Assessment of Revenue Options

Lower Merion Township (the “Township”) faces a challenge most likely unique in the Commonwealth of Pennsylvania. As one of the few “AAA/Aaa”-rated municipalities in the country, and as one of the most prosperous localities as well, it offers its citizens a mix of services and amenities not frequently delivered by local government.

Supported by high property values, a vibrant small business community and an well–educated and largely affluent population, the Township deservedly has the reputation of being among the most forward-looking and well-administered municipalities in the Commonwealth.

The financial picture is not completely free from concern, however. Costs increasing at a rate greater than revenue growth have combined with other factors to place pressure on the Township’s fiscal base. The Township has been required to use a portion of its reserve fund to cover an anticipated shortfall in the current budget year, and while it remains among the most financially stable governments in the nation, it has determined to take steps to improve its position. Specifically, the Township has requested an examination of revenue alternatives be made, with an eye towards the 2003 budget year and beyond.

This study examines three separate revenue options currently under consideration by Township staff, recognizing that there are many variables and other alternatives which might be considered:

Increasing the real property tax;
Increasing solid waste disposal fees; and
Imposition of an earned income and net profits tax (partially offset by other tax reductions).

Lower Merion Township’s real estate tax is 2.62 mills per dollar of assessed value, a rate it has held since 1993. It sets residential solid waste disposal fees on the basis of a per-container charge ($192.00 for a single container, $262.00 for two containers, and $322.00 for 3-5 containers). Unlike many municipalities in the region, the Township does not impose an earned income and net profits tax (the “EIT/NPT”).

The focus of this report is not on determining the desirability of instituting any of the options, but rather on estimating the amount of revenue which might be obtained from each and the probable impact on representative Township taxpayers. A study was made of the elasticity of revenues under alternate tax rates (or fees, in the case of solid waste disposal), intended to determine the extent to which changes in rates could be relied upon to produce a certain level of return. [i] The effort included a review of Township-generated information, as well as additional research and examination of other sources of data.

The report is divided into several sections:

Introduction and Overview
Executive Summary
Section 1: Real Estate Taxes and Collection
Section 2: Solid Waste Fees and Collection
Section 3: Earned Income and Net Profits Tax
Section 4: Estimated Revenue Generation
Section 5: Illustrations of the Impact of Tax Adjustments on Representative Taxpayers
Section 6: Comparisons with Other Jurisdictions

Executive Summary

Lower Merion Township is assessing several general alternatives for the generation of additional revenues. Township staff has developed a set of options as a first step in the process, which involve possible increases to the Township’s real property tax and/or solid waste fees, or imposition of an earned income and net profits tax. The options were reviewed as part of this study, recognizing that they are “starting points” to be considered in much greater detail, and that many other configurations are possible:

Option 1: Multi-phase increases in both real estate taxes and solid waste fees

2003: 9.0% Increase in real estate taxes and 10% increase in solid waste fees
2004: 8.0% Increase in real estate taxes and 10% increase in solid waste fees
2005: 2.0% Increase in real estate taxes and 8% increase in solid waste fees

Option 2: Multi-phase increases in real estate taxes

2003: 9.0% Increase in real estate taxes only
2004: 12.0% Increase in real estate taxes only
2005: 3.0% Increase in real estate taxes only

Option 3: Earned Income and Net Profits Tax, instituted in 2004 and fully effective in 2005

0.5% Earned income tax on both residents and nonresidents
Partially offset by $3 million in other tax reductions in 2004

As more particularly discussed below in Section 4, in comparison with anticipated 2002 amounts Option 1 is estimated to produce approximately $4.8 million in additional revenue for the Township in 2005 ($3.6 million attributable to the real estate portion and $1.2 million from solid waste fees), Option 2 likely would yield $4.6 million in 2005 (in that real property taxes are based on assessed values, which have increased only slightly in recent years, no allowance has been made for inflation). Option 3 may reasonably be expected to generate (without regard to the tax reductions alluded to in the second bullet point) $7.0 million in 2004 and $10.1 million in 2005. Projected inflation would raise the estimated 2005 amount to $10.9 million. More conservative assumptions, which take into account the need to credit payments to other states and the prospect for all Pennsylvania municipalities enacting an EIT/NPT by 2005, would bring the total down to $8.4 million, although indexing that amount to 2005 dollars would produce $9,110,000.

Unlike Options 1 and 2, which anticipate enactment for the 2003 budget year, Option 3 assumes that the EIT/NPT will not be imposed until 2004, and fully implemented in 2005. Option 3 projects an initial reduction in other local taxes of $3 million, and gives the Township flexibility in how it can use its fund balance. As discussed at greater length below, the likely substantial returns generated by an earned income tax - even in its initial year - could provide an opportunity for the Township to restore its fund balance and/or effect tax reductions sooner rather than later. Further, if the Township instead chooses to enact a 0.5% EIT/NPT for 2003, it is expected that reductions of other local taxes or fees could be greater and sooner than if the initial enactment is made for 2004. As the Township moves forward to consider its options in more detail, weight must be given to striking the appropriate present value balance between cost and revenue, recognizing that care must be taken to provide adequate room to deal with currently unknown factors.

Real Estate Tax – In Pennsylvania, the real property tax is imposed by counties, school districts and municipalities. Given that overlap, and changes which may be made by each taxing jurisdiction without regard to actions which the other local government units may be taking, it is not possible to attribute particular consequences to rate changes made by one of them.

Revenues generated by Lower Merion Township have been highly predictable in terms of yield per mill of tax rate. Even with frequent increases by the Lower Merion School District (the “District”), which might raise questions about property owners’ capacity to pay, collections have been stable.

The Township has not increased its real estate taxes since 1993. During that time, both assessed values and market values have increased significantly, and the market for new and existing homes remains strong. Those property values and an active housing market have allowed the Township to maintain a relatively low millage rate.

The Township currently taxes real property at a rate of 2.62 mills on assessed valuation. On the basis of a consideration of relevant data, and as more completely discussed below, the Township can anticipate collection of approximately $180,000 (based on the Township’s estimate for 2002) in real property tax revenue for each 1% in real property tax rate increase, without imputing any growth in the assessed value of real property in the Township. In the effect of the increases described in Options 1 and 2, the revenue allocable to real estate tax adjustments only is shown in Tables EX.1 and EX.2:

Table EX.1 – Option 1 Real Estate Tax Effect
Real Estate Tax Component ONLY	Millage	% Increase (Annual)	$	$ Increase (Annual)
2002	2.62	n/a	18,000,000	n/a
2003	2.86	9.0	19,620,000	1,620,000
2004	3.08	8.0	21,189,600	1,569,600
2005	3.15	2.0	21,613,392	423,792
*Cumulative 2002-05 Increase*	*.53*	*20.07*	*3,613,392*

Table EX.2 – Option 2 Real Estate Tax Effect
Real Estate Tax Component ONLY	Millage	% Increase (Annual)	$	$ Increase (Annual))
2002	2.62	n/a	18,000,000	n/a
2003	2.86	9.0	19,620,000	1,620,000
2004	3.20	12.0	21,974,400	2,354,400
2005	3.29	3.0	22,633,632	659,232
*Cumulative 2002-05 Increase*	*.67*	*25.74*	*4,633,632*

Solid Waste Fees – The Township changed its approach to dealing with the costs of solid waste management in 1992, when it first assessed a fee for the collection and disposal of household refuse (recyclables are collected at no cost). Under the current system, and as described more completely below, users annually notify the Township of the number of containers they expect to fill each week over the course of the year, and are charged accordingly.

While the Township collects at most residential units, its costs are greatly influenced by disposal fees charged by the Waste System Authority of Eastern Montgomery County (the “Authority”), to which the Township delivers its refuse. As such, the Township has little choice but to pass on cost increases directly and/or absorb them through annual operating subsidies from its general fund. One feature of the alternatives under consideration is their utility in providing revenue to enable the Township to eliminate its annual solid waste fund subsidy (estimated at $1.3 million for 2003) and make the fund self-supporting.

