Understanding Act 24 of 2001: The Optional Occupation Tax Elimination Act

Questions about Act 24:

• What is Act 24 of 2001?

• What is the Occupation Tax?

• What is the Earned Income Tax?

• Who can use Act 24?

• How can these tax changes be implemented in my school district?

• Is Act 24 of 2001 a hidden tax increase?

• How will Act 24 affect school districts?

• How will Act 24 affect local governments?

• How will Act 24 affect taxpayers?

• Will Act 24 reduce my property taxes?

• Can Act 24 be used indirectly to reduce my property taxes?

• How does Act 24 differ from Act 50 of 1998?

• Does adopting Act 24 means a school district can't later adopt Act 50?

Introduction

Reforming the way Pennsylvania finances public schools has been a major concern of state officials, school board members and administrators, and citizens for decades. School districts account for the largest share of local taxes in Pennsylvania, which means the fairness and efficiency of the taxes districts use has major implications for the local tax burden borne by citizens.

Local school districts have the ability to pick and choose which local taxes they use, but they are limited to choosing from the local tax options authorized for them by the Commonwealth. State law defines which taxes school districts can use and the maximum possible rate for each tax (although several local taxes have no maximum possible rate). Some have argued that the available choices are too restrictive, and that school districts need additional options to reduce their reliance upon particularly unpopular or overused taxes.

Much of the local tax reform discussion in parts of Pennsylvania has focused on the occupation tax (sometimes referred to as the “occupational assessment” tax), which many people view as one of the Commonwealth’s most unfair local taxes. The occupation tax is a tax on an individual's occupation, and does not always correspond to individual’s ability to pay. Under state law, the millage-based version of the occupation tax has no maximum tax rate limit (the only other major local tax without an effective tax rate limit is the real property tax) As a result, some school districts have relied heavily upon the occupation tax to keep real property taxes low. Act 24 of 2001 was created to allow school districts to eliminate the occupation tax and replace it with higher earned income tax revenues.

Act 24 of 2001 follows an earlier local tax reform initiative, Act 50 of 1998, and shares some elements with that earlier act. However, Act 24 is much more focused than Act 50, and does not attempt to deal with the range of issues and local taxes addressed by Act 50. It is important to recognize that Act 24 does not overturn the current system of local school taxation or Act 50, but instead simply provides an additional tax reform choice for school districts.

This webpage  is intended to help you understand Act 24 of 2001, what it does and does not do, and how it can be implemented in your community.

What is Act 24 of 2001?

Act 24 of 2001 allows school districts to raise earned income tax rates to eliminate the occupation tax. This is a substitution of one tax (the earned income tax) for another tax (the occupation tax), and not an overall tax cut. Some individual taxpayers will end up paying less in local taxes, and some will end up paying more. School districts can voluntarily choose to use Act 24, or keep their current system of local taxation.

School districts that choose to use Act 24 are allowed to raise their earned income tax rates just enough to offset the revenue they will lose by eliminating the occupation tax. Most school districts already use the maximum earned income tax rate they are allowed (1 percent, or 0.5 percent if the taxpayer’s local municipality also levies the earned income tax). Act 24 allows them to exceed this maximum tax rate solely for the purpose of replacing the occupation tax, with their new earned income tax rate being just enough to make up for the revenue lost from the occupation tax.

What is the Occupation Tax?

The occupation tax is a tax on residents’ occupations. It can be levied by school districts in two different ways: (1) as a proportional tax using a millage rate, whereby the amount people pay depends upon their occupation; or (2) as a flat rate on all working residents, whereby every person pays the same amount no matter what they do for a living. The proportional version of the occupation tax is used slightly more often in Pennsylvania than is the flat rate version, and typically elicits the strongest public attention. Act 24 applies to both versions of the occupation tax.

The proportional occupation tax has roots in England during the seventeenth and eighteenth centuries. At that time, many occupations were created by grant or title and could be sold or transferred between individuals. Thus, occupations often were a form of property that could be bought and sold, much like real estate. It is not surprising then that the occupation tax is very similar to the real property tax. The tax is levied on the value of residents’ occupations, as determined by the county tax assessor’s office. The occupation of a school bus driver may have an assessed value of $25, for example, while that of a lawyer may be $290. Assessed values are not based upon income, so all members of the same occupation will pay the same amount of occupation tax even if their incomes differ significantly.

The local jurisdiction levies a tax rate on these occupational assessments, and the occupation tax is collected from residents, without regard to where they actually practice their occupation. School districts have no tax rate limit on the occupation tax when it is levied as a proportional tax, so some school districts have relied on it heavily to keep real property tax low.

