A devastating ruling in a tax lawsuit may force the city to borrow millions, hike property taxes and/or reduce services.
Lackawanna County Judge James Gibbons ruled Dec. 16 that Scranton routinely collectively overtaxes workers, businesses, realty transfers and concertgoers by about $10 million a year. Gibbons ordered the city to put about $50 million in escrow to make up for tax overcharges from 2015 through 2019, plug that cash into future budgets and stop the annual overtaxing going forward.
To get an idea of how big of a fiscal hit is at stake, $50 million equals the combined annual expenditures of Scranton’s police ($25.1 million) and fire ($24.9 million) departments in the city’s $115 million budget for 2020.
The adverse ruling set off a scramble by the city to appeal to Commonwealth Court to overturn the decision.
Though Scranton withstood several financial knockout punches in recent years, the Act 511 ruling represents a potentially huge wallop in the wallet for the city in several ways, officials said.
Scranton does not have $50 million to spare. It also cannot readily forego collecting $10 million a year in tax revenues that help fund annual budgets. Alternatively, the city cannot simply cut spending by $10 million to fix the overtaxing.
Mayor Paige Gebhardt Cognetti and city council members view an appeal as the city’s only viable option.
On Monday, Cognetti hired an outside law firm, Stevens & Lee, to handle the appeal and defend what she describes as the city’s “alleged overtaxation.”
“The circumstances are dire,” council President Bill Gaughan said. “It seems we’re putting all of our eggs in the appeal basket. As far as I know, there is no alternative.”
Fighting city hall
Gibbons’ ruling came in a lawsuit filed in March 2017 by eight Scranton residents represented by Scranton attorney John McGovern. The plaintiffs include Gary St. Fleur, Nicholas Gettel, Casey Durkin, Damian Biancarelli, Rich Johnson, Ethan Green, Angela Gilgallon and Michele McGovern, who is John McGovern’s wife. Johnson has since died.
The lawsuit claims the city violated a tax cap on taxes collected under state Act 511, including wage — also called an earned-income tax — real estate transfer, amusement, business privilege, mercantile and local services taxes.
The lawsuit argues that under law, total Act 511 taxes Scranton collects in any given year cannot exceed 1.2% of the city’s fair market value as determined by the Pennsylvania State Tax Equalization Board. Using that formula as a guide, the suit claims the city went over cap anywhere from $7 million to $12 million from 2015 through 2019, or about $10 million a year.
The city instead should have reduced Act 511 taxes so the total collected fell under the annual cap, or rolled over excess amounts in any given year to meet the cap in the following year, the lawsuit contends.
The city argues it has unlimited taxing power under its Home Rule Charter, therefore the Charter trumps Act 511 limits. The city also argues it “parses” Act 511 taxes, and therefore, excesses are authorized under the city’s Home Rule Charter or state Act 47, the distressed municipalities law under which Scranton has been designated as financially distressed since 1992.
Gibbons determined the Home Rule Charter does not trump Act 511 and rejected the rationale that excess taxes can be parsed.
“The city’s argument that it is not subject to Act 511 has no merit,” Gibbons said in his ruling. “The city cannot consider Act 511 applicable in one breath and inapplicable in the next.”
Plugging holes
Even if the city had $50 million to make up for past overtaxing, that would not solve the $10 million-a-year overtaxing problem going forward.
The city collected nearly $38 million in Act 511 taxes in 2018, the most recent data available. If Scranton loses the appeal and has to set aside $50 million to make up for past violations, the city likely won’t be able to collect any Act 511 taxes the following year. That, and reducing future Act 511 collections to meet the cap, would create a titanic hole in the city’s budget and leave officials with few options to plug it.
One likely option is significantly hiking property taxes to offset the lost Act 511 revenue. Another is for the city to try to borrow the $50 million through an “extraordinarily expensive” method called unfunded debt, said state Sen. John Blake, D-22, Archbald, whose district includes Scranton.
Another option could involve cutting the city’s 2.4% wage tax, to bring the total Act 511 tax collections under the cap. To make up for the reduced wage tax collection, the city likely would increase property taxes.
