[Note: This article was originally published by the Law Practice Management Section of the American Bar Association in Law Practice Management, Vol. 19, No. 7, p. 26 (October 1993).]

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Why Lawyers Can’t Manage

By Daniel B. Evans
Copyright 1993, 2003. All rights reserved.

I have read too many articles and commentaries which lament the extent to which law has become a “business”. The implicit assumption is that if a lawyer acts like a greedy, unprincipled, and insensitive pig, he is acting like a businessman. The truth is that a successful service business strives to provide useful and attractive services at reasonable prices, promote customer satisfaction, and earn a profit. Why are those concepts so offensive to the legal profession? (Also, why is the legal profession so quick to attribute to the business community those faults which the business community likes to attribute to lawyers?)

Fortunately, the practice of law will never become a business because lawyers will never learn to think or act like business managers. Lawyers will never think or act like business managers because law schools, law firms, and the legal system itself teaches them not to.

Law Schools

One of the biggest influences on lawyers is the training received in law school. This is not necessarily good for their attitudes and aptitudes for management.

Academia

If we assume that law schools are performing their proper function, and if we examine what it is that law schools do in order to work backwards and determine their function, we would have to conclude that the function of law schools is to take reasonably intelligent people and turn them into naive, academically proficient (but otherwise dysfunctional) idiots.

The average graduate from a law school understands the concept of a tort, the elements of negligence, and the social and legal policies underlying the tort system enforced by American courts. If pressed, he or she may even know what must be alleged in a complaint to initiate a lawsuit for negligence. However, the process of preparing a complaint, filing it with the proper fees, serving the complaint on the defendant, and conducting the case through to trial will probably be a complete mystery.

Even if a law school has a clinical program to acquaint students with the procedures of the real legal system, there will almost certainly be no instruction in how to dictate a letter, how to delegate work to secretaries or paralegals, how to maintain a file, how to record billable time, or any of the other practical office skills which go into practicing law.

From this perspective, a law school graduate most nearly resembles an idiot savant, able to perform impressive mental feats of calculation and memorization but unable to perform simple survival tasks or otherwise function in society.

Issue Identification

Even the job which law schools supposedly do well, which is to indoctrinate impressionable youth in arcane legal reasoning, can actually get in the way of running a law firm, because law schools teach students how to identify issues or problems, but not how to solve them. Given a particular factual situation on a law school exam, the highest grade goes to the student who can spot the most issues and describe the most number of potential legal arguments, both pro and con. Similarly, the most valuable lawyer is supposedly the one who can spot the most potential tax problems in a proposed transaction or the most weaknesses in a pleading or complaint. Law schools (and law firms) therefore place a premium on the discovery and identification of problems.

These is a useful skill in academic circles, and even in preparing an appellate brief, but it can produce disasters while managing a law firm. At a partnership meeting, most lawyers will be better at raising issues than at resolving them. They will not be happy until they have dissected every aspect of the situation, raised every possible problem or consideration, and voiced every possible argument for and against every issue. Trained to identify problems, they do so at every opportunity, whether or not it is appropriate, often blocking any managerial action by the firm.

Because they raise (or create) so many problems in business transactions, lawyers have a reputation for being “deal killers”. What is often overlooked is that lawyers can also be “law firm killers”.

Aristotelian Logic

Law school training is inherently aristotelian, not scientific. The socratic method used in law schools encourages students to believe that, through discussion, analysis, and contemplation, the “right” result will emerge. This was the “scientific” method of Aristotle, who believed that the sun revolved around the earth. The modern scientific method requires that, after you have developed an idea, you must test it and prove that it is right. Lawyers are never taught this second step, which is not part of the legal process, and so lawyers tend to believe that a group of lawyers, sitting in a conference room, can solve firm management problems without any additional input, learning, or testing.

An anecdote may help to illustrate the tendency of lawyers to try to solve problems by examining their individual or collective navels. Several years ago, a bar association decided to establish guidelines for evaluating and recommending judicial candidates. A committee of lawyers was formed. It met, discussed, drafted, and finally published guidelines describing the qualities and experience which were most important for a judge, and which would be used by the bar association in evaluating and recommending judicial candidates. However, no lawyer on the committee ever talked to any judge about what it was like to be a judge. In the factual vacuum of their offices, the committee members had prepared guidelines for what they thought a judge needed to do without every talking to a judge to find out what judges really did. This violates a simple and basic management rule: When finding someone to do a job, you first interview the last person to do that job to find out what the job is.

Those who cannot learn from the past are doomed to repeat it. Not knowing how to learn from the past experiences of others, and not knowing how to test their own ideas and learn from their own experiences, each generation of lawyers will make the same management mistakes as their predecessors.

Law Firms

The ways in which law firms operate are self-perpetuating systems which discourage any attempt to manage effectively.

Owner/Employees

The partnership (or shareholder) structure of every law firm obstructs efficient management.

In any business enterprise, ultimate management authority lies with the owners, whether those owners are the stockholders of a corporation or the partners in a partnership. Law firms are unusual among business organizations in that the owners also constitute a significant portion of the work force. In a typical law firm, the owners are the partners (or shareholders if a professional corporation), and those partners (or shareholders) are also practicing lawyers, so they are affected (along with all other employees) by all management decisions.

When partners are inconvenienced by a management decision on file management, document formats, billing, or other internal procedures, they may simply ignore the decision, which will defeat the goal of uniformity within the firm and sabotage the original purpose of the decision. If the partners don’t ignore the decision, they may oppose it, in which case every management decision becomes a partnership decision, requiring debate and consensus among the partