Gabriel L. I. Bevilacqua, Chancellor
Philadelphia Bar Association
City Council Committee of the Whole – February 25, 2003

Good Afternoon.

Council President Verna and members of City Council -- I offer my thanks and appreciation for this opportunity to testify on tax reform.

On behalf of the 13,000 members of the Philadelphia Bar Association I thank you for your leadership and your commitment to our city.

The Philadelphia Bar Association has been an integral part of the Philadelphia community for 202 years now. Indeed, it is hard to imagine Philadelphia without Philadelphia lawyers. And we wear the title “Philadelphia lawyer” proudly – as does our Mayor, various members of City Council and so many other distinguished Philadelphians. We see ourselves as partners with the Mayor and Council in helping to ensure a bright and prosperous future for our great city and its citizens.

We commend the Mayor and Council for your continuing commitment to the courts and the justice system.

Today, we are here to talk once again about taxes.
“The power to tax,” United States Chief Justice John Marshall once said “involves the power to destroy.” And he added that “the power to destroy may defeat and render useless the power to create.”
Though Marshall uttered those words in 1819 they remain particularly relevant to tax policy generally and to Philadelphia’s tax situation today. Taxes can choke and destroy economic growth. And taxes can actually prevent the creation of businesses and jobs. Misplaced or unbalanced taxation can pre-emptively strike at the heart of our local economy.

Taxes levied in one area (or tax breaks selectively granted) affect every other segment of the economy. That’s why it is important to take a broad view of local tax policy and look at everything in context. Wage, net profit, real property, business privilege and other taxes must be viewed in aggregate.

So, it is not my intention today to go into minute detail regarding the recommendations of the Tax Reform Commission. I will simply reiterate that generally, we support those recommendations. We understand that any tax legislation will involve so many details and technical considerations as the legislative process unfolds.

Accordingly, the members of our Bar Association’s Tax Section are available to assist in any way that they can as this process moves forward.
For now, we continue to urge the city to restructure its tax system.

Studies have time and again shown that the City’s tax structure is one of the principal reasons why businesses leave Philadelphia, do not expand here, or never locate here. A recent study by the Pennsylvania Economy League came to this very conclusion. These studies are confirmed by our own experience as well as those of our clients. In dealings with business clients in the region lawyers have repeatedly heard businesses express their concerns with the city’s tax structure. And we understand those concerns.

Regrettably, the current tax structure actually encourages lawyers to follow their clients out of the city. And over the past fifteen years our surveys show that Philadelphia law firms have been opening satellite offices in surrounding counties at an accelerating rate. Yet, incredibly the area’s major law firms (including many national and regional powerhouses) have continued to maintain their headquarters offices in the city. Clearly, the firms would rather not leave.

But as the City’s tax structure continues to drive businesses and workers out of the city, how much longer can this last? One study shows that a Philadelphia family of four earning $40,000 annually can save at least $816 per year by moving out of the city. That is significant. This worker migration also limits the available talent pool for employers.

Second, we urge the city to address the inequality that is inherent in the Business Privilege Tax and correct the over-taxation of professional firms that are organized as partnerships.

Specifically, the City effectively taxes partner income at a combined rate of at least 6.7% but taxes compensation paid to employee owners of businesses operated as corporations or sole proprietorships at rates ranging from 3.9127% for nonresidents to 4.5% for residents. If the proposed slot machine legislation passes, and Wage Tax rates are reduced, the disparity between how partners in a service firm are taxed and how employees of a corporation are taxed will grow even larger This discrimination against service partnerships, and the extremely high 6.7% rate of tax, is a major factor in the large shift of service sector jobs from the City to the suburbs. Given today’s computer and networking technology, law firms and other service firms no longer need to be located in the City. They are highly mobile and can work virtually anywhere.

Due in large part to the City’s tax structure as it applies to partnerships, many firms have left the City, either entirely or in part, by expanding suburban offices. It is difficult to determine the extent to which new firms have chosen to locate in the suburbs, rather than the City, as a result of the City’s tax structure. A study released in January 2003 by the Central Philadelphia Development Corporation explains that Pennsylvania suburbs have enjoyed a robust 34% rise in professional services jobs between 1990 and 2000. The study goes on to note that Philadelphia added no new commercial office buildings in the 1990s. By contrast, the Pennsylvania suburbs have added 12 million square feet of space, the equivalent of 10 Liberty Place Towers, surpassing Center City in total space in the process.

Had 12 million square feet of new commercial space been developed in Philadelphia, the City would have received approximately $64 million per year in real estate taxes, $150 million a year in new annual business and wage taxes and would have generated between 156 thousand and 240 thousand more hotel room nights per year in business travel.

If Philadelphia had added just half this amount of office space, the City would still have realized over $100 million annually in new tax revenues.

The problem faced by professional service firms stems from the City’s taxation of partnerships relative to its taxation of other forms of business entity. Many professional services firms operate in partnership form for various reasons. Significant tax and non-tax restrictions exist to limit their ability to convert to non-partnership (or corporate) form. In light of such restrictions, and, faced with onerous taxation by the City, firms have, as the CPDC has recognized, explored alternatives such as relocating outside Philadelphia. The City has suffered and continues to suffer as a result.

As you may know, the Philadelphia Business Privilege Tax (or BPT) applies to businesses conducted within the City, regardless of form of organization (for example, corporation, partnership, sole proprietorship, LLC). The BPT consists of two tax bases, a tax on gross receipts and a tax on net income. With regard to the tax on net income, taxpayers pay at the rate of 6.5% on income attributable to business done within the City. By regulation, the City’s Department of Revenue has directed that businesses conducted in partnership form, may not deduct payments made to partners even where partners perform a significant level of service on behalf of the partnership. Businesses formed as corporations, certain LLCs or sole proprietorships, however, may deduct payments of compensation made to employees and owners (i.e., shareholders). No apparent policy supports this treatment. For the reasons we encourage the Council to consider the inequity presented in this situation and resolve to propose to the City the allowance of a deduction by partnerships of payments made to partners who participate in the operation of their business.

The top 22 Philadelphia law firms employ about 8,500 people in Philadelphia and pay nearly $44 million annually to the city in taxes (including net profits, wage, business privilege, use and occupancy and real property taxes). These same firms pay nearly $70 million annually to lease 14% of all office space in center city.

Most of the law firms in the city are small and medium-sized. So, you can multiply these figures and consider that a large majority of our lawyers, while operating small businesses, make huge contributions to Philadelphia’s tax base. The city’s tax structure greatly impacts on these small and medium sized firms as well.

Taxes affect everyone: small business, large businesses, families, laborers, professionals. It makes no sense to pit one group, one class or one segment against another.

The power to tax involves the power to destroy business, jobs and economic vitality or the power to create a growing, vital, economically vibrant city and region.

Philadelphia must now choose.

On behalf of the Bar Association I thank you and say once again: We resolve to work with you and provide whatever help we can as Philadelphia addresses these important issues.