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Philly predicament: Cut taxes or raise revenue

For some time now, Philadelphia has been working diligently to reduce wage and businesses taxes to attract residents and businesses.

For some time now, Philadelphia has been working diligently to reduce wage and businesses taxes to attract residents and businesses.

As tax revenues have gone down, the city's spending has gone up, forcing officials to take money from the city's slim savings, or fund balance.

The balance is now near empty - about 1 percent of revenue - and financial experts suggest that the city stop the tax cuts or increase property taxes.

Moody's Investor Services, troubled by the trend, recently downgraded the city's outlook from stable to negative on its A2 (high-medium grade) bond rating and warned that further decline in reserves could result in a rating downgrade.

In a newsletter to market participants and regulators, Municipal Market Analytics said last week that Philadelphia should stop cutting taxes and increase its reserves.

Without a healthy fund balance, the city could be in trouble financially and at risk for a rating downgrade. The lower the rating, the more expensive it is for a city to borrow money and the higher the burden for taxpayers.

Halting tax cuts runs counter to the city's decades-long efforts to reduce the wage tax, the city's main revenue-generator. The current rate is 3.9004 percent on city residents' wages, and 3.4741 percent on non-residents who work in the city.

Forty-six percent of the city's $4.1 billion budget comes from wage and earnings taxes.

The city started lowering the Business and Income Receipts tax (BIRT) in 2014 and plans to continue doing so in the coming years. With planned cuts to both the wage and receipt taxes, the city is expecting to forgo $281.3 million in revenues over the next five years.

In the meantime, the Kenney administration has embarked on an ambitious expansion of city services by promising universal early childhood education, community schools, and a refurbishing of city recreation facilities and libraries. The administration is relying on the recently enacted sweetened-beverage tax to cover much of the costs.

The tax, which has been challenged in court, comes online in January, far ahead of much of the increased spending. As a result, the tax should favorably impact the fund balance by about $24 million.

City finance director Rob Dubow said that the city's long-term goal is to raise the fund balance.

"The single best way to do that is to grow the economy, which is part of the reason why we want to keep reducing tax rates to make us more attractive to businesses," Dubow said.

The finance chief said the city looks at the budget in five-year spans and that the fund balance starts improving in 2019.

The city has been spending more than it brings in since 2014 when it had a reserve of $257 million. As of June 30, the city's fund balance was down to $106 million and the city is predicting that the balance will go down to $47 million by the end of fiscal year 2018 before picking back up.

Sam Katz, the former chairman of the Philadelphia Intergovernmental Cooperation Authority and a municipal finance expert, said that the city needs to get its spending "under control."

"What Philadelphia needs to do is increase growth," said Katz, a supporter of wage and business tax reductions. "I don't think Philadelphia's spending is aligned with Philadelphia's capacity to pay for it."

Matt Fabian, a partner at Municipal Market Analytics, said that while lowering wage and business taxes make sense "politically", the city needs to increase taxes elsewhere or cut spending.

"They are one bad year away from having to potentially cut deep into their regular spending and services," Fabian said.

Dubow has said that the city can trim departmental budgets if the economy goes south. As for the fund balance, it is one of the Kenney administration's many priorities, he said.

"It's going to take a little while to build it up because there are competing priorities that make it harder than it would be if that was our only priority," he said. Those priorities are prekindergarten, creating community schools, fixing city facilities, and lowering taxes.

The latter one having the business community's full support.

"The wage and business tax reductions are incremental over the next several years, and we think will encourage additional businesses to come locate here and stay here," Rob Wonderling, president of the Greater Philadelphia Chamber of Commerce said in a statement.

In the end, the rating agencies focus on what the city can do to right its finances and its willingness to do so, said Alan Schankel, managing director at Janney Capital Markets in Philadelphia.

Stopping tax cuts or increasing property taxes are the "low-hanging fruit" for getting more revenue. Or the city could strap its belt and spend less, he said.

"You either have to raise revenue or cut expenses," he said. "Everybody wants something. That's the hard thing about politics."