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Is the Philadelphia Wage Tax Unconstitutional? And If It Is, What Can and Should the City Do?

(Photo: Ethan Schwartz/Flickr)

Philadelphia, the fifth largest city in the United States with a population over 1.5 million, has a complex and antiquated tax system. The Philadelphia tax system in general, and the City’s business taxes in particular, have long been criticized for driving employers and jobs away from Philadelphia by making it expensive to conduct business in the City. According to Professor Robert Inman of the University of Pennsylvania’s Wharton School, taxes alone make operating a business in Philadelphia 19% more expensive than in the suburbs. And those tax‐induced higher costs have had a dramatic effect. According to Inman, about half of the 300,000 jobs Philadelphia lost between the 1960s and 1990s are attributable to the City’s tax system, which Inman described as “a primary contributor to the city’s decline” over that period.

Although Philadelphia is not the only city facing fiscal challenges, the specific problems Philadelphia faces are not widely shared by other cities. Philadelphia places an unusually large tax burden on highly mobile factors of production, such as capital and labor, and less on fixed factors, most notably land. According to a 2014 report, 66% of Philadelphia’s tax revenue comes from taxing mobile wages and profits. In contrast, for New York and Washington, D.C., the comparable figures are 34% and 35%. And only 17% of Philadelphia’s tax revenue comes from real estate, whereas the corresponding figures for New York and Washington, D.C., are 41% and 36%. Moreover, not only does Philadelphia place an excessively high reliance on taxing mobile factors of production, but the centerpiece of the Philadelphia tax system, the Philadelphia wage tax—which raised more than $1.6 billion in 2014—now faces a constitutional challenge. Several petitions recently filed with the Philadelphia Tax Review Board seek a declaration that the wage tax, one of Philadelphia’s largest sources of revenue and one of its most controversial business taxes, is unconstitutional. Although the cases have not yet been heard, let alone decided, in our view the Philadelphia wage tax—is clearly unconstitutional as currently constructed (as described below). Accordingly, the City will soon face the question whether to save the wage tax by reforming it or eliminating it altogether and replacing it with other sources of revenue.

This Essay explains the constitutional challenge to the City wage tax, describes steps that could be taken to save that tax, and raises the question of whether Philadelphia should save or eliminate its wage tax.