The occupation tax can also be levied as a flat-rate tax. Every person who works pays the same amount, regardless of their occupation. The maximum levy in the flat-rate version is $10 per person. as a flat rate,

What is the Earned Income Tax?

The earned income tax is a tax levied on residents’ earned income (such as wages, salaries, or other reimbursements for work). Unearned income, such as interest, dividends, pensions, and social security, are exempt from the tax. The earned income tax currently is available to and used by many municipal governments and school districts in Pennsylvania. Act 24 does not change the definition of the earned income tax, but simply allows school districts to increase their earned income tax rate to offset the loss of the occupation tax revenues.

A benefit of the earned income tax to school districts is that collections naturally grow over time as the economy grows, and as wages increase through inflation. On the other hand, during years of economic downturn, earned income tax collections can drop due to local layoffs. This dynamic makes it a little more difficult to project the amount of tax revenue that will be collected in future years.

Many people consider the earned income tax as fairer than the occupation tax because it more closely reflects an individual’s ability to pay. The amount an individual owes through the earned income tax is based entirely upon how much money they make in wages, salaries, and other remuneration for work, rather than on some broad classification of their occupation which may not at all represent their earnings. Yet the tax is not a perfect reflection of ability to pay because it ignores other important sources of income, such as interest and dividends. Wealthy residents who get most of their income through investments are affected less by the earned income tax than are their lower-income wage-earning neighbors.

Who Can Use Act 24?

Only school districts who levied an occupation tax in 2001 are allowed to use the provisions of Act 24. This includes about 40 percent of Pennsylvania’s 501 school districts, and varies by region (see Table 1). Local governments that also use the occupation tax, such as counties, boroughs, and townships, are not eligible to use the Act 24 provisions.

How Can These Tax Changes Be Implemented in My School District?

School districts are not required to implement Act 24's tax changes- district officials can stay with their current use of taxes if they prefer. School districts that want to use Act 24 can only do so through a local referendum. The ballot question must be in clear language, such as:

 “Do you favor increasing the rate of the earned income tax to a maximum of X%, with the requirement that the increase be used to eliminate the occupation tax?”

The referendum question can only be placed on the ballot by the local school board, through adoption of a resolution. The school board has to must provide public notice of their intent to adopt such a resolution, and hold at least one public hearing on the resolution. The referendum will appear on the first general or municipal election (the November election, not a primary election) occurring at least 90 days after election officials have received the resolution.

Is Act 24 of 2001 a Hidden Tax Increase?

No. Earned income tax rates can only be raised enough to offset the revenue lost by eliminating the occupation tax. School districts cannot use Act 24 to create a “surplus” or take an inflationary increase through the earned income tax.

How Will Act 24 Affect School Districts?

In general, the tax shift provisions will have little impact on school districts. Unlike Act 50, Act 24 does not require voter approval for large future tax increases. It also does not limit future tax increases. Districts that adopt Act 24 provisions will lose the ability to spread tax increases across several local taxes, however, and will instead find that future tax increases must be solely carried by the real property tax.

The average possible increase in the earned income tax rate of eligible school districts in each county appears in Table 2 (the calculations are based upon 1998–1999 budget figures). The average possible earned income tax rate increase statewide is 0.28 percent, which compares to most districts’ current earned income tax rate of 0.5 percent. In other words, on average, earned income taxes would increase about 56 percent.  Based upon 1998–1999 budget information, the possible earned income tax rates under Act 24 in all  school districts except one would be less than Act 50's 1.5 percent maximum.

How Will Act 24 Affect Local Governments?

Local governments will not be affected by Act 24 of 2001. Even though some counties and municipalities currently use the occupation tax, only school districts are authorized to use the provisions of Act 24 to eliminate the tax. Furthermore, municipalities that currently share earned income tax revenues with a school district that adopts the Act 24 provisions are bound by the terms of that agreement. (Typically, such agreements divide the maximum 1 percent earned income tax rate equally, with both the municipality and school district receiving 0.5 percent of that rate.) A municipality in a district that adopts Act 24 provisions thus cannot raise its own earned income tax rate as a result.

How Will Act 24 Affect Taxpayers?

It is important to recognize that Act 24 is a tax shift rather than a tax cut; it changes where tax dollars come from, rather than reducing the total amount of local taxes that schools collect. Because it is a tax shift, some taxpayers will pay more so others can pay less. In general, the tax changes in Act 24 will only affect working-age taxpayers, who typically are the only residents who pay both the occupation tax and the earned income tax. Retirees generally do not pay the occupation tax, and they only pay earned income tax on their current earnings if they work. Nonresident property owners will be unaffected by Act 24 because they are not subject to either local tax.