The current fee structure has been in place since 1999, when charges were increased and additional container options were added, and the Township is weighing two fee structures. The first is an “across-the board” percentage increase in solid waste fees (without structural changes in the current system), and the second is imposition of a new fee keyed to collection points. Household refuse currently is collected from locations of the ratepayers’ choice, and points of collection vary from curbside to more than 100 feet from the street, with related differences in Township collection costs, but at no additional expense to the user.

As discussed in more detail below, Township staff has determined that 55% of its refuse collection points are 30 feet or less from the curb, and consideration is being given to a two-level fee structure which would provide curbside collection (defined as being within 5 feet of the street) for no additional charge beyond the per container fee. Persons choosing to have their refuse collected from more distant locations would be subject to a new charge for non-curbside collection of refuse, in addition to the per container fee.

The analysis in the “Solid Waste Fees and Collection” section, below, notes that since the last fee increase in 1999, the Township has received per container subscription revenues lower than what would have been expected on the basis of the percentage adjustment. During the same period, the volume of household refuse collected in the Township has increased slightly, but at a rate below that of the Authority area as a whole. Both events are indicative of some elasticity of demand, and it is likely that there would be continued moderation of demand in the case of a fee increase, and/or imposition of a new charge. Although the former would be expressed by ratepayers’ selecting fewer containers, the economic effect of the latter (particularly if linked to a change in the per container fee) is more difficult to estimate reliably.

Were the Township to increase its per-container solid waste subscription fee as outlined in Option 1, it is estimated that $1.2 million in present dollar value revenue would be generated in 2005, inflation bringing that amount to about $1.3 million.

Incremental revenue gain from charging for rear yard collection at a rate designed to deal with the costs attributable to collection at those locations based upon likely responses from residents, is estimated at $723,000. Taking operating cost savings as a result of movement to elect curbside collection as a result of imposition of the new fee into account, were a rear yard fee to be imposed the amount of the anticipated per container increase could be substantially smaller.

Earned Income Tax – As noted above, Lower Merion Township does not levy an EIT/NPT on its residents, nor does it impose such a tax on nonresidents working in the Township. While as a general matter municipalities levying an earned income tax have collection priority in terms of taxing the earnings of their residents versus taxes levied by other municipalities, that is not the case with respect to the Philadelphia wage tax. The City of Philadelphia retains taxes collected on the earnings of nonresident wage earners (currently set at 3.9127%), and that feature of Pennsylvania tax law often has discouraged municipalities in this region from imposing the tax. Over the years, however, more municipalities have elected to impose the EIT/NPT, and the Pennsylvania Department of Community and Economic Development reports that only ten municipalities in Montgomery County do not now impose such a tax. [ii]

Should the Township decide to enact the EIT/NPT, it would be well advised to initially make only relatively modest reductions in other taxes until it has a full understanding of what the predictable EIT/NPT yield will be. Reliable data as to the possible collections from an earned income tax are not easy to develop. There is no central repository for information, and many localities which impose the tax do not keep records as to taxpayers from municipalities with respect to which they have no payment responsibility (i.e., those jurisdictions which do not impose an earned income tax). Any estimates must be considered in the expectation that some adjustments will be necessary as actual information becomes available.

While that makes calculation challenging, it also highlights a peculiarity of the system. Many Lower Merion residents work in jurisdictions (other than Philadelphia) which impose an EIT/NPT, and those municipalities retain the funds collected for their own use. Were Lower Merion Township to impose a .5% earned income tax, Lower Merion residents working in areas with an EIT/NPT would have no additional tax burden. Their payments (except for those made to Philadelphia) would be shifted to the Township. Also, were the Township to enact an earned income tax on the earnings of the estimated 6,648 persons who work in the Township and who live in jurisdictions not now imposing an earned income tax, it would be able to retain those amounts until and unless those “home” municipalities elected to enact their own EIT/NPT.

