Not exactly prime: Philly’s taxing business environment doesn’t help odds of landing Amazon’s HQ2

Like nearly every other city in North America, Philadelphia is putting the final touches on its bid to convince Amazon to build its second headquarters here ahead of Thursday’s deadline. The tech giant is making big promises to the winner: a $5 billion dollar investment and 50,000 high-paying jobs. In a series this week, PlanPhilly is using Amazon’s request for proposals (RFP) as a lens to examine the costs and benefits of doing business in our region.

Today: Amazon says it wants a “stable and business-friendly environment,” and asks cities to provide a tax incentive package — is that something Philly can deliver?

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With its RFP, Amazon is playing the game all big companies play – the economic development sweepstakes.

Philadelphia is no stranger to the game. The city and state joined together to give Aramark more than $20 million in direct subsidies and infrastructure improvements to convince it to keep the company’s headquarters — and its 1150 employees — here. Comcast played this game to get $40 million for it’s Comcast Center, and played it again to get another $40 million for its new Comcast Tower, too. Combined, the skyscrapers will hold around 8,000 Comcast employees.

Amazon, however, is in a league of its own when it comes to playing this game. According to a recent analysis by the Business Journals, Amazon has coaxed $1.24 billion in state and local government subsidies for its warehouses across the U.S. In Pennsylvania, Amazon has elicited at least $24.75 million for 15 warehouses employing around 9,900 workers.

With the RFP deadline approaching, the team putting together Philadelphia’s bid for Amazon’s HQ2 has been tight-lipped about what the city will offer. According to city officials, Amazon is requiring Philadelphia to enter a non-disclosure agreement, meaning  the size of the incentive package will remain a mystery unless the city wins.

Amazon’s economic development sweepstakes is a game nobody seems to like – well, nobody besides companies and their shareholders.

“From my point of view I’m not a big fan of offering subsidies to firms that come in and start negotiating with the city because in most instances it’s a zero sum game. You’ll end up lowering benefits or raising taxes elsewhere in the city to subsidize the relocater with probably little impact on jobs,” said Robert Inman, a professor of finance and public policy at The Wharton School.

Inman said trying to lure companies to town with tax breaks and other incentives is usually a bad way of doing business. It’s economically inefficient. More often than not, the winning city ends up losing, spending more on subsidies than it gets in new jobs and taxes.

“It’s called the winner’s curse,” said Inman. “If the city was going to adopt a strategy to attract business, I’d much rather see it be a uniform strategy, and, in that instance, probably lowering taxes generally on business.”

General Motors invented the modern version of this game in the mid-eighties when it announced plans to build a Saturn plant somewhere other than Detroit. Tennessee, which had landed a Nissan factory just a few years earlier, won the contest, thanks in large part to some $80 million in subsidies.

And giving huge companies big tax breaks just feels unfair, said Kevin Gillen, an economist at Drexel University.

“It would be difficult to look the owner of a North Philadelphia bodega in the eye and say, ‘You have to pay a sales tax, and U&O tax, and a property tax, and a gross receipts tax and a wage tax, but we’re going to let all these $100,000 employees of Amazon get a break on that,” said Gillen. “I would imagine he might probably not going to be okay with that, even if you can present him a nice graph or chart showing what the benefits would be.”

And when cities join these bidding wars for companies, Gillen says it encourages even more bad behavior. It’s what economists call “moral hazard” — incentive structures that induce rent-seeking behaviors. Other firms see Amazon or Comcast being rewarded with tax breaks and wonder, “Why not me?”

That’s the question being asked in Philly’s tech startup scene. Like most of her peers, Melissa Schipke is excited by the idea of a Amazon coming to Philly, even though it’d mean more competition for good employees in the short-run.

“The amount of jobs they’d bring to the area and the amount of visibility for Philly —  to be put on map — and innovation are huge benefits,” said Schipke, the CEO of Tassl, a startup analytics company with seven full-time employees.

“As excited as we are to have those big companies and the presence and visibility they give to the city, one would hope that some of those tax incentives are shared across the board, too, so of the young rising startups here as well, especially now as we’ll be competing for talent with some of the bigger competitors in the area.”

