Is Tax Windfall Worth the Wait? Philadelphia's abatement is to pay off big - in 2021.

Posted: December 14, 2008

Former Phillies slugger Pat Burrell might not fit the profile of a guy who needs a tax break, but he gets an enormous one nonetheless: a $37,284 discount on the $42,628 annual property-tax bill for his $2.6 million condo in Center City.

Though the free-agent left fielder has paid a king's ransom in other city taxes, he is one of more than 8,000 Philadelphia real estate owners who are beneficiaries of the city's property-tax abatement program. The most generous of its kind in the nation, it offers 10 years of lowered real estate levies on buildings that are renovated or newly constructed.

The breaks can be as modest as 3 percent for a new deck. Or they can be as huge as the 95 percent savings - $4.6 million annually - on the $500 million Comcast Center.

Introduced in 1997, when Philadelphia was desperate for development, the abatements are widely credited with catalyzing the Center City building boom.

But along with vocal champions, the program also has collected critics, who've long objected to substantial tax discounts going largely to developers and well-off homeowners such as Burrell. Now, as the city shutters libraries and drains public pools to close a five-year budget deficit topping $1 billion, the abatements are stirring new grassroots ire, on display at Mayor Nutter's town hall meetings, at demonstrations protesting his cuts, in confrontations in City Hall corridors, in community blogs.

The critical refrain: The abatements have served their purpose and ought to be retired or at least scaled back.

Developers are rallying to the program's defense. Ending the abatements amid the worst economic crisis since the Great Depression, they say, would be a death sentence for development in Philadelphia. The mayor agrees.

"It literally would be throwing water on a drowning person to change the tax-abatement program when it has already become increasingly difficult, if not impossible, to build anything in this city," Nutter said in a recent interview.

The mayor, however, has yet to take a position on a bill introduced this month by Councilman Darrell L. Clarke that would reduce the value of future abatements by 20 percent. It is the first attempt to scale back the program.

"Council members have heard complaints for years, but they are louder now," Clarke said. "Everybody knows it's not fair."

Fair or not, as enough abatements expire in about two decades, hundreds of millions of dollars in new property-tax revenue is expected to rain on the city and the school district.

Until then, the rewards are being reaped primarily by the developers and owners of abated properties. Since the first subsidies were granted, a total of $256 million has been shaved off their tax bills.

The program has suffered not a scratch from Nutter's budget ax, testament to the conviction held by him and other city officials that abatements have already generated wage taxes and business levies that have more than made up for the discounts.

"It makes money for us," Nutter said in a recent interview. "It's been a big winner."

However, according to an analysis conducted for The Inquirer, the abatement program has been, so far, a fiscal drain.

Even with all other tax revenues from Philadelphia's real estate renaissance factored in, the city has collected $19 million less since 1997 - just shy of $2 million a year - than it would have had the program not existed, according to a study by the economic-consulting firm Econsult Corp. and staffer Kevin Gillen, also a Wharton School fellow.

Gillen and Econsult - who support the abatement program - developed a sophisticated economic model that estimated that two-thirds of all development in Philadelphia since 1997 would not have occurred without the abatements. They calculated the broader tax impact of the program, factoring in revenue sources such as the wage and sales taxes paid by new Philadelphia residents living in abated buildings. (See the box on this page for a full explanation of Econsult's methodology.)

By 2015, their analysis shows, abatements will have kept $96.8 million out of the city's coffers - about $5.4 million a year. That is a relatively small portion of the total amount the city spends. This year's budget, for example, is $4 billion.

By 2021, the program is projected to go into the black, having accumulated $16.6 million in new revenue. Eventually, it should produce a mountain of cumulative tax dollars: $228 million by 2025, $1.28 billion by 2035, and more than $3 billion by 2045.

Nutter said in a recent interview that if the city immediately stopped issuing new abatements, it would not help him fill the hole in this year's municipal budget. But even if savings were to be had, he said, he would be disinclined to abandon the program, calling it "one of the most powerful development tools this city has ever had."

The mayor suggested the abatements have been even more crucial to development than Gillen and Econsult estimated.

"They did a mathematical analysis, and that's fine, but it has nothing to do with the reality of the marketplace," said Nutter, who worked briefly for Econsult after resigning his City Council seat to run for mayor. "Unless you've sat across the table from a developer trying to get a deal done, you don't know how important abatements have been."

In an earlier interview last month, the mayor acknowledged that "there are some property-tax fairness issues, and information issues, that need to be addressed."

Abatements are available to all property owners. But the city does nothing to publicly promote the program, so the majority of Philadelphians are unaware that their home-renovation projects could get them tax breaks.

The bulk of the abatements has gone to big developers, landlords, and upper-income residents. The condos and homes that qualify are, on average, worth four times as much as the typical Philadelphia residence and are concentrated in affluent areas such as Center City, Queen Village and Northern Liberties.