Cutting spending for critical services, such as police and fire protection or the Department of Public Works, likely isn’t possible because of labor contracts. Cutting services also would be a troubling prospect for a city that has been on track to finally successfully shed state Act 47 distressed status later this year.
“The city under Act 47 … has already been pretty bare bones,” Blake said. “They don’t have a lot of latitude to cut their way out of a ruling that could cost them $50 million.”
The case may have implications beyond Scranton, too. At least 15 other Pennsylvania municipalities are in a similar situation with their Act 511 tax collections and could be vulnerable to similar overtaxation legal challenges, Blake said. Those municipalities include the cities of Wilkes-Barre, Harrisburg, Reading, New Castle, Warren, Farrell, Washington, Shamokin, Beaver Falls, Sharon and Mahanoy City, and the boroughs of Upland, Youngsville, Cassandra and Rankin.
“I believe that an adverse ruling in this (Scranton) case, meaning that if the appeal were to fail based upon current law, all of these municipalities ... would be put into the same precarious position,” Blake said.
Got it all wrong?
If Scranton wins its appeal, Gibbons’ ruling becomes moot and the city can continue with its Act 511 tax collection.
Some local attorneys said they believe Commonwealth Court will overturn the ruling.
Clarks Summit attorney Joseph O’Brien, of Oliver, Price & Rhodes law firm, who is a former Lackawanna County solicitor, penned a guest column in the Jan. 5 edition of The Sunday Times saying Gibbons got the case all wrong and predicted the ruling will be reversed on appeal. If Gibbons’ decision were to stand, “it would likely force the city into bankruptcy” and reduce services, he wrote.
“My view of the law is that the Home Rule Charter law allows municipalities to set their own tax rates and that the limitation on those rates in Act 511 no longer applies when someone chooses Home Rule,” O’Brien told the newspaper last week. “Not only does the statute say that, but you couldn’t get more explicit.”
McGovern said he disagrees with O’Brien, and points out that O’Brien was not present during any of the four hearings about the lawsuit.
Even if the city prevails, O’Brien said there would be a price to having the case hang over the city during an appeal process that could take several years. Uncertainty of the outcome may dissuade outside investors and potential homebuyers from coming to Scranton and cause property values to fall and interest rates on municipal financing to rise, O’Brien said in his column. To expedite the appeal, O’Brien suggests the city take a unique step called “King’s Bench” — bypass Commonwealth Court and seeking an immediate review by the state Supreme Court.
The case ultimately may end up at the Supreme Court because either side likely will appeal an adverse Commonwealth Court decision.
Cognetti and the outside law firm handling the appeal, Stevens & Lee, filed a notice of the appeal Monday to Commonwealth Court.
Gibbons issued an order Wednesday directing the city to file within 21 days a “concise statement of errors complained of on appeal.”
“Any issue not properly included in the statement … shall be deemed waived,” meaning not allowed to be raised during the appeal, Gibbons’ order said.
Questionable numbers
Citing insight gleaned from lawyers, Blake also said he believes the city has a strong case to make on appeal and that Gibbons’ ruling “probably will be overturned.”
Blake said the Pennsylvania State Tax Equalization Board figures for the city’s annual fair market values, which form the basis of the plaintiffs’ claims that the city overtaxes, and which Gibbons relied upon in his ruling, are arbitrary and don’t reflect the value of Scranton real estate.
Blake also said home rule municipalities like Scranton may reference Act 511 to determine the subjects of taxation, but can set their own tax rates.
“(Gibbons) would not have arrived at where he did if he did not think there was some interpretation (of the law) that supported it, that substantiated it, so you have to give credit where credit is due,” Blake said. “But, it’s up to the city, with support from the state, to make the case — to guarantee that it is defensible under law.”
Gerald Cross, executive director of the Pennsylvania Economy League, the city’s Act 47 recovery coordinator, declined to comment about Gibbons’ ruling and its potential impact on city finances and anticipated successful exit from Act 47 oversight.