“What we might gain from Amazon we might lose from other businesses that are considering expanding here or relocating here because they are afraid they won’t be treated as fairly,” explained Gillen.

State and local officials are stuck playing the game, though. Their elections depend heavily on the state of the local economy — being able to say “I brought jobs here” is something all politicians strive for. The costs of bidding up the tax breaks are often borne by another city — it’s somebody else’s lost revenues. It presents a classic prisoner’s dilemma, where the incentives for each individual player encourage the socially worse outcome.

Elected officials justify paying off the private companies by pointing at the jobs, relying on the implicit, perhaps specious, assumption that but for the tax incentives and subsidies, the companies would have moved elsewhere. But tax breaks are inefficient, benefiting plenty of companies that would have moved or remained regardless of the incentives.

Even those who spend ridiculous sums to win companies end up touting their dubious achievements. Across the river, New Jersey gave Holtec $260 Million to move to Camden from the company’s previous home just twelve miles away in Marlton, NJ. Even accepting the company’s promise to expand its workforce at the new plant by 2,600, that still works out to around $100,000 per job. Right now, the company’s workforce is closer to 400.

And yet, despite their misgivings, both Gillen and Inman agree: Philly should play the game to entice Amazon into coming.

“As a rule, I’m not a fan of these kind of bidding wars and participating in the bidding war, but if there’s a case to be made for such exercises, then Amazon is certainly a candidate for that,” said Inman.

According to Inman, bribing a company into relocating makes sense when that company can change the regional economy.

“Typically, [this] occurs for very big firms, of which Amazon is clearly one. And its relocation to an economic area that has the potential to offer the kind of supplemental services and businesses that will enhance the productivity of Amazon.”

When a corporation grows large enough to create a form of business gravity that pulls smaller companies into its economic orbit, then cities can get the kind of returns to justify large subsidies. Amazon wouldn’t come alone. Other firms would relocate to be close. Perhaps more importantly, local firms would enjoy better access to a massive potential new client.

So incentives can make sense as a deal sweetener, said Gillen, but not as the main course.

“I think where the real issue is not whether to use them or not, I think where they should have impact is on the margin as opposed to being the main reason the firm relocates,” said Gillen. “If Amazon is serious about relocating here, I want them to move here because our underlying fundamentals are good, our labor force our cost of living our amenities, things like that.”

A bevy of levies

Compared to a lot of cities in the U.S., business taxes in Philadelphia are high. Like Inman, Gillen would prefer the city reduced business taxes more broadly, rather than shower Amazon in special incentives. But Philadelphia’s relatively large tax burden can justify giving special tax breaks to a few big companies, Gillen argued, despite the market distortions and inherent unfairness.

Philadelphia’s City Council has introduced some bills to do just that. Councilman-at-large David Oh introduced a bill to exempt an Amazon-sized company from the city’s business income and receipts tax (BIRT). Last week, Council held hearings on expanding and renewing Keystone Opportunity Zones (KOZ) to include the potential sites for Amazon’s HQ2 campus. KOZs offer companies that move into them breaks on a suite of state and local business and real estate taxes for ten years.

But here’s the thing: if Amazon came here, it wouldn’t have to pay most of those taxes anyway. For both Philadelphia’s and Pennsylvania’s business taxes, what matters is where the sale happened, not where your office is. The state and city use single sales factor apportionment for the corporate net income tax and the BIRT, respectively. As long as the company also has “nexus” with the city and state — usually accomplished by having some additional presence in the area, such as having a warehouse or advertising extensively there — the profits attributable to sales there can be taxed.

So if your company is based in Philly, but makes its money mostly elsewhere, it doesn’t pay a ton in state or local business taxes. Philadelphia’s BIRT and Pennsylvania’s corporate net income tax have a disparate impact on smaller businesses who mostly sell their goods and services locally.

In recent years, Philadelphia has worked to make this burden not so crippling. A company’s first $100,000 in revenues are now exempt from the BIRT. According to Marisa Waxman, Philadelphia’s first deputy revenue commissioner, that change reduced the number of firms paying the BIRT from around 90,000 to just 30,000.

The city has also reduced the wage tax slowly over the last twenty years by about a percentage point. It’s now 3.8907% for city residents and 3.4654% for commuters.