Developers and landlords own $1.6 billion worth of abated real estate, more than all other abated properties combined. They are the program's staunchest champions.

They point to $3.25 billion worth of development in Philadelphia since abatements were granted, and a 250 percent increase in residential construction. Those accomplishments, they say, would have been vastly diminished, if not impossible, without the program.

It has been "an unqualified success judged by any criteria," said developer Carl Dranoff, who has gotten abatements for at least 725 condos and apartment units in the last decade, saving well over $10 million in property taxes.

"It created development in fallow areas," he said. "It cleaned up blight. It brought new residents into the city. It created new jobs. And of course, it created an annuity for future tax revenues."

The program's critics cast abatements as welfare for developers and rich homeowners, another inequity in a property-tax system riddled with defects.

At recent town hall meetings on the budget crisis, Nutter has been asked repeatedly how he can justify giving tax breaks to millionaires while core city services are cut.

"I'd like to know why we're being asked to fight over the crumbs instead of you repealing the tax abatements," one woman told him at a meeting in Kensington, to audience applause.

When the town hall tour hit South Philadelphia, a resident expressed disbelief that the city offers a helping tax hand to people in "ludicrously expensive" condominiums.

"Can you help me out with that?" she asked Nutter when the microphone was passed her way.

"It's an investment in the future," the mayor replied, expounding on the benefits. With a 10-year abatement, "in Year 11, somebody is going to pay a very large real estate tax bill in perpetuity."

For the earliest abated properties, "Year 11" arrives in 2009, when 306 abatements will expire and the property owners will be on the hook for the full tax bill.

Some national abatement researchers say the city is giving away the store to the wealthy.

"Philadelphia is being overly generous. It makes absolutely no sense," said C. Kurt Zorn, an Indiana University professor who did a national study of abatements in 2005.

Abatements offered by other cities usually have significant restrictions. They can be used only in low-income neighborhoods, for instance, or the discounts are capped.

Not so in Philadelphia.

"The whole idea of an abatement is that it's not an across-the-board tax break," Zorn said in an interview. "It's supposed to target aid to areas that are traditionally blighted. I don't think downtown Philadelphia is blighted."

The program's expansiveness eventually will mean a big fiscal lift for the city's perennially struggling school system, which receives 60 percent of property-tax collections. The first profits - $1.6 million - are expected to materialize for the district in 2025, and accumulate to $583 million in 2035 and $1.6 billion by 2045, according to projections.

But in the meantime, the schools do not share in whatever wage, sales and business taxes are going to City Hall from abatement-fueled construction.

"The school district is always being promised, 'Don't worry, we'll take care of you later on,' " said Helen Gym of Parents United for Public Education. "We have a generation of kids paying right now for something that we hope makes money in 20 years."

The district's chief business officer, Michael Masch, declined to discuss the abatement program. (A former Philadelphia budget director, Masch left City Hall in 1996).

If only in theory, abatement-fueled expansion of the city's property-tax base should eventually lead to lower property taxes for all Philadelphians, who have been paying the same mill rate since 1989. In other cities and counties, lawmakers react to expanding or contracting property-tax bases by raising and lowering mill rates.

The mayor declined in a recent interview to speculate whether city property owners might benefit from the future deluge of revenue with a tax cut.

"The district will get theirs, and we [the city] will get ours," Nutter said. "As for the millage rate, that's a wonderful theoretical conversation, but I've got a $109 million deficit right now and a $1 billion deficit over the next five years.

"We'll have that discussion when we get to better financial times."

*

Philadelphia's real estate market was in bad shape in 1997, the year the first 10-year abatement law was passed.

Although Mayor Ed Rendell had succeeded in restoring some semblance of life to Center City through restaurants and retail, the pace of construction, particularly residential, was glacial.

In the five years before 1997, only 2,272 new units were added to Philadelphia's housing stock.

The suburbs, meanwhile, were booming.

Bucks, Chester and Montgomery Counties each had an increase of 10,000 to 16,000 housing units during the same five-year period. Even in Delaware County, whose population is one-third the size of Philadelphia's, nearly twice as many new homes, condos and apartment units were built as in the city.

Developers didn't want anything to do with Philadelphia. They couldn't make enough money here.

High construction costs were largely to blame. Developers typically point the finger at the building-trade unions and the city's much maligned permit and zoning processes; yet it is always more expensive to erect a tower on a crowded urban block than to build an apartment complex in a meadow.

In wealthier cities such as New York and Boston, there were plenty of residents who could afford the high rents and asking prices of newly built apartments and condos.

In 1990s Philadelphia, there were not.

"Given the depths to which we had descended, we needed something dramatic, universal and simple," said David Bartelt, a Temple University professor specializing in urban development.

