Resentment over the city’s policy of giving 10-year tax abatements to new construction has been bubbling below the surface for years.

Folks don’t like the fact that while they pay real estate taxes on their home, the owners of that fancy new house down the street is exempt from paying a large portion their taxes. (The land is taxed, but improvements are not.)

Now, with the citywide reassessment know as AVI, the debate over the tax abatements is joined again.  In a city with 579,000 properties, why should 15,000 owners enjoy a generous, 10-year tax holiday? The abatement is given citywide, and the aggregate market value for the abated properties is $8 billion.  It includes residential and commercial construction.

Kevin Gillen, economist at the Fels Institute, recently stepped into the fray with a report that seeks to justify the abatement using facts and figures (see below).

According to Gillen’s analysis, the tax abatement has played a major role in Philadelphia’s revival.  In the 10 years before the tax abatement, the city issued building permits for 6,405 housing units; since then it has issued 17,700.

Most economists and public policy people I know agree with Gillen’s analysis: The abatement did its job.  It was a tax incentive that spurred development.  While it was not the only factor, it was a significant one and an overall plus for the city.

Whether we need to continue it in its present form — on all new construction and major renovations — will be a matter of debate, probably in City Council.

But, let’s take a step back and ask a more fundamental question: Why do we need to give any tax abatements?  Why did new construction in the city lag behind regional and national averages for so long?

Gillen’s analysis is helpful in answering those questions.  In Philadelphia, there is a fundamental imbalance between the cost of new construction and the prices that project will yield.

In his analysis, Gillen said he looked at building costs and found that Philadelphia ranks fourth in the nation in cost per square foot.  It is $128 per square foot here, compared to a national average of $102 per square foot. Only New York, San Francisco and Boston have higher costs, so we are in heady company.

The problem is we cannot get New York, Boston or San Francisco prices for our homes. We don’t have the wealth.  Our median household income is lower — a lot lower — than that of those cities.  At $37,000 a year, we are far below the U.S. income average of $50,000 per household.

Why are construction costs so much higher in Philadelphia?  High labor costs.  The building and construction trades unions enjoy a virtual monopoly on construction in the city and the hourly rates their workers charge are high. Using an all-union workforce can add 30 percent to the cost of a project.  (You can fly under the radar and use non-union help on small projects, but watch out if you try that with larger ones. The Ratmobile will soon be parked outside.)

Developers know how to use spreadsheets.  On any given project, they will add in all of their costs, and then estimate the price they can get for the properties.  The difference is their profit.  If that bottom line is too small — or a negative number — they won’t proceed.

Paul Levy, head of the Center City District, learned this through experience in the mid-1990s.  At the time, the city’s office center had migrated west to new office towers on the west side of Market Street.  Older retail establishments were exiting the city.

The District commissioned a study to develop a strategy to combat vacancies.  The result was “Turning the Lights on Upstairs.”  Released in 1996, it recommended strategies for converting old office and retail space into residential uses.  The study made a lot of sense.  It even gave specific examples of buildings ripe for conversion.  But no developers bit.

What could be done to push this project along?  New York had offered tax abatements to spur development on Wall Street.  Levy and others went to City Councilman Frank DiCicco to see if the same could be done here.  In 1997, a law was passed allowing a five-year tax abatement, but only for projects involving conversions of commercial/retail properties into residential ones in Center City.

The bottom lines on the developers’ spreadsheets suddenly jumped in an upward direction.  They were able to charge higher prices to buyers who would get some of that money back through tax abatements.  The conversion boom began.

In 2000, at the urging of Mayor John Street, City Council increased the abatement to 10 years, made it for major renovations and new construction for all types of properties and applied it citywide.  A citywide building boom commenced.

People tend to view the abatement as a subsidy for developers and home buyers. In reality, it is a taxpayer-financed subsidy for the building trades unions.  It allows unions to maintain wages that are higher than the average in the region and in most other cities.

In the post-AVI frenzy, Council could choose to do away with the abatement. Several Council people say it is no longer needed to sustain development.

They are kidding themselves if they believe that. Do away with the abatement if you wish.  But unless something is done at the same time to lower construction costs, you can kiss the building boom goodbye.

PHILADELPHIA’S TEN-YEAR PROPERTY TAX ABATEMENT