Russell Richie: Philadelphia’s job-killing wage tax — and a better alternative

On January 1, 1940, Philadelphia became the first American city to levy a wage tax. The idea was simple: tap the concentration of workers and firms in the city to fund local services. Within a generation, six of the ten largest U.S. cities had copied the model.

Philadelphia never stopped. The tax that began as a Depression-era stopgap at 1.5 percent climbed to 4.3 percent by the mid-1970s, and though it has fallen gradually since 1995, it still sits above 3.4 percent for nonresidents — nearly triple its original rate. In 2019, it accounted for 37 percent of the city’s entire general fund revenue. No major American city is more dependent on this particular instrument of taxation.

Now a working paper from two Harvard economists, Matthew Jacob and René Livas, provides the most rigorous evidence to date that this dependence has come at a steep price. Their conclusion: replacing the wage tax with a land value tax — a tax on the value of land itself, rather than on what people earn working on it — would bring approximately 26,000 jobs back into Philadelphia from the suburbs.

Better understanding the harms of the wage tax could hardly be more timely. Center City’s office vacancy rate sits at over 20 percent, roughly double its pre-pandemic level, as remote and hybrid work have allowed white-collar workers to untether from downtown. The city’s own budget documents acknowledge “heightened fiscal risks” as Covid-era federal relief funds have run dry. Mayor Parker’s administration is pursuing gradual wage tax reductions — the nonresident rate is set to fall from 3.44 percent to 3.39 percent by 2029 — but the Philadelphia Chamber of Commerce has called even that modest pace insufficiently ambitious, arguing the city needs to reach 3 percent to be genuinely competitive. Against that backdrop, a rigorous study quantifying exactly what the wage tax costs in jobs, and what a better alternative might look like, arrives at a useful moment.

Philly’s wage tax: A natural experiment 

Philadelphia’s wage tax applies to city residents regardless of where they work, but it also applies to suburban residents who commute into the city. That means a suburban accountant deciding between a Center City firm and one in King of Prussia faces a real tax penalty for choosing the city. Do that math across hundreds of thousands of workers, and you’d expect it to quietly push jobs outward over time — which is exactly what the researchers found.

How they found that is clever. Because the wage tax applies inside Philadelphia’s borders but not across the street in Delaware or Montgomery County, the city line functions as a kind of natural experiment. The researchers compared commuting patterns in neighborhoods just inside the boundary versus neighborhoods just outside it, as the wage tax rose sharply in the 1960s and 70s and then slowly fell after 1995. The boundary itself dates to the 18th century and has nothing to do with tax policy — it’s just where the city ends — which makes the comparison clean.

As the nonresident wage tax rate climbed from 1.5 percent to 4.3 percent between 1960 and 1980, the share of suburban residents commuting into Philadelphia fell — and the drop was sharpest right across the city line. When the tax began declining after 1995, commuting from those same border neighborhoods picked back up. The same pattern appeared in Detroit and Cleveland, two other wage-tax cities, and was absent in comparable cities without such taxes. By the researchers’ best estimate, every one percentage point increase in the tax rate reduced suburb-to-city commuting by more than 6 percent — a substantially larger effect than most prior studies of tax competition had found.

Reducing the wage tax therefore ought to bring jobs back to Philly. But if the city unilaterally cut the wage tax, the city would be bereft of the funds it needs to fund its schools, roads, police, and other public services. So the question is: is there a better – or at least less bad –  tax the city could use instead of the wage tax, and make the revenue math work? The authors looked to a land value tax.

Land value tax: The least bad tax

A land value tax (LVT) is exactly what it sounds like: instead of taxing a property based on the total value of the land and the building on top of it, you tax only the underlying land. The building, the improvements, the investment a property owner has put in — none of that is penalized. Only the location itself is taxed.

Economists across the political spectrum have long regarded this as the cleanest way to raise public revenue. Milton Friedman, the Nobel laureate and free-market icon, put it plainly in a 1978 interview: the least bad tax, he said, is “the property tax on the unimproved value of land”. 

The efficiency case for LVT is simple: unlike taxing wages or buildings, taxing land doesn’t reduce the supply of what’s being taxed. Land can’t move, and it can’t be created. A tax on its value doesn’t discourage anyone from working, building, or investing. The fairness case is equally strong. When a neighborhood improves — when streets are repaved, when a new park opens, when policing improves public safety — nearby land values rise. That increase was created by public investment and community effort, not by anything the landowner alone did. A land value tax returns some of that windfall to the public rather than letting it accumulate privately.

The idea also has deep Philadelphia and Pennsylvania roots. Henry George, whose bestselling 1879 book Progress and Poverty made the land value tax famous worldwide, was born here. Pat Toomey, before his career in Congress and the U.S. Senate, was a businessman in Allentown who helped pass a land value tax there through a 1996 charter amendment. After it passed, building permits in Allentown increased 32 percent, and 70 percent of residential parcels saw their tax bills go down — with the biggest relief in the city’s most vulnerable neighborhoods. Similar effects played out in the 20 other PA cities that implemented LVT.

Taxing land, not man

Armed with this knowledge of the advantages of land value tax, the authors built a model of how the whole metropolitan economy would adjust if the wage tax were replaced with a land value tax. Their result: Replacing the wage tax with a land value tax would bring roughly 26,000 jobs into Philadelphia from the suburbs. Land values inside the city would rise 9 percent, as economic activity reconcentrated where infrastructure and workers are already clustered. Factor in the productivity gains that tend to happen when more workers are in proximity to each other, and the job gains triple.

The paper doesn’t pretend the choice is politically simple. The wage tax is deeply embedded in Philadelphia’s fiscal architecture, and the authors calculate that raising it further from current levels would actually bring in more money in the short run, since the lost economic activity takes time to materialize fully (i.e., people don’t move out instantly, but they do eventually leave). The fiscal case for cutting it is therefore weaker than the efficiency case. The paper also doesn’t answer questions about how the economic gains from shifting to land value tax would be distributed. Philly’s leaders are sure to want that answer before considering any reform.

Conclusion

Philadelphia’s signature tax has been quietly pushing jobs to the suburbs, and now Jacob and Livas have put hard numbers on the cost. Twenty-six thousand jobs means more tax base, more SEPTA riders, more customers for neighborhood businesses — and a city that works better for the people who live in it. That’s worth a serious political conversation.

Russell Richie is the Director of Strategy and Impact at the Progress and Poverty Institute, and the Board Treasurer of 5th Square Advocacy.