On that basis, those newly impacted by the enactment of an earned income tax would be the approximately 22,200 persons who:

Live and work in the Township
Live in the Township, but work out of state
Live in the Township, but work in a jurisdiction which either does not impose an EIT/NPT, or which does not impose it on non-residents
Live in a jurisdiction which does not impose an EIT/NPT and work in the Township.

Taken as a group, those persons would represent over 86% of the anticipated revenue from the EIT/NPT.

Several approaches were taken to estimating the possible yield from enactment of an EIT/NPT as anticipated by Option 3, which are discussed in detail in the ” Earned Income and Net Profits Tax” section, below. It is estimated that the Township would receive $7,070,000 during the first year of imposition (returns relating only to 9 months of income due to collection of the tax quarterly on a retrospective basis, as well as a 5% allowance to take implementation issues into account), and $10,100,000 (in 2002 dollars) when fully implemented in 2005, and if indexed for anticipated cumulative inflation of 8.2%, the amount rises to $10.9 million. Use of conservative assumptions reduce the full-year total in 2005 to $8,420,000 (or $9.1 million with inflation taken into account).

As noted in the discussion of Option 3, an assumption underlying this study is that the Township will enact $3 million in initial offsetting tax reductions in 2004 if an EIT/NPT is imposed. While analysis in other parts of this report details the impact of such offsets, as well as other alternatives, the amounts estimated for new revenue from the EIT/NPT, above, do not take those reductions into account.

Lower Merion’s Relative Tax Burden – The section entitled “Comparisons with Other Jurisdictions” addresses the relative burden which would be borne by Lower Merion taxpayers under each of the options under consideration. While it was not possible to develop a benchmark for comparison in terms of prospective solid waste fee adjustments, on the basis of illustrative changes to real property and earned income taxes it is clear that Lower Merion Township would continue to be highly competitive with municipalities which it views as its peers in terms of per capita real property and EIT/NPT taxes, even without taking into account possible tax increases in those other municipalities, or including tax reductions beyond the initial $3 million anticipated in this report. Some Lower Merion Township residents employed in EIT/NPT jurisdictions would see their aggregate taxes fall under Option 3.

Under even the most conservative estimates, over $1.5 million is now being paid by Lower Merion residents who work in other jurisdictions (other than Philadelphia) which impose an earned income tax. That is money which could be paying for services in the Township - or funding reductions in taxes paid by Township citizens - were the Township to enact a .5% EIT/NPT.

[i] “The price elasticity of demand for a good [or service] is the elasticity of quantity consumed per capita with respect to the price of the good.” Microeconomics, Fifth Edition, B. Curtis Eaton, Diane F. Eaton, Douglas W. Allen, Prentice Hall, 2002, p. 103. Elasticity may be impacted by several factors, not the least of which is the “necessity” quality of the good or service provided and the availability of alternative sources for it. In the case of taxes, consumers have the alternative of moving from the jurisdiction imposing the tax, or changing the value upon which the tax is assessed. In the case of the real estate tax, a choice may be made by moving to a home assessed at a lower value, an alternative that frequently is uneconomic due to transactional costs. For solid waste charges, most residents are required to have their household refuse collected by the Township, thereby limiting alternative sources for the service and leaving volume reductions (expressed by electing a smaller number of containers) as the only legal alternative. The only choices available in the case of the earned income tax is a change of residence and/or employment. The number of jurisdictions in the region which do not impose an earned income tax is relatively small, and the economics of relocation would be equally discouraging as is the case with the real estate tax.

[ii] Pennsylvania Department of Community and Economic Development, data as to earned income taxation, by county and local government unit, , July 11, 2002, http://ctcoas01.state.pa.us/dced/MSS.DYN_EITOPT_TAX_RATE_2002.show.

Assessment of Revenue Options

August 12, 2002

711 Pennstone Road

Bryn Mawr, Pennsylvania 19010-2939

Table EX.1 – Option 1 Real Estate Tax Effect