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Keystone Opportunity Zones on the Downtown Philadelphia Office Market

90-774 Public Expenditure Analysis April 30, 2005. Presented by K i Young Lee Pan o te Preechyanud Takahiro Su z uki. Keystone Opportunity Zones on the Downtown Philadelphia Office Market. Agenda. Introduction Costs Benefits Synthesis Conclusion. Introduction.

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Keystone Opportunity Zones on the Downtown Philadelphia Office Market

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  1. 90-774 Public Expenditure Analysis April 30, 2005 • Presented by • Ki Young LeePanote PreechyanudTakahiro Suzuki Keystone Opportunity Zones on the Downtown Philadelphia Office Market

  2. Agenda • Introduction • Costs • Benefits • Synthesis • Conclusion

  3. Introduction

  4. What’s a KOZ? • Initially started in 1999 • Specific areas with greatly reduced or no tax burden for property owners, residents, and business • Designed to attract development where little or not activity existed beforehand • Business must expand employment by 20% or must make capital investments of at least 10% of the gross revenue of the business in the pervious year • Over 23,000 new job created, over 20,000 jobs were retained • 12 regional KOZ in Pennsylvania • 4 different expiration year: 2008, 2010, 2013 and 2018

  5. KOZ – Legislature • KOZ Act 92 of 1998 • Initiate KOZ to foster both private business and residential reinvestment in Pennsylvania area to regain the economic stability of communities. • Original KOZ’s expire in 2008 • KOEZ Act 119 of 2000 • Initiated Keystone Opportunity Expansion Zone (KOEZ) to enable numerous area that missed inclusion in the original KOZ • KOEZ’s expire in either 2010 or 2013 depending on the choice of the local zone • KOIZ Act 217 of 2002 • Empowered the Governor by executive order to propose Keystone Improvement Zones (KOIZ) by no later than January 1,2003. Approval of the political subdivisions was required by June 1, 2003. If no approval from political subdivisions, proposed zone would not be designated.

  6. KOZ on Downtown Philadelphia • Designed for the Cira Centre at 30th Street Station and one is under consideration for One Pennsylvania Plaza at 17th and JFK Blvd. Source: maps.google.com

  7. KOZ on Downtown Philadelphia • Designed for the Cira Centre at 30th Street Station and one is under consideration for One Pennsylvania Plaza at 17th and JFK Blvd. One Pennsylvania Plaza 56 Occupied Floors; 1,346,000 Sq.ft. Office Tower Source: maps.google.com

  8. Philadelphia Economic Environment • Decrease in population growth since 1970 Philadelphia Population Growth (1970-2000) 2,000,000 1,900,000 1,800,000 Population 1,700,000 1,600,000 1,500,000 1,400,000 1970 1980 1990 2000 Year

  9. Philadelphia Economic Environment • Employment shows positive sign at the end of last year’s quarter

  10. Philadelphia Economic Environment • Office Vacancy rate is constantly high compare with other cities, and it has the highest negative change in vacancy rate last year

  11. Existing CBA analysis • Developer – Pro KOZ • Central City District – Anti-KOZ $ Millions

  12. Differences among two models

  13. Our model • Using economic equilibrium which the Wharton’s model used • Include initial benefit from construction (direct and indirect effects) • Standing is city of Philadelphia

  14. Costs

  15. 2018 2004 2008 2043 Cost Construction Period Operation Period KOZ expired • Decrease of Tax Revenue • Property tax • Business income tax • Environmental Cost Environmental Cost

  16. Environment Cost • Environmental construction cost of both building is $0.1 per sq.ft • Environmental operation cost of both building is $0.01 per sq.ft. • Environmental operation cost will annually increase 4% Calculation • Environmental construction cost :Total square of feet *0.1 • Environmental operation cost: Total square of feet *0.01

  17. Result of Cost in Each Period $Millions 2007- 2018 2004- 2006 2019- 2043

  18. Loss of tax revenue (cont.) Rent $/sq.ft S S’ KOZ buildings D Amount of office space

  19. Loss of tax revenue Assumption Existing offices KOZ NO-TAX !! Decrease of Tax revenue

  20. Loss of tax revenue (cont.) Assumption Property values = perpetuity of net operating income = NOI/r r = market rate of return Net Operating Income = Revenue – Cost Revenue = Rent/sqf × Square feet Cost = Cost/sqf ×Square feet Calculated from economic model Assume constant $7.5/sqf

  21. Loss of tax revenue (cont.) Rent ($/sqf) V = Vacancy rate (%) S = Total stock of office space (sqf) E = Total office employment (millions of employees) From empirical data, α = 382.8 β = 8.03

  22. Loss of tax revenue (cont.) • KOZ entails tax exemption • Philadelphia City Taxes Based on companies’ profits Based on property values

