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John Kromer, a lecturer and senior consultant at the Fels Institute of Government at the University of Pennsylvania, is a former Director of Housing for the City of Philadelphia. His book, Fixing Broken Cities: The Implementation of Urban Development Strategies, includes a chapter on the origins and outcomes of Philadelphia’s ten-year tax abatement.
Participants in the heated debate over the future of the city’s 10-year tax abatement haven’t figured out how to deal with a fundamental contradiction: if we reduce the abatement term, the abatement amount, or the citywide scope of this incentive, then we’ll weaken the city’s potential to attract investors and developers. But if we agree to maintain this incentive in its current form, then we’ll be recommitting to its inequitable structure, through which property owners and buyers with the most capital to invest in the most marketable areas of the city will continue to profit most from the program.
This contradiction is resolvable, and it should be resolved before Mayor Michael Nutter’s budget proposal is approved by City Council. Here’s what to do.
We need to recognize that the biggest beneficiaries of the abatement — wealthy investors and higher-income homebuyers — are rewarded twice under the current program. They enjoy a decade’s worth of lower property taxes, and they also get to keep all resale proceeds when they’re ready to sell. In the strongest real estate markets where the biggest abatements can be found, resale proceeds are likely to be significant. Absent another Great Recession, housing prices downtown and in newly trendy neighborhoods are likely to appreciate substantially during the coming years.
The sales price appreciation associated with these higher-end properties is attributable in large part to the existence of the tax abatement. Many of these big-ticket properties — luxury condominiums and townhouses — would never have been developed but for this incentive, as documented in Kevin Gillen’s most recent analysis (see below). So, when the time comes to sell, why aren’t these fortunate property owners sharing the resale proceeds with their business partner, the City of Philadelphia?
We’ll need to continue to offer a big incentive on the front end — the existing tax abatement — in order to make Philadelphia competitive in the regional real estate market. Fifteen years ago, in the dialogue that led to the approval of the first 10-year abatement, developers cited four barriers to doing business in Philadelphia: struggling public schools, the city wage tax, the cost of labor relative to the suburbs, and delays in the permitting and regulatory approval process. These barriers remain. When they’re eliminated, we can talk about reducing or doing away with the 10-year abatement, but not before then.
In the meantime, however, there’s no reason to reward wealthy property owners on the back end by letting them keep all the resale proceeds associated with a valued asset that the public sector helped create.
For higher-end properties that receive the tax abatement in the future, why not require that any resale proceeds exceeding the original purchase price be shared dollar for dollar with the city? One example: a tax-abated Penthouse in the Murano building in Center City West was purchased for $3.8 million late last year. If this property were later to be sold for $4.6 million, then the City would have been able to collect $400,000 if this requirement had been in effect. A tax-abated property in the Rittenhouse Square area was sold for $3.7 million in 2010. If that property subsequently sold for $4.7 million, the City would have collected $500,000 if this requirement had been in place.
Properties initially purchased for less than $750,000 and properties with existing tax abatements would be exempt from this requirement. Wealthy property owners could prepare for the eventual payoff that would occur at resale by depositing an amount equal to half the abated taxes into an interest-bearing account. Or they could choose not to take the abatement at all—but that would be unlikely.
What if we experienced a Great Recession encore, or what if, for some other reason, the resale amount turned out to be less than the original purchase price? In the event of no price appreciation there would be no requirement to share sales proceeds with the City.
Would the City be capable of administering a program with a payoff requirement of this kind? The City already does something similar with respect to tax increment financing, in which a portion of the increased tax revenues associated with a completed development project are used to pay debt service on project financing. With millions of dollars in new revenue to be earned, the City could find a way to handle related administrative tasks.
We should celebrate the benefits that Philadelphia has experienced as a result of the ten-year tax abatement. But we should also start getting our share of the rewards, in order to make sure that these benefits are shared with all Philadelphia taxpayers.