Who will pay more and who will pay less under Act 24 depends upon (1) how much their school district will have to increase the earned income tax rate; (2) the taxpayer’s earned income; and (3) how much the taxpayer currently pays in occupation tax. To get a rough estimate of how Act 24 might affect taxpayers in your school district, find your school district’s potential earned income tax rate increase, either directly from the ballot wording (if an Act 24 vote is being held in your district) or from your school district.  If neither is available, use Table 3 as an approximation.  The potential earned income tax increases listed in Table 3 are based upon 1998–1999 fiscal data, which was the most recent statewide data available at the time this publication was written, and which should be viewed as approximations of how earned income tax rates might change. If your district has raised the occupation tax rate since 1999, the estimate in Table 3 will be low.  If your district is not listed, it did not use the occupation tax in 1998–99 and will be ineligible to use Act 24 unless it has newly imposed the occupation tax since 1999.

In Figure 1, find the line that is closest to the potential earned income tax rate increase for your school district. This line is the “break point” for which taxpayers will end up paying more and which will pay less if Act 24 provisions are adopted in their school district. To see how specific taxpayers will fare, find the intersection of the taxpayer’s earned income and the amount they currently pay in occupation tax. If this point is above the line for the percentage increase in their school district’s earned income tax, they should pay less under Act 24. If the point is below the line, they should pay more under Act 24. A taxpayer with $30,000 in earned income who pays $400 a year in occupation tax, for example, will pay less in local tax if their district raises their earned income tax rate by 1.0 percent (see the example in Figure 2).

What should be clear from the graph is that taxpayers who pay a lot in occupation tax compared to their earned income generally will pay less under Act 24, while those taxpayers who pay relatively little in occupation tax compared to their earned income generally will pay more.

Will Act 24 Reduce My Property Taxes?

No. Act 24 only authorizes changes in the occupation and earned income taxes. It does nothing directly to address concerns about the real property tax. It does take away the only other local tax some school districts have used to balance tax increases, so future tax increases will have to be made entirely through the real property tax rather than through a mixture of the occupation and real property tax.

Can Act 24 Be Used Indirectly to Reduce My Property Taxes?

Possibly, though this was not the intent of Act 24’s sponsors. Theoretically, a school district could raise their occupation tax rates dramatically for one year, using the new monies to reduce their real property taxes through either a Homestead/Farmstead Exclusion or lower real property tax rates. Then the following year they could enact Act 24 to shift the tax burden from the occupation tax to the earned income tax (provided they were already using the occupation tax as of July , 2001). This would effectively shift the tax burden from the real property tax onto the earned income tax, although it would require having a very high occupation tax rate for two years, which could create even greater burdens on taxpayers. Because the new earned income tax would not take effect until the fiscal year after the Act 24 referendum, the higher occupation tax rates would be in effect for two years.

Districts thinking about such a strategy should carefully consider the potential impact of the higher occupation tax in the first two years, how to reduce the real property tax (Homestead/Farmstead versus lower tax rate), and the fairness of using earned income revenues to pay for such tax breaks.  

1. Impact of Higher Occupation Taxes the First Two Years?

Using such a strategy to reduce real property taxes means people who pay the occupation tax will be particularly burdened in the two years when the occupation tax is temporarily raised to generate funds for real property tax reductions. Many taxpayers already see the occupation tax as an onerous burden; increasing it even temporarily will create additional hardships for taxpayers that may be difficult to justify. The earned income tax increase allowed depends upon the amount of occupation tax revenues actually collected in the fiscal year ending prior to the referendum, so simply increasing the occupation tax rate without actually collecting the higher revenues will not help. The occupation tax already is difficult to collect accurately and completely; raising the tax rate potentially could make collecting the tax even more difficult.

 2. How to Reduce Real Property Taxes?

New revenues from the occupation tax could be used to reduce the real property tax by either implementing a Homestead/Farmstead Exclusion (which was authorized under Act 50 and can be used by school districts separate from the other Act 50 provisions), or by reducing the real property tax rate. The major difference between these two approaches is who gets the tax break. Simply reducing the tax rate means all property owners who pay the real property tax (including homeowners, local businesses, vacation home owners, and anyone else who pays the real property tax) would receive a tax break, and that the size of their tax break would depend upon how much they pay. Because the tax cut would be proportional (such as “4 percent”), taxpayers with more expensive properties would receive a larger dollar tax break than would taxpayers with less expensive properties. The amount of tax relief going to non-homeowners could be substantial; if implemented statewide, for example, about one-third of the dollars for tax breaks would go to businesses.