  23. Loss of tax revenue (cont.) Amount of tax on companies’ profits = $9.05/sqf × Square feet Assume constant $9.05/sqf

  24. Benefits

  25. 2018 2004 2008 2043 Benefit Construction Period Operation Period KOZ expired • Increase of Tax Revenue • Commercial Tax • Property Tax • Increase of Tax Revenue • From direct construction cost • Indirect direct effects of construction • Increase of Tax Revenue • Wage tax from incremental new employees • Wage tax from maintenance workers • Sales tax revenue

  26. Result of Benefit in Each Period $Millions 2019- 2043 2004- 2006 2007- 2018

  27. Increase of Tax Revenue During Construction TAX • the Business Privilege Tax ( BPT): levied as 2,300 miles on gross receipts and 6.5% on taxable net income • the Net Profit Tax (NPT) :Resident: 3.9462% , Nonresident: 4.5385% Assumptions • This model is from Center City District • Philadelphia city government will have a contract with local company in Philadelphia • When city have net employment from direct and indirect, we assume that 50% of people are from nonresident and resident • We assume that 50% of development costs were labor and the taxes generated by construction jobs over 2.5 years • We assume that 25% of all pre-development costs consisted as well as of taxable labor and calculated a total tax benefit to the city • Construction Cost: OPP-$325 per square of foot, Cira- $300 per square of foot

  28. Increase of Tax Revenue During Construction period Short-term employment Source:Gilen

  29. Increase of Tax Revenue During Operation Wage tax from incremental new employees Assumption • This model is from E-consult • Opp: 1.58 s/q , Cira: 0.735 s/q • OPP project will produce from 1178 to 1535 Job and Cira will produce from 548 to 714. Therefore, Both project will produce from 1726 permanent jobs to 2249 permanent jobs • Wage will annually increase 4% • Net Profit Tax (NPT) :resident: 3.9462% , nonresident: 4.5385% • Average salary: $65,000 Calculation Average salary*0.5*(resident tax+ nonresident tax)* Number of employees.

  30. Increase of Tax Revenue During Operation Wage tax from maintenance workers Assumption • There are net increase of low level employment from this project such as maintenance like cleaning, security officer, and electricity • Average salary : $35,000 • Number of Employees in Cira: 80 • Number of Employees in Opp:160 Calculation Average salary* Salary *0.5*(resident tax+ nonresident tax)* (Number of Employees in Cira+ Number of Employees in Opp )

  31. Increase of Tax Revenue During Operation Sales tax revenue Assumption • There are net sales tax increase from low-level employment and office workers. • we assume that they will spend 30% of their salary in Philadelphia. • They will pay 7% of sales tax, however, 6% will belong to Pennsylvania state government, and 1% will belong to Philadelphia. Calculation 1% sales tax* ( Number of employees of office worker* their salary+ Number of employees of office worker*their salary)

  32. Synthesis

  33. CBA

  34. Synthesize • Social discount rate: 4%, 8%,12% • NPV: 15 Year (With Koz) , 40 Years ( Without Koz) • IRR: 15 Year (With Koz) , 40 Years ( Without Koz) • Break even: 4%, 8%,12% • Sensitivity analysis: Inflow employment (30%, 60%, 90%)

  35. Synthesizing Scenario Source:Gilen

  36. NPV( 0.04%)

  37. NPV( 0.08%)

  38. NPV( 0.12%)

  39. Internal Rate of Return (IRR)

  40. Social Discount Rate Neutral 30% Neutral 60% Neutral 90% Optimistic 30% Optimistic 60% Optimistic 90% 0.04 31 Years 2034 37 Years 2040 32 Years 2035 28 Years 2031 0.08 0.12 Time spent to reach break even point 36 Years 2039

  41. Conclusion

  42. Feasibility of the project • Generate deficit according to sensitivity analysis, except in the case when social discount rate is 4% • Depend on employees inflow from outside Philadelphia as the model states that in normal social discount rate (8%), it needs about 90% on inflow employees from outside Philadelphia • Without tremendous inflow employees and strong economic base, the city should not implement this program

  43. Future tasks • More proper economic models • This model only considers the relocation of office spaces from existing office space to the KOZ buildings. (The economic model only consider the real state market in Philadelphia • Chronological prediction is not clear • Additional empirical research for demand and supply regarding office space market in the downtown • Find clear benchmark for environmental cost • Option Value • Analyze Secondary Market Effect • Real estate Market (Apartment, Housing and other areas ) • Other Industries ( Construction, Material, and other areas )

  44. Other problems of KOZ • The program benefit big corporation such as Comcast, not small or medium business (Regressive tax effects) • KOZ reduces the amount of property taxes part of which is a major revenue of school district

  45. If KOZ is not implemented…. • Fire Department: 96 more firemen employed • Police Department: 91 more police officers hired • Transportation: 12.3 miles of city streets resurfaced • Recreation: 21 community recreation center hold • School District: 135 new school teachers hired

  46. Q&A

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