July 1 2003

Philadelphia's unique Wage Tax has long complicated tax reform efforts. What is different, and why is it a problem?

(July 2003) No examination of income taxes in Pennsylvania - or the quest for local tax reform - is complete without a closer look at Philadelphia’s city wage tax. Historically, it’s been a key stumbling block. Why? IssuesPA sought answers.

Why is Philadelphia different?

Local income taxes in Pennsylvania are fairly straightforward - a flat percentage, usually 1%, levied on wages and salaries. Philadelphia, however, imposes a local income tax that’s taken on a controversial life of its own for city residents and suburban residents who work in the city.

A 1939 state law - The Sterling Act - gave Philadelphia authority to impose the wage tax as a temporary measure to help cope financially with The Depression. Since then, its role has grown significantly. In Fiscal 2003, Philadelphia expected to collect 52% of all local tax revenues from the wage tax.

A wage tax in major cities isn’t common. Only four of the nation’s 10 largest cities levy a wage tax, and virtually no major cities have enacted a new wage tax in the last 40 years. No city relies on a wage tax like Philadelphia does.

Philadelphia’s city government levies the tax on city residents and non-city residents working in the city. City residents pay 4.5% on all wages and salaries earned regardless of their job location. Non-residents pay 3.9127% on wages and salaries they earn within the city limits. Since Philadelphia’s wage tax applies to workers living in the city as well as those commuting to the city, it’s actually a regional tax. However, because Philadelphia retains all wage tax proceeds for its own use, non-residents receive for their tax dollars only the benefit of services provided within the city limits.

What are the real implications of this tax?

The state law establishing the city wage tax gives Philadelphia’s government first claim on wages earned in the city. In 2000, this removed $7.9 billion from the earned income base of the four suburban counties surrounding Philadelphia - Bucks, Chester, Delaware and Montgomery. This represents $314 million or 25.4 percent of wage tax revenues collected by Philadelphia. According to Philadelphia’s Department of Revenue, 68.2% of non-resident taxes came from wages earned by residents of Philadelphia’s Pennsylvania suburbs, with the rest from non-residents living elsewhere, primarily New Jersey.

Many believe the wage tax is responsible for a steady, undesirable exodus of jobs and people from Philadelphia. Robert Inman, Professor of Finance and Economics at the Wharton School of the University of Pennsylvania, estimated Philadelphia lost 207,000 jobs over the past 30 years solely due to increases in the city’s wage tax rate.

What’s the public’s opinion?

There are many:

  • A Pennsylvania Economy League poll of 403 city residents in April 2002 found 50% had considered leaving the city. When asked why, 18% specifically said the wage tax was too high, and 17% said taxes in general were too high. When asked which tax caused the most people to leave, 53% cited the wage tax, and 52% cited high taxes overall.
  • Over 60% of office workers surveyed by the Central Philadelphia Development Corporation identified the wage tax as what they liked least about working in Center City.
  • In a 1999 survey by Greater Philadelphia First, the wage tax ranked second in a list of factors mentioned - behind only the crime rate - as the primary reason for people leaving the city.
  • In a 1999 survey of suburban Philadelphia technology firms by the Texcel Corporation, based in Plymouth Meeting, 34% of those responding said the wage tax is a prime deterrent to the growth of technology firms in the city. Taxes were second only to the 40% who said the lengthy commute is a key barrier.

So what does all this mean?

Philadelphia’s city wage tax impacts the city’s finances and the finances of its neighbors. And it impacts the growth of southeastern Pennsylvania’s economy as a whole. Any attempts to reform local taxes in Pennsylvania must reform, in some way, Philadelphia’s city wage tax.