes for businesses should be revised in my post on business tax reform, but here is a quick recap:
- Scale business property taxes and the Use and Occupancy tax to profit and/or size of the business through a progressive, bracketed system with deductions.
- Push for changing the State constitutional requirement that all things of the same category be taxed equally.
- Introduce Payments in Lieu of Taxes (PILOTs) for large nonprofits.
Before getting into my proposals for the tax abatements, I want to give an overview of the issue. Philadelphia offers four tax abatements that give a 100% tax break for 10 years for any new construction or rehab of residential, commercial, or industrial real estate. Pretty much every kind of development is covered, anywhere in the city. The abatement only applies to the building, and not the land. This is significant because of the City’s recent Actual Value Initiative, which shifted some property value to land. Still, the buildings on the land make up the vast majority of property value. These abatements have been in place since 2000.
The tax abatements have been incredibly controversial (see this article or this article for examples, especially the comments). On one side of the issue, supporters of the abatements argue that the economic benefits outweigh any costs in lost tax revenue. They claim that the tax revenue gained in the long-term from having a larger tax base outweighs the immediate losses in tax revenue, since far more development occurs under the abatements. Additionally, they point to the real estate transfer tax and other taxes that are paid as a result of development, like increased wage taxes from having more residents. Finally, they emphasize benefits such as creating more jobs in construction and real estate, and revitalizing neighborhoods that have many abandoned properties.
On the other side of the issue, opponents of the abatements argue that the costs of the abatements are too high to justify any benefits. They claim that this development would have happened despite the abatements, and that the City is foregoing significant tax revenue that it desperately needs. Further, they emphasize that the abatements mostly benefit wealthier residents who are buying luxury real estate, which also raises tax costs for their neighbors while they pay nothing. Therefore, it has been considered by many as a major contributor to gentrification.
These are the two sides, exaggerated and simplified. Of course, most people probably fall somewhere in the middle, holding some views from both of these descriptions.
In order to effectively evaluate the impact of the abatements, we would need considerable amounts of data directly from City departments. Further, it is exceedingly difficult to evaluate even with this data, because we are trying to determine what would have happened and what will happen. Thankfully, the City already has two studies on the issue that I will use for my own analysis. The first study was published in 2014 by Jones Lang LaSalle, one of the largest real estate investment advisory firms in the world. The City hired this firm to conduct the study when council members were considering revising the abatements. The second was published in 2018 by the City Controller, Rebecca Rhynhart.
The 2014 report was overwhelmingly in favor of the full tax abatements as they are. It analyses the abatements from a developer’s profitability perspective, considering three scenarios:
- Eliminating the School District portion of the abatement, which is 55% of property taxes.
- Phasing out individual abatements with a five-year, linear amortization (100% the first year, 80% the second, and so on).
- Completely eliminating the abatement.
The researchers estimate that 65% of recent development would not have happened without the full abatement. Without the School District portion, they estimate that 45% of recent development would not have happened. They claim that removing the School District portion would result in a net loss of $22 million over 30 years, and removing the City portion would result in a net loss of $46 million. Additionally, an estimated 3,000 additional residential properties would not be built over the next 10 years without the abatements. Overall, the report focuses on the fact that construction costs are exceptionally high in Philadelphia, while expected sale or rental prices are exceptionally low. Therefore, they argue that the abatement is needed in order to attract real estate investment that would otherwise go to places like New York or Boston.
The 2018 study doesn’t take a stance on the issue, leaving the judgment to city council and the mayor. It is also much more extensive. The report discusses general real estate conditions since the abatements were implemented, an overview of the types of properties, the tax dollars gained and foregone, and six possible scenarios for revision.
As of writing the study, there were 580,133 properties in Philadelphia, and about 15,000 added in the last 15 years. The property market has been booming, with median home value tripling since 1996. However, this was mostly for neighborhoods in and around Center City.
Abated properties have received a tax benefit worth $1.05 billion since 2000. In 2017 alone, there were 14,345 properties with active abatements, worth $6.7 billion and receiving a tax benefit worth $93 million. 12,477 properties with expired abatements generated $83 million, assuming 100% collection rates.
The report also found that tax abatements have been highly concentrated in high-value properties. Only 2.5% of Philadelphia’s properties had active abatements, but they accounted for 6.6% of all real estate value in the city. Commercial properties especially have concentrated abatement value. Only 2% of the abated properties were commercial properties, but they accounted for 11% of the abatement benefit. In 2017, just 15 properties received 16% of the abatement benefit, or $15 million. Additionally, only 7% of actively abated properties were worth more than $700,000, but they accounted for 51% of all abatement benefits. Despite this, the median value of residential property receiving an abatement was much lower, at $255,000. Still, this was 93% higher than the citywide residential median property value.
The tax abated properties are also highly concentrated by geography. Most are in or around Center City. Only 6% of Philadelphia’s neighborhoods accounted for 59% of the abatement tax benefits.