When the Pennsylvania General Assembly was considering local tax reform and how to target real property tax reductions to those in most need, some legislators were worried that using higher earned income tax revenues to pay for lower real property tax rates would make households pay for tax breaks for businesses. Their solution to this concern, the Homestead/Farmstead Exclusion, allows real property tax breaks to be targeted directly to homeowners and farmers.  The dollar size of the tax reduction is the same for every eligible property owner, so it particularly helps low-income residents and those on fixed incomes.

3. Fairness of Using Earned Income Tax Revenues for Such Tax Breaks

Because the earned income tax discriminates against certain types of income, some critics claim it is not the fairest way to pay for real property tax reductions. The earned income tax predominantly affects working-aged people who have little investment or retirement income. High-income residents who make most of their money through investments and retirement income can end up paying little or nothing in earned income tax, simply because their sources of income are not subject to the tax. Raising earned income tax rates to pay for real property tax breaks means that these low- and middle-income households could be paying for tax breaks for some of their wealthier neighbors. This has been raised as a concern in parts of Pennsylvania with large numbers of wealthy retirees who have moved in from out-of-state.

How Does Act 24 of 2001 Differ from Act 50 of 1998?

Act 24 of 2001 is much more focused than Act 50 of 1998, the other recent local tax reform act. Act 24 is strictly limited to the occupation tax, while Act 50 affects a wider range of local taxes, including real property, occupation, occupational privilege, and per capita taxes. Unlike Act 50, Act 24 contains no provision for local voter approval of future large tax increases. (Some argue that the “backend” tax referendum requirement in Act 50 is the main reason Act 50 had only been adopted in 3 of Pennsylvania’s 501 school districts as of July 2001). Act 24 also lacks Act 50's ability for local citizens to attempt to put it on the local ballot (see Table 4 for a summary of important differences).  

 

Table 4. Comparison of Key Elements of Act 24 of 2001 and Act 50 of 1998
	Act 24 of 2001	Act 50 of 1998
Effect on:
Occupation Tax	Eliminates	Eliminates
Real Property Tax	No effect	Reduces
Occupational Privilege Tax	No effect	Eliminates
Per Capita Tax	No effect	Eliminates
Earned Income Tax	Increases just enough to offset loss of Occupation Tax	Increases up to 1.5 percent
Homestead/Farmstead Exclusions for Real Property Taxes?	No	Yes
Voter approval for future large tax increases?	No	Yes
Inflationary increase allowed from higher Earned Income Tax?	No	Yes
Implemented in a School District via:	Voter approval	Voter approval
Placed on ballot via:	School Board resolution	School Board resolution or citizen petitions and Local Tax Study Commission

Does Adopting Act 24 Mean A School District Can’t Later Adopt Act 50?

Adopting Act 24 should not prevent a school district from later adopting Act 50, as long as its earned income tax rate under Act 24 is less than Act 50's maximum of 1.5 percent.

Summary

Act 24 of 2001 provides an important new local tax option for Pennsylvania school districts. It provides a straightforward method of eliminating one of the most unpopular local taxes, shifting the tax burden onto the earned income tax, which is arguably the fairest local tax currently available to school districts. It avoids much of the complexity and uncertainty involved with Act 50 of 1998, which is the other recent local tax reform option, so is relatively easy to understand.

The local referendum requirement in Act 24 of 2001 gives citizens a voice about whether such a change should occur in their own school district, but also creates an obligation for voters to carefully think through the implications of that decision. Voters need to consider the fairness of the occupation tax and of the earned income tax, and the potential impact of Act 24 on their school district, students, and taxpayers. They may find it a very attractive alternative to their school district’s current local tax structure.

References:

Governor’s Center for Local Government Services. Taxation Manual. Harrisburg, PA. 2001.

Kelsey, Timothy W. “Understanding School Tax Change Under Act 50 of 1998.” Penn State Cooperative Extension. College of Agricultural Sciences, Penn State. University Park, PA. 1998.

Pennsylvania Department of Education. Act 511 Taxes for Pennsylvania School Districts, 1998–1999. Harrisburg, PA. 2000.

Pennsylvania Department of Education. Selected Revenue Data for Pennsylvania School Districts, 1998–1999. Harrisburg, PA. 2000.

This publication is intended strictly to help you know and understand more about the school tax changes possible under Act 24 of 2001. The material is general and educational in nature. It is not intended to be legal advice, nor to replace the need for legal advice. If legal advice is what you need, you are encouraged to seek the aid of a competent professional in your area.

Prepared by: Timothy W. Kelsey, associate professor of agricultural economics

Acknowledgments:

The comments of several reviewers were particularly helpful in developing this material on Act 24. These include Donald E. Grell, II, Executive Director, House Local Government Committee, and Representative Lynn B. Hermann, Chairman, House Local Government Committee. The views expressed on these webpages  are those solely of the author, and do not necessarily reflect those of the reviewers.