In 1997, a few influential builders, including Dranoff, convinced City Councilman Frank DiCicco that an abatement program - tailored for developers - would be the charm. They wanted to fatten profit margins. The 10-year abatement did so in two ways.

In the case of condos, builders could charge higher prices for their units, since buyers would be willing to pay more - sometimes a lot more - for an abated property. (The abatement is transferred to the buyer.)

With apartment buildings, developers pocket the tax savings themselves. In theory, at least, that would help tamp down rents.

The first 10-year abatement bill applied only to rehabs and conversions, not new construction. Under that plan, the value that the renovation added to the property was tax-free. When City Council passed the law, a handful of developers jumped at it.

First was Dranoff, who announced plans to spend $24 million to turn the abandoned National Book Publishing building, on Locust Street between 24th and 25th, into 152 luxury apartments. Then he sank $58 million into the old General Electric building at 32d and Walnut Streets, converting it into a mix of 282 high-end apartments and more affordable studios.

There was "no chance" those projects would have happened without the abatements, Dranoff said. Next year, the discounts on those properties expire; the full measure of their combined tax bill will top $1 million.

Through 1998 and 1999, residential development remained disappointingly slow. But in 2000, the abatements were extended to new construction. Suddenly, developers were sinking money into abated projects, from Center City condo towers to townhouse communities such as John Westrum's Brewerytown Square and Toll Bros.' Naval Square in Grays Ferry.

In 2004 alone, more new housing units were built in the city than in the entire five years before the abatement program was created.

"From 2000 onward, the papers and magazines were filled with ads for Center City housing," said Paul Levy, executive director of the Center City District, a business interest group. "When you opened the paper 10 years ago, the only ads were for suburban tract housing."

Philadelphia had to "bring back the wealth that had been decanted out into the suburbs," said Sam Sherman, president of the city's Building Industry Association.

Realtors heavily marketed the tax-abatement savings, along with the amenities of the new, upscale housing stock and Center City's sophisticated environs. "Suddenly," Levy said, "there were lots of pictures in the real estate section of attractive young couples drinking wine."

Something clearly clicked: While Philadelphia as a whole has lost residents since 2000 - albeit at a slower rate than before - Center City's population has increased 14 percent.

Judging from resident surveys and new condo prices, many recent arrivals are in fine financial fettle.

At Dranoff's latest project, the Symphony House at Broad and Pine Streets, the smallest units start at $500,000. He estimates that 75 percent of the new denizens are former suburbanites, largely "empty nesters, executives, professionals and well-off retirees."

"These are the people who really create a tax base for the city," he said. "It's hard to see a negative in a program that got them to buy here."

Yet many longtime Philadelphians do see a problem with a tax program that benefits those who can afford the Symphony House, with its 24-hour concierge service and private wine lockers.

"It is plain wrong," said Joyce Carter, 64, a housing activist from the Lower Northeast. "The working person isn't getting the same break."

The biggest breaks have indeed gone to the city's rich and famous, including dot.com magnate Srinivas Balijepalli, who saves $47,600 a year, and celebrity restaurateur Stephen Starr, with a $39,700 reduction.

Although he understands that the size of such discounts creates resentment, said Gillen, the tax analyst, he supports the abatement program nonetheless.

For his reasoning, consider the case of Pat Burrell.

The slugger's property tax this year is just $5,344. But because Burrell lives in Philadelphia instead of the suburbs, where many local pro athletes settle, his taxes and a lot of the economic activity he generates stay in town.

The Phillies paid him $16 million this year, of which about $800,000 was sent to City Hall in the form of wage taxes. That amounted to about $500,000 more than he would have paid in nonresident wage taxes had he lived in the suburbs.

Add to that the sales taxes on his household's spending: the dinners out, the shopping, the dry cleaning, and so on.

"If I build a condo tower and fill it with Pat Burrells who don't pay property taxes, I still get their wage taxes," Gillen said. "In 10 years, I get their property taxes, too."

Levy pointed to a less tangible advantage. "There's a halo effect when a celebrity lives in your city," he said. "There will be profiles of him in Sports Illustrated, and maybe they'll talk about his condo in Philadelphia. That's not quantifiable, but it's important."

Yet Burrell's presence in Center City could as easily be used to make a case against abatements.

"The bottom line is, the abatement played no role in Pat's decision to live in the city," said his attorney, Edward Hayes. " . . . He's always been a Center City person."

Indeed, before buying his abated condo, Burrell lived in unabated Center City apartment buildings, so City Hall has long had the benefit of his wage taxes. For him, Hayes said, the city's attractions matter far more than any tax break.

Burrell has company. In a 2006 Center City District survey of new residents, abatements ranked dead last on a list of 16 amenities that drew them to Philadelphia. Far more important, they said, were restaurants, shopping and cultural attractions.

