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Pennsylvania: A 21st Century Tax Code for the Commonwealth

13 min readBy: Jared Walczak, Nicole Kaeding, Scott Drenkard
Below is a brief excerpt from Pennsylvania: A 21st Century Tax Code for the Commonwealth. To download our full reform guide, click the link below.

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Today, Pittsburgh and Philadelphia are thriving cities, but in the early colonial era, Pittsburgh was a western outpost on the Forks of the Ohio. Life on the frontier was beset by strife, violence, and occasional open warfare, yet for years the region’s security was outsourced to volunteers from Virginia, since the colonial assembly would not appropriate funds for garrisons or defense.

Partly this was borne of religious compulsion, but increasingly it transformed into a dispute over taxes.[1] Pennsylvania was, after all, a proprietary colony headed by dual proprietors, Thomas and Richard Penn. Outside of Philadelphia and the surrounding counties, vast tracts of land were held in fief, and since much of the land was forested and unproductive, the colonial charter afforded tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s for this land, held by the colony’s richest landowners.

To Benjamin Franklin, this was an affront to the liberty of the colony to govern its own affairs and levy its own taxes in an equitable manner. Decades before Pennsylvania’s most honored son observed that nothing in life is certain except death and taxes, Franklin penned a petition to the Deputy Governor outlining the assembly’s bargaining position: the safety of the western frontier could not be provided for until the assembly enjoyed the liberty to taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. . Or, in words now familiar to many: “Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety.”[2]

Today it may seem peculiar to regard the authority to impose such a tax an “essential liberty,” but from that early fight over tax powers, through the Whiskey Rebellion, to the fitful efforts to tax income,[3] to the 1991 income tax vote that sparked a literal scuffle in the lower house,[4] and on to the present day, debates over taxes are interwoven in the fabric of Pennsylvania’s history.

The vision of a tax system that looks like someone designed it on purpose has proved elusive, here even more than in other states. Governing structures look different in Pennsylvania than they do elsewhere, and that is part of the Commonwealth’s charm. Unfortunately, it has also helped yield a tax code patched together over the years, overlaid on a system that has been evolving – not always in one direction – since William Penn affixed his name to a treaty under that ancient elm.

Policymakers from across the spectrum recognize that the Commonwealth’s tax code has not kept up with a 21st century economy, even if they cannot always agree on a course of action. This book is intended to help fill in the gaps.

In the following pages, we examine Pennsylvania’s economy, outline the existing tax structure, and offer recommendations for reforming the tax code. We seek to identify what the Commonwealth does well and to point out opportunities for improvement. Underlying our analysis is the goal of enhancing Pennsylvania’s competitive standing and a commitment to the principles of sound tax policy—that, to the greatest extent possible, taxes should be simple, transparent, neutral, and stable, and that the best tax structures are those with broad bases and low rates.

In the course of our research, we pored over Pennsylvania’s tax code, dusted off old tax studies, reviewed the economic literature, and examined successful reforms implemented by other states. First and foremost, however, we talked to Pennsylvanians—state and local government officials, business leaders, and everyday taxpayers alike. The insights and perspectives of those who actually interact with Pennsylvania’s tax system inform every page of this book.

The Pennsylvania Chamber of Business and Industry commissioned the Tax Foundation to prepare a review of the Pennsylvania tax system and recommend possible solutions, and this book is the result. While they supported our study, they did not direct our study or any of our recommendations. We offer our thanks to the many Pennsylvanians of all walks of life who met with us as we worked on this book. It is our hope that this book will help reform a robust and much-needed debate about the future of the state’s tax code.

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A Menu of Tax Reform Solutions

Corporate Net Income Tax

Pennsylvania’s 9.99 percent Corporate Net Income Tax rate is the second-highest in the country, and the tax is beset by structural shortcomings which impose particularly high burdens on certain industries. Our corporate tax solutions would make Pennsylvania more competitive by moving to a lower rate and broader base while reducing disincentives for corporate investment.