The state Department of Community and Economic Development designated PEL as the recovery coordinator.
“My guess is that (DCED and PEL) will probably provide the city’s legal team as much backup and technical assistance and guidance and direction as they can,” Blake said. “And, I think the city would be wise to take that technical assistance and that guidance in making their case, quite simply because these guys live and breathe this stuff every day.”
Blake said he is exploring whether there are shortcomings in relevant state law that require a legislative fix. If so, that 15 other municipalities may be subject to similar Act 511 litigation improves the prospects of building consensus around corrective legislation in Harrisburg, Blake said.
Who’s affected?
The Greater Scranton Chamber of Commerce is no fan of the complex nature of the city’s tax structure or the gross receipts taxes that fall under Act 511, but supports and endorses the city’s appeal.
“Clearly, a $50 million escrow is impossible,” chamber President Bob Durkin said. “It would completely flip the financial stability that has been generated over the past several years.”
Durkin said he agrees with O’Brien’s argument and is optimistic the city will win its appeal based on conversations with attorneys and officials.
“I think it’s going to be a slam dunk that (the ruling is) going to be overturned,” he said.
Durkin said he hasn’t gotten the sense chamber member businesses are worried about the court ruling, noting the chamber remains focused on growing the local tax base and working with officials to create a more prosperous community.
“Dale Carnegie would say, ‘You can’t control the weather,’” Durkin said. “You can only control what you can control, so focus on that.”
Civic watchdog Joan Hodowanitz, said the appeal launched by the new mayor and supported by the new council, both of whom took over Jan. 6, was unavoidable.
“I have very mixed feelings,” she said. “Obviously, the city has got to attempt to appeal this. The city budget and all prior budgets were built on the assumption that’s the revenue (from Act 511 taxes) you would suck in. You take $50 million out, and what’s left? You can’t get there from here. That’s why they have things called bankruptcy, for when you’re so far in over your head, you’re looking at disaster city.”
McGovern said until the city faces its grim fiscal realities, it won’t ever truly achieve financial recovery.
“For me, this is all a matter of right and wrong, that’s all it is,” McGovern said. “If I’m right, the city will have to change and the future will be different. And, if I’m wrong, the city goes right back to where it is, which is distressed.”
Contact the writers: jhorvath@timesshamrock.com; 570-348-9100 x9141; @jlhorvathTT on Twitter; flesnesky@timesshamrock.com; 570-348-9100 x5181; @jlockwoodTT on Twitter; jlockwood@timesshamrock.com; 570-348-9100 x5185; @jlockwoodTT on Twitter
Scranton’s ‘financial hit’ parade
Act 47 battle: $31 million. This epic war between the city and its police and firefighter unions took 13 years to resolve, and the unions won. The case between the city, supported by the state Department of Community and Economic Development, and the unions pitted Act 47, the distressed municipalities law, against Act 111, the arbitration law. The city and state contended certain arbitration awards were outside the scope of Act 47 limitations. Former Mayor Bill Courtright and his administration reached a settlement in 2016 for the city to pay $30.9 million to the unions and they agreed to give up $3.6 million in interest owed to them.
Scranton Parking Authority default: $35 million. In 2012, the city council allowed the city to default on SPA debt. The city backed the SPA debt, but council refused a bailout. The default, a black mark on the city’s creditworthiness, brought the city to the brink of bankruptcy. SPA bondholders installed a receiver. In 2016, the city unloaded the city’s parking system to an outside firm in a long-term monetization lease called the most complicated deal ever in the city. The city borrowed $35 million to retire the defaulted parking debt.
Distressed pensions: In 2014, state Auditor General Eugene DePasquale warned that the city’s severely distressed municipal pension system was on track to go broke within three to five years, and possibly push the city into bankruptcy. Since then, various steps taken by the city, unions and pension boards — including the city putting $22.9 million of proceeds from the 2016 sale of the Scranton sewer system into pensions, higher annual contributions, reduced debt, strong investment returns and concessions from police and fire unions — all contributed to significant improvement and raising the classification to moderately distressed.
— JIM LOCKWOOD