Prioritizing Transparency, Predictability, Fairness, and Market Awareness in Raising Funds for Affordable Housing in Philadelphia
In the face of rising rents and home prices, Philadelphia has the opportunity to implement a mechanism that generates stable and adequate revenues for affordable housing and allows our city to avoid the fate that high-growth cities like San Francisco, Seattle, and Boston are facing, where skyrocketing rents have made quality housing out of reach for a sizable portion of the population. As City Council deliberates options for raising funds for affordable housing development in Philadelphia, we encourage members to advance tax policy that is transparent, predictable, fair, and market-aware.
In Philadelphia, despite comparatively low average rents and home prices, the need for more affordable housing is real. While the cost to rent or buy a home here may be substantially lower than in other major US cities, wages here are also low. With 48% of city residents living below 200% of the federal poverty line, rising rents are placing undue pressure on a growing number of households.
The recent proposal to impose a 1% construction impact tax on all construction activity in Philadelphia, which City Council’s Committee on Finance will consider soon, is one of a range of possible mechanisms that have the potential to raise revenue for affordable housing development in the city. The construction impact tax is viewed as a compromise following the proposal and subsequent withdrawal of Councilwoman Quinones-Sanchez’s mandatory inclusionary zoning proposal. That proposal would have required developers building projects with more than nine units to set aside at least ten percent of the units as affordable or pay into the City’s Housing Trust Fund.
Adopting a construction impact tax that generates revenue for affordable housing would put Philadelphia in a group with few US peers. Portland, Oregon, imposes an 1% excise tax on construction projects of more than $100,000. This tax generates funds for affordable housing development, and works in concert with mandatory inclusionary zoning regulation. The construction tax being proposed in Philadelphia would go considerably further than the Portland tax, however, applying to all construction, including home renovations and construction activity carried out by nonprofit organizations.
As a backdrop to debate around how to fund affordable housing in Philadelphia is the prospect of raising revenues through modifications to the City’s existing 10-year property tax abatement. Much ink has been spilled on options to this end, including phasing out the abatement after five years, limiting the availability of the abatement to properties under a certain assessed value, and restricting the abatement to select neighborhoods.
These options are worthy of consideration, as Philadelphia’s existing property tax abatement programs are among the broadest offered by large cities in the US. Available on the full value of new construction and improvements to residential, commercial, and industrial properties in the city, these abatements have been widely used and are often cited as driving factors for the development renaissance in and around Center City over the past 20 years.
As the real estate market in Philadelphia has evolved dramatically in recent decades, however, calls have been made to revise the abatement programs to capture foregone revenue. And while the abatement ordinances themselves have not been modified, changes in recent years in the way the City assesses property have shifted more of a property’s value to land and have effectively reduced the share of property value eligible for abatement. As a result, few properties today enjoy a 100% property tax abatement.
Ultimately, the direction that Council takes regarding raising affordable housing revenues will have an impact on household budgets as well as the overall cost and competitiveness of Philadelphia’s residential, commercial, and institutional real estate markets. As Council weighs options for generating funds for affordable housing development, we lay out four policy principles to help inform and guide discussion: transparency, predictability, fairness, and market awareness.
As a general rule, preserving transparency and predictability in the tax system is a good principle for lawmakers to follow. Naturally, achieving pure transparency is not always feasible when tinkering with a multilayered, decades-old system, but it is good practice for Council members to consider the impact that new regulations will have on taxpayers’ ability to understand what they must pay, when, and to what end.
Generating affordable housing revenues from a tax on real estate or development activities makes sense at a basic level, as there is a clear link between the base being taxed (property owners) and the intended use of tax revenues (development of housing for low-income households). That said, adding a new layer to the suite of taxes currently levied on property and real estate development in Philadelphia will add to the complexity of development in Philadelphia and further obscure the true cost of construction, whether it be high-rise development or simple home renovations. Put simply, creating a new mechanism to recapture revenue foregone through property tax abatement will make the tax system more complicated and harder for taxpayers to understand.
Beyond prioritizing simple transparency, another feature of a good tax system is predictability. Tax predictability is important for households, businesses, and the real estate development and investment community, and lack of predictability can result in challenges that stretch family budgets thin and limit business activity. For example, over the past decade, multiple increases in the property tax rate coupled with reassessments that have dramatically changed the assessed value of many properties have resulted in regularly changing tax bills for many property owners. This lack of predictability makes it difficult for taxpayers – homeowners and developers alike – to prepare and plan. For homeowners, this can have a destabilizing effect on household budgets; for developers, it can mean more difficulty securing project financing.
Good tax policy also balances the need to raise revenues with the ability to pay of the those being taxed. The base for property and development-related taxes is broad, including homeowners, commercial property owners, small-scale housing developers, corporate real estate development firms, and all other owners of property. Within this class of taxpayers there is wide variation in wealth.
The property tax is often called regressive, as low-income homeowners are subject to the same percentage tax burden as are wealthier property owners who have more capacity to pay. Excise taxes like the proposed construction impact tax can be considered even more regressive than property taxes, as the cost of improvements (for example, renovating a bathroom) is relatively fixed, unlike property value.
Limiting tax burden on vulnerable populations can be achieved through targeted exceptions, rebates, and abatements that help offset excess burden on low-income property owners. Layering these types of programs into the tax system, however, adds complexity. As a result, taxpayers who are eligible for certain programs are often not aware that they qualify and do not take advantage.
Abatements themselves can contribute to inequitable outcomes if not structured carefully. In Philadelphia, most of value of the residential property tax abatement accrues to high-value properties. According to analysis by the City Controller, just seven percent of actively abated properties (those receiving abatements greater than $700,000) receive more than half of the total tax benefit made available through the program.
It is no secret that there is a link between taxation and market activity. Because market sensitivity can vary widely depending on how taxes are structured, it is critical to consider and understand the impact that any modification to property and development tax policy will have on the real estate market in Philadelphia.
While development in and around Center City has taken off over the past few decades, and average Philadelphia property values and rents have been rising, they are still not at a level that can cover the relatively high local costs of development and regularly generate margins or returns that are attractive to developers and investors. As many in the real estate community have pointed out, impinging on developer margins with an additional tax may have the effect of slowing down development activity in the city. Within the housing market, this would mean fewer new units. In the face of constant demand for housing, limited supply would have the effect of further raising property values and rents in the city, exacerbating the challenge that Council is committed to addressing. And what is more, a slowdown in development activity would also lead to a corresponding decrease in revenues from property and construction taxes, leaving less money available for the development of affordable housing.
As Council engages in what is sure to be a fast-moving, multi-faceted debate around the best way to raise funds for affordable housing in Philadelphia, maintaining focus on the four core principles of transparency, predictability, fairness, and market awareness will help members advance a solution that is sensitive to market realities in the city, equitable, and easy to understand.