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May 10, 2004

Chancellor's Testimony at May 10 Tax Hearing

Gabriel L. I. Bevilacqua, Chancellor
Philadelphia Bar Association
City Council - Tax Hearings - May 10, 2004

Good Afternoon.
Council President Verna and members of City Council, on behalf of the 13,000 members of the Philadelphia Bar Association I offer my thanks and appreciation for this opportunity to once again testify on tax reform.
I have met today with my colleague and Vice Chancellor Alan Feldman. Alan will lead our Association in 2006. He has joined me so that we may demonstrate the sustained commitment of our Association and its members to tax reform. Indeed, several Chancellors of the Bar Association have appeared before you in the past few years to speak on this topic. Our concern is real and it is ongoing.
We understand that tax reform is a huge issue for this Council and this city government to confront. And, indeed, that is reflected by the fact that there are 13 pieces of legislation that you are considering.
But I want to call your attention today to one particular inequity which we believe can and should be promptly addressed--especially if we are really serious about tax fairness and a pro-growth, pro-jobs economic policy in our city.
Specifically, we urge the city to address the disproportionately high tax burden imposed by the Business Privilege Tax the Net Profits Tax on service firms that are organized as partnerships.
Under the current tax rules, if a service firm is organized as a corporation, the employee owners of the business will pay City Wage Tax at a rate of 3.9127% for nonresidents and 4.5% for residents. In contrast, if that same firm were organized as a partnership, the partners would be subject to a Business Privilege Tax of 6.5% on their net income. In addition, the partnership would pay a Net Profits Tax, but would be able to claim a credit of 60% of the net profits portion of the BPT. The effective rate of tax on partnership net income could, in some cases, exceed 7%.
As you may know, the BPT applies to businesses conducted within the City, regardless of form of organization (for example, corporation, partnership, sole proprietorship, LLC). The BPT consists of two tax bases, a tax on gross receipts and a tax on net income. With regard to the tax on net income, taxpayers pay at the rate of 6.5% on income attributable to business done within the City. By regulation, the City's Department of Revenue has directed that businesses conducted in partnership form, may not deduct payments made to partners even where partners perform a significant level of service on behalf of the partnership. Businesses formed as corporations, however, may deduct payments of compensation made to shareholders who provide services. As a result, service firms organized as corporations have little or no net income, and pay little or no City taxes on their net income. Instead, their shareholders pay City Wage Taxes, at substantially lower rates. 
No apparent policy supports the discrimination against service firms organized as partnerships.  For the reasons we encourage the Council to consider the inequity presented in this situation. We are not asking for special treatment.  We are only asking for a level playing field.  Specifically, we ask that the BPT be amended to permit partnerships to deduct distributions made to partners who provide services to their partnerships.  The effect of this amendment is that service partnerships would pay tax on their net income at the rates imposed by the NPT, which are the same rates as are imposed under the City Wage Tax. 
I have here today the proposed legislation which would accomplish this and I am happy to present it to you and would respectfully welcome the opportunity to have it introduced by a member of Council.
We believe that the inequities which I've just enumerated are among the major factors in the relocation of professional firms from the City into the suburbs.  That's why we care so deeply about this. 
Due in large part to the City's tax structure as it applies to partnerships, many firms have left the City, either entirely or in part. 
Many professional services firms operate in partnership form for various reasons. Significant tax and non-tax restrictions exist to limit their ability to convert to non-partnership (or corporate) form.
And in many ways, this is really a small business issue. Bear in mind that many small and mid-size firms are organized as partnerships and consequently suffer under this provision. In fact, nearly two-thirds of the membership of the Bar is composed of small and mid-sized firms.
So, this is a serious issue.
A study released in January 2003 by the Central Philadelphia Development Corporation explains that Pennsylvania suburbs have enjoyed a robust 34% rise in professional services jobs between 1990 and 2000. The study goes on to note that Philadelphia added no new commercial office buildings in the 1990s.  By contrast, the Pennsylvania suburbs have added 12 million square feet of space, the equivalent of 10 Liberty Place Towers, surpassing Center City in total space in the process.
In light of such restrictions, and, faced with onerous taxation by the City, firms have (as the CPDC has recognized) explored alternatives such as relocating outside Philadelphia. The City has suffered and continues to suffer as a result. 
A recent Pennsylvania Economy League study showed that a law firm is faced with an 80% greater increase in taxes if it expands in Philadelphia rather than in the suburbs.
And over the past fifteen years our surveys show that Philadelphia law firms have been opening satellite offices in surrounding counties at an accelerating rate. Yet, incredibly the area's major law firms (including many national and regional powerhouses) have continued to maintain their headquarters offices in the city. Clearly, the firms would rather not leave.
Think for a moment about where Philadelphia would be without center city law firms. If you take a virtual walk up Market Street West with me, you will find nationally known leaders in the legal services sector. Big important businesses, one after the other:
1500 Market Street, Saul Ewing, 305 employees
1600 Market Street, Schnader Harrison Segal & Lewis, 303 employees
1650 Market Street, Duane Morris, 485 employees
1650 Market Street, Reed Smith, 316 employees
1650 Market Street, White and Williams, 436 employees
1650 Market Street, Woodcock Washburn, 215 employees
1701 Market Street, Morgan Lewis & Bockius, 563 employees
1735 Market Street, Ballard Spahr Andrews & Ingersoll, 629 employees
1735 Market Street, Dilworth Paxson, 162 employees
1900 Market Street, Cozen O'Connor, 704 employees
2000 Market Street, Fox Rothschild, 411 employees
2005 Market Street, Stradley Ronon Stevens & Young, 286 employees
That's nearly 5,000 employees just on Market West. When you take in all of center city, you can virtually double that figure to nearly 10,000 employees. And that 10,000 is only one third of the entire Philadelphia legal community and its support staff.
The jobs that the legal services sector brings to our city are good jobs. The ancillary business that the legal services sector supports are vital to our regional economy.
Remember: The top 22 Philadelphia law firms pay nearly $44 million annually to the city in taxes (including net profits, wage, business privilege, use and occupancy and real property taxes). These same firms pay nearly $70 million annually to lease 14% of all office space in center city.
In fact, if all of the city's lawyers and law firms were part of a single corporation, we'd be one of the very largest corporations in the region.
Philadelphia without Philadelphia lawyers? It's hard to imagine. Center City as it exists today would be totally unrecognizable. Whole parts of it might well be deserted, blighted, barren. That's not our vision of the city. We love Philadelphia. We want to see our city continue to grow and prosper. We care about the city.
We don't want special treatment. We simply want tax equity and reasonable tax reform. And we want to work with the city government and with City Council to continue to bring good jobs and solid businesses to the city. We can start with the change that I've recommended today.
Thank you, and I welcome your questions.
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