If Amazon did come to Philly, they’d have to pay the city’s wage tax and the Commonwealth’s income tax of 3.07 percent. Neither the city or the state government is likely to be able to promise Amazon relief on those taxes, thanks to the state constitution’s Uniformity Clause, which limits Pennsylvania lawmakers’ ability to give targeted tax breaks.

While Philly’s wage tax is considered high by national standards, Pennsylvania’s income tax is low compared to other states in the Northeast. New York state has a progressive income tax, ranging from 4 to 8.82 percent, on top of which the city imposes another 2.907 to 3.876 percent levy. New Jersey also imposes a graduated income tax running from 5.525 to 8.97 percent. In Washington, there are five income tax brackets levying between 4 and 8.5 percent. So, for top earners, Philadelphia’s combined city and state rate of 6.9607 percent is relatively cheap compared to other cities in the Northeast (and relatively regressive for lower income employees).

But a lot of cities and states don’t have these wage taxes at all. Income taxes effectively add to the cost of labor — firms, in theory, need to pay their workers more to make up for the amounts tithed to the government. Amazon could avoid them altogether if it picked a southern city like Austin or Nashville. However, despite the wage and income tax, Philly might still be the better deal, thanks to a lower cost of living.

Workers in Philadelphia command lower salaries than their peers in many other cities. Philly employees aren’t getting a raw deal, though. Things are generally cheaper here than they are in similarly sized cities, especially major expenses like housing. According to Zillow, the median home price in Austin is $325,000; In Nashville, it’s $329,900. In Philly, the average home goes for just $139,900. Because you get more bang for your buck in the Delaware Valley, companies can get away with paying workers here less than they would have to pay similarly skilled hires in most other big cities. So, even with the added expense of covering the wage and income taxes, Philly employers can enjoy lower labor costs compared to firms elsewhere.

Further complicating matters is the Republican push to overhaul the federal tax code. Currently, the internal revenue code allows taxpayers to deduct state and local income taxes from their federal tax returns, but GOP lawmakers have proposed cutting this deduction to partially offset reduced tax rates. Eliminating the state and local deduction would effectively make those taxes hurt more, forcing employers in places like Philly to pay their workers more to cover some of the loss… or encouraging them to leave for income tax-free jurisdictions.

Government officials attend a ceremony for the raising of the final steel beam at Holtec International.

If Amazon’s decision comes down to whoever offers the most cash, Philly won’t win. Across the Delaware River, New Jersey Governor Chris Christie has promised to cover all of Amazon’s construction costs to the tune of $5 billion. Philly simply doesn’t have that kind of money, and neither does Pennsylvania.

Pennsylvania’s Redevelopment Assistance Capital Program, one of the state’s primary tools for subsidizing companies into moving or staying here, provided around $310 million in grants to 162 projects across the state last year. But with Harrisburg unable to pass a budget, spending programs like this are imperiled.

And that’s another, bigger problem for Philly’s business prospects. Like most companies, Amazon says it wants a quote “stable and business-friendly environment”.

“You can say gridlock is a form of stability,” joked Josh Sevin, acting executive director of the Economy League of Greater Philadelphia.

Sevin was only half kidding. Harrisburg’s dysfunction is no laughing matter for the region’s economy.

“Businesses can handle a certain level of cost and regulation, but more than anything they’re hungry for predictability and consistency. And there is a certain basic level of gov’t functioning, like being able to pass a budget,” said Sevin. “I get concerned about what kind of signal that sends.”

Companies like Amazon look at chronically unbalanced budgets today and see severe service cuts or big tax hikes in the future. That fear is not unfounded. Two weeks ago, Republicans in the Pennsylvania House of Representatives floated a proposal to tax commercial storage. That would have hit Amazon’s fifteen warehouses across the state pretty hard.

That bill — like so many others to close the months old budget gap — died. But Amazon’s site selection team undoubtedly took notice. Harrisburg’s lingering dysfunction — this is but the latest year that the budget has been late — casts a pall on business prospects across the state.

So if Amazon does pick Philly, it won’t be because of the incentives offered.

It’ll be despite them.