Like the 2014 study, the 2018 study discusses profitability. The City Controllers agree that development costs are exceptionally high in Philadelphia, while expected profits are exceptionally low. However, they go into more detail by offering a ZIP code-level analysis. They found that most ZIP codes are unprofitable, and that the eight most profitable ZIP codes where abatements were concentrated would have been highly profitable regardless of the abatements.
Finally, the researchers considered six possible scenarios for revision by applying different proposals to data from 2016:
- Eliminate the tax abatements entirely. This would have generated an additional $10.4 million from 1,411 properties.
- Eliminate the School District portion of the abatements. This would have generated an additional $5.7 million from 1,411 properties.
- Eliminate the abatements in the eight most profitable ZIP codes: 19102, 19103 19107, 19118, 19123 19130 19146, and 19147. This would have generated an additional $5 million from 712 properties.
- Cap the abatement at a property value of $700,000. This would have generated an additional $5.8 million from 72 properties.
- Cap the abatement at a property value of $150 per square foot. This would have generated an additional $1.5 million from 491 properties.
- Reduce the abatement over 10 years for individual properties, so that it would be 100% in the first year, 90% in the second, 80% in the third, and so on. This would produce no additional revenue the first year, and $1 million additional revenue in year-two from 1,411 properties.
As the authors note, it is important to be aware of the compounding effect of each proposal. For instance, if a proposal would generate an additional $5 million in the first year, it would generate an additional $10 million in the second, $15 million in the third, $20 million in the fourth, $25 million in the fifth, and so on. Over just five years, it would generate a total of $75 million.
I advocate for a mixture of these reforms to more strategically target neighborhoods with desired development. While the abatements undoubtedly encourage development, it is not at all clear that they significantly increase development that would not already be happening. Additionally, it is not clear that a reformed abatement would have negative impacts. Therefore, we are likely foregoing significant amounts of revenue unnecessarily, while encouraging luxury development with a one-size-fits-all approach. We should be encouraging production and renovation of affordable homes, rental units, and commercial properties, rather than luxury properties, and we can afford to do so.
First, we should eliminate the abatements in the most profitable parts of the city that do not need them. The eight ZIP codes identified in the 2018 report are a great starting point. The regions should be updated each year to reflect current market conditions.
Second, we should cap the value of the abatements. The proposals for a flat $700,000 cap and a $150 per square foot cap are great starting points. This could work similarly to a tax bracket system, so that the amount below the threshold receives the normal abatement, but the amount above it would not. This way, there is still reason to go above the threshold, but it just wouldn’t come with the same tax benefits. The caps should also include different levels for every type of property, such as commercial property, and they should be adjusted yearly to reflect market conditions and desired development.
Third, we should introduce an amortization of the abatement, like the linear reduction proposed. This would maintain the incentive for development up-front, but reduce the negative impact on tax revenues over time. It would also help to ease property owners into paying the full tax rate.
Finally, we should create flexibility with the abatement to encourage certain types of development and discourage others. We should make it so affordable developments that benefit everyday Philadelphians take priority, while luxury developments are discouraged. One way to achieve this is to increase the rate of amortization for desired properties and prolong it or even eliminate it for undesired properties. This way, more expensive properties will not be enjoying as much of the abatement benefit.
All of these reforms should exempt existing abatement properties in order to maintain continuity of policy. These should be reforms moving forward.
Overall, property taxes in Philadelphia should ease the tax burden on those with fewer resources and ask the most from the wealthiest among us, much like with income taxes. Here are my proposals, in short:
- Introduce progressively increasing tax surcharges on very expensive properties.
- Make all tax relief programs automatically apply.
- Introduce property tax relief for all low-income households.
- Make all renter-occupied households eligible for the same tax relief, with guidelines.
- Introduce business tax reforms as outlined in my earlier post.
- Reform the tax abatements to create a more strategic policy that encourages cheaper development in certain regions and discourages luxury development.
Like with most proposals, all of this requires legislation. The good news is that this is all local reform, so Philadelphians can begin to enact these changes immediately. This will require pressuring city council members and electing members who support these reforms.
There is only one hurdle, outside of convincing sitting council members to enact these changes. As mentioned in an earlier post, the State constitution prohibits taxing things of the same type at different rates. This would prevent passing a bracketed tax for property. This is why the Use and Occupancy tax exists—to create an effectively higher tax rate for commercial real estate while avoiding this restriction.
City council can use similarly creative strategies. For instance, they can introduce separate taxes for different tiers of luxury real estate that overlap with existing property taxes. This would be the same method of the Use and Occupancy tax. Or, they could implement fees for different real estate values that are effectively taxes. Or, they could create a higher tax rate for all properties, but with significant exemptions that effectively create a bracketed tax. There are likely many more potential methods.
The long-term goal should be one tax with several brackets, since this is the most direct and simplest method. However, this requires changing the State constitution, which requires passing a statewide referendum that can only hit the ballot once the state legislature approves it. So, this would be a long and difficult movement. Philadelphians should push for this regardless, since this constitutional requirement prevents Philadelphia from controlling its own fiscal policy in many other areas. In the meantime, however, we can enact all of the other changes.