Improving the treatment of net operating losses. Pennsylvania is one of only two states to cap the amount of net operating losses which can be claimed in a given year. This policy undermines tax neutrality and results in particularly heavy tax burdens for companies with longer business cycles. We propose the prioritizing of continued increases in the percentages of net operating losses businesses may carry forward.

Making the corporate rate more competitive. While many companies only pay a fraction of the statutory tax rate, for others, Pennsylvania’s 9.99 percent Corporate Net Income Tax rate, combined with structural shortcomings which increase their overall liability, can result in prohibitively high tax burdens. We recommend targeting a rate reduction to 6.99 percent or lower, bringing the Commonwealth more in line with its peers, with reductions funded by tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. reform and base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. elsewhere.

Reforming corporate tax credits. Pennsylvania does better than most peer states in avoiding substantial carveouts of its corporate income tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. through targeted credits, but the state still forgoes an estimated $265 million a year due to Corporate Net Income Tax credits. The state should enhance its review of these credits and consider paring them back.

Personal Income Tax

Our individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. solutions begin with the recognition that there is already much to commend the state’s Personal Income Tax, which is levied at a low, flat rate on a broad definition of income. Where the Personal Income Tax falls short, however, is its substantial carveout for retirement income, its use of distinct classes of personal income, and the large rate differential between individual and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es owing to Pennsylvania’s anomalously high corporate rate. Our solutions seek to address these concerns.

Taxing retirement income. Though difficult politically, any long-term rebalancing of Pennsylvania’s tax code cannot ignore the complete exemption from taxation of all retirement income, an exemption that is far more generous than the tax treatment in peer states. As the Commonwealth’s population continues to age, a policy which already turns away $3.4 billion in annual revenue cannot go unexamined forever.

Eliminating distinct classes of income. Pennsylvania divides income into eight classes and does not allow taxpayers to carry losses over from one class to another, or from one spouse to another. This outmoded tax structure introduces complexity into an otherwise straightforward income tax code and penalizes some taxpayers on a largely arbitrary basis. We recommend its elimination.

Rolling back business incentives. Policymakers should eliminate most or all business credits (which can be claimed by pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es against Personal Income Tax liability), using them to pay down reforms which benefit Pennsylvanians more broadly. Fortunately for taxpayers, Pennsylvania’s reliance on incentives is already modest.

Sales TaxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es

Pennsylvania’s sales tax is an important source of revenue for both the state and for Allegheny County and Philadelphia, but it has one of the narrowest tax bases in the country. Currently, many goods and services are unnecessarily exempted, while some business inputs are subject to tax, which can lead to multiple layers of taxation being imposed on the same final product at different points along the production process. We urge that steps be taken to avoid the taxation of business inputs and offer a range of base-broadening options.

Broadening the sales tax base. A well-structured sales tax applies to all final consumer transactions, both goods and services, but Pennsylvania’s tax code exempts many goods and most services. Accordingly, we offer a range of options for expansion to services. Any base broadening provides an opportunity to pay down reductions in the rate of the sales tax or other taxes.

Our base broadening options are as follows:

  • Modest expansion to personal services, amusements, candy and gum, and similar goods and services ($900 million);
  • Broader expansion to also include clothing, nonprescription drugs, household utilities, and motor fuels, and similar goods and services ($3.58 billion);
  • Broad-based expansion to further include groceries and personal use of legal and accounting services ($5.39 billion); and
  • Inclusion of nearly all final consumer transactions in the sales tax base, including medical services, financial institution fees, and private educational expenditures ($11.00 billion).

Revenue projections are given for each line item considered, allowing policymakers to design their own base expansion options, modernizing the state’s sales tax code while generating revenues which can help offset improvements elsewhere.

Exempting business inputs. Pennsylvania taxes relatively few services. Nevertheless, it does manage to tax 27 categories of services (as defined by the Federation of Tax Administrators) which count as business inputs and lead to tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. . We offer suggestions for removing business inputs from the sales tax base.