Yet real estate agents are adamant that buyers at all income levels are keen to get abatements. And some newcomers, like Bill and Laura Towey, formerly of Marlboro, Monmouth County, N.J., say they might not have relocated to Philadelphia without one.

The couple figure they will save $40,000 to $50,000 in taxes over the life of the abatement. The savings, Bill said, "let us buy more home."

Realtors said many of their abatement-seeking clients are like the Toweys: well-off, but not filthy rich.

Mike McCann, of Prudential Fox Roach, estimates that one-third of the properties he sells are abated. "It's not like these are all luxury condos," he said. "It's a lot of $400,000, $500,000, $600,000 homes."

In some neighborhoods, abated properties sell for significantly less than that. At Westrum's middle-income Brewerytown Square, a $350,000 home comes with an annual tax bill of $54 - a savings of about $2,450.

Even the Philadelphia Housing Authority has made use of abatements, selling 390 tax-discounted homes to low-income buyers in the past few years. Those buyers get the same deal as the owners of the Comcast Center, albeit on a wildly different scale.

Liberty Property Trust, developer of the Comcast Center, is spared $4.6 million a year in property tax. That sum, said senior vice president John Gattuso, was a "critical element in getting this project off the ground."

The developer of the proposed $1.1 billion American Commerce Center - at 1,510 feet, the city's tallest skyscraper, if it is built - is concerned about Councilman Clarke's bill to reduce the value of abatements by 20 percent.

"If you're talking about a project worth several hundred million of city market value, a 20 percent [cut to the abatement] is pretty big," said attorney Foster Kelsen, representing the developer, Hill International Real Estate Partners. "But is it a deal breaker? No."

Asked if the project would be a go if no abatement at all were available, Kelsen replied, "That's where you'd have heart failure."

Abatement critics, however, say they believe developers would still clamor for a piece of the Center City market.

At a minimum, they contend, the program should be more drastically limited than Clarke's bill proposes. They suggest halving the term of the abatements to five years, and offering them only in poorer sections of the city.

Even abatement champion DiCicco - recently spotted defending the program to an angry constituent in a City Hall corridor - said he had pondered amending the program. But that was before the economy soured. Now, with credit scarce, DiCicco said he agrees with developers who say the discounts are as crucial today as in 1997.

"The tax abatement is a hard habit to kick," said Sherman, of the Building Industry Association. "Any attempt to take it away is going to be met with resistance, at least in this challenging economic climate."

Even if the program is scaled back, the city is facing a future full of abatement unknowns.

Will residential property owners agreeably pay full freight when their discounts run out? Or will they sell, glutting the market with condos?

New York City, which recently retired its own 10-year property-tax abatement, did not see a spike in sales as abatements ended. But the discounts were phased out gradually, by 20 percent every two years, to ease the adjustment to higher bills.

In a 2005 study, the Center City District concluded that property owners were unlikely to sell when their tax breaks ended. But that was based on a small sample.

"We could have a real flood of properties hitting the market," said McCann, the Realtor. "We have to hope people are hooked enough on Philadelphia to stay."

Contact staff writer Patrick Kerkstra at 215-854-2827 or pkerkstra@phillynews.com.

Inquirer staff writer Anthony R. Wood contributed to this article.

How the Analysis Was Performed

Econsult used economic models to estimate the abatement program's net impact on city tax collections.

The calculations were based on the following assumptions:

That two-thirds of all abated construction would not have occurred without the program. Econsult came to that estimate through two independent methods. One analyzed construction and sales costs to determine which projects would not be profitable without abatements; the other compared suburban and Philadelphia residential construction rates before and after the abatement program was enacted. Both methods arrived at the same conclusion.

That the abated homes were filled with new Philadelphians or existing city residents whose newly vacated homes were then made available to new Philadelphians.

That the abated homes are populated by residents earning the city's median wage.

That future abatements would be granted at the 2006 rate, which in Econsult's view is a conservative estimate.

That values of the abated properties would remain unchanged.

Philadelphia's Tax-Abatement Program

1997 City passes first 10-year tax abatement for home renovations and housing conversions.

1999 First abatements kick in as projects are completed.

2000 Program extended to new housing, commercial and industrial construction.

2006 Program's busiest year: 1,976 properties valued at $576 million abated.

2009* Earliest-abated properties begin paying full taxes.

2015* Program's cost reaches high of $96.8 million in cumulative forgone tax revenue.

2021* Program pays off. Cumulative revenue exceeds what would have been collected had abatements never been granted.

2025* Abatements start paying off for schools, which lag the city because they don't share in non-property tax revenues.

2035* Program's cumulative tax revenue reaches $1.28 billion.

2045* Cumulative revenue tops $3 billion.

*Projected

SOURCE: Econsult Corp., the Philadelphia Board of Revision of Taxes

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