Local Earned Income, Occupational, and Nuisance Taxes

Pennsylvania’s earned income, occupational, and nuisance taxes receive extensive treatment because they play an outsized role, not only in local finances, but also in overall tax complexity in the Commonwealth. The challenges begin with Pennsylvania’s patchwork approach to local government, which yields multiple layers of local tax authority and extends different degrees of taxing power to local governments based on population and other factors.

The Commonwealth’s fractured approach to local governance—and both the powers and constraints imposed by the state—has serious consequences for local tax policy. The resultant complexity, administrative duplication, and local reluctance or inability to shed deeply outmoded taxes imposes real costs on government and taxpayers alike. Our recommendations favor simplicity and consolidation.

Broadening the local income tax base. Pennsylvania’s local earned income taxes have a narrower base than the state income tax. While there are arguments in favor of the chosen local base, local taxation would be simplified by sharing the state income tax base. Additional revenue associated with base broadening could help pay for reduced reliance on, or even elimination of, business gross receipts and nuisance taxes which impose significant compliance burdens to collect a modest amount of revenue.

Repealing gross receipts and nuisance taxes. Pennsylvania’s remaining mercantile and business privilege taxes are nonneutral and both economically and administratively inefficient. Other legacy taxes, like head taxA head tax, also known as a poll tax or capitation, is a flat or uniform tax levied equally on every taxpayer. Unlike an income tax, it is a fixed amount and not based on how much one earns, nor does it change based on any taxpayer circumstance or action. es and the extraordinarily arbitrary assessed occupation tax, are generally small but contribute substantially to taxpayer frustration with an outdated tax code. They should be phased out entirely with the assistance of new state grants of tax authority like an expansion of the local income tax base.

Consolidating collections at the county level. Policymakers should build on the success of Act 32 to reduce the number of tax authorities with which the average taxpayer must interact. Consolidating local tax collections at the county rather than the state level should help ameliorate concerns local governments have about local autonomy and revenue certainty.

Simplifying statutory tax authority. Pennsylvania has eight classes of counties, four classes of cities, two classes of townships, and boroughs, many of them operating under separate tax codes. Policymakers should begin consolidating the different tax codes into the primary authorization statute, eliminating as many distinctions as possible along the way.

Property and Related Taxes

Real property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es are an uncommonly contentious topic in Pennsylvania, with popular contempt for property taxes arguably driven in significant part by the highly visible inequities and complexities of the Commonwealth’s approach. Our solutions emphasize fairness, uniformity, and simplicity.

Adopting mandatory assessment cycles. The infrequency and inconsistency of countywide property tax reassessments results in significant inequities and actively discourages improvement to properties. Counties are understandably reticent to initiate reassessments on their own. State government should address the serious distortions created by this anomalous approach, mandating countywide reassessments at regular intervals.

Consolidating property tax administration. Pennsylvanians receive separate property tax bills from counties, municipalities, and school districts, and the state lacks a uniform filing deadline. The state legislature should consolidate collections at the county level and adopt a uniform filing deadline statewide. Policymakers should also explore ways to consolidate the property tax codes under which different jurisdictions operate.

Repealing the inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. . Inheritance and estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. es are becoming less and less common nationwide, as they promote costly tax avoidance strategies and can be uniquely burdensome to small businesses, which may have to be broken up to pay the resulting tax bill. Pennsylvania’s inheritance tax is unusually broad, which makes it uniquely burdensome but also makes it harder to replace, or do without, the revenue it brings in, but policymakers should at least explore rate reductions or exemptions to mitigate its adverse economic effects.

Comprehensive Reform

Most of our proposals are intended to stand on their own, providing policymakers with discrete ways of improving the competitiveness of each element of the state’s tax code. Often, however, successful tax reform is more comprehensive in nature, which is not only good policy but often good politics, including additional stakeholders and facilitating a broader rebalancing of the code.

In some cases, moreover, it may be strictly necessary: reduced reliance on a counterproductive tax may require offsets elsewhere in the system. Therefore, while we intend this book to facilitate important conversations about priorities within each tax type, it is also important to illustrate the ways that they can complement each other.

Local governments, for instance, could be empowered to eliminate nuisance taxes through a broader local income tax base and, in the two counties with local option sales taxes, a broader sales tax base which extends to more services and perhaps captures additional remote sales. Modernizing the property tax would also help alleviate local revenue pressures. At the state level, broadening the sales tax base, coupled with scaling back exemptions in the Personal Income Tax, could facilitate structural improvements to, and reduced rates in, both taxes, and also pay down important corporate tax reforms.

For illustrative purposes, consider the following package of comprehensive reforms. Because Pennsylvania’s tax code is highly anomalous, some of its less competitive features are not captured in our State Business Tax Climate Index. Similarly, recent adverse developments like the disallowance of all depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. of machinery and equipment investments are not yet captured in the Index and can be expected to hurt Pennsylvania’s rank in the next edition if left unaddressed. Nevertheless, we offer a projection of how the Commonwealth would improve on the Index for those elements which contribute to the state’s rank. The illustrative comprehensive reform package includes:

  • A reduction in the Corporate Net Income Tax rate to 6.99 percent, coupled with the repeal of the state’s job creation and research and development credits;
  • Moving to federal treatment of net operating losses;
  • Modest expansion of the sales tax base to include personal services, amusements, candy and gum, and similar goods and services;
  • Broadening the local income tax base to match the state base and phasing out local gross receipts and nuisance taxes; and
  • Adopting mandatory assessment cycles for real property taxes.

A much more aggressive reform package might also contemplate building upon the above by adding the following:

  • The inclusion of retirement income in the income tax base coupled with a Personal Income Tax rate reduction to 2.5 percent;
  • Eliminating the eight distinct classes of income in the Personal Income Tax;
  • Repealing the Inheritance Tax; and
  • Cutting the Corporate Net Income Tax rate to 5.99 percent.

Alternatively, the state might focus on broader sales tax base broadening for further reforms, rather than taxing retirement income or making other modifications to the Personal Income Tax:

  • Further broadening the sales tax base to include clothing, household utilities, nonprescription drugs, motor fuels, and burial services;
  • Reducing the state sales tax rate to 5.6 percent;
  • Repealing the Inheritance Tax; and
  • Cutting the Corporate Net Income Tax rate to 5.99 percent.

These more aggressive packages, while politically difficult, are intended as illustrative, to show how much could change if the state adjusted its overall tax environment. The analysis and individual recommendations contained within this book are intended to help lawmakers develop comprehensive packages consistent with their policy priorities and the goal of creating a simpler, more neutral, and more competitive tax code.

Projected State Business Tax Climate Index Rankings
Total Corporate Individual Sales Unemployment Insurance Tax Property
Current System (2018) 26 44 17 21 50 33
Reform Package A 18 8 17 20 50 33
Reform Package B 15 5 17 20 50 21
Reform Package C 13 5 17 12 50 21

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Our Objective

We hope these solutions contribute to the tax conversation in Pennsylvania by providing a framework upon which legislators and citizens can base future decisions. The menu of options we present all ensure that the state builds a tax system for a diversified economy and positions itself as a destination for investment, entrepreneurs, and talented individuals in the years ahead.


[1] Alvin Rabushka, Taxation in Colonial America (Princeton, NJ: Princeton University Press, 2008), 797.

[2] Francis Parkman, Montcalm and Wolfe (Boston: Little, Brown and Company, 1884), Vol. 1, 345.

[3] William J. McKenna, “The Income Tax in Pennsylvania,” Pennsylvania History: A Journal of Mid-Atlantic Studies 27:3 (July 1960),

[4] Karen Langley, “Pennsylvania Has History of Contentious Tax-Hike Efforts,” Pittsburgh Post-Gazette, Oct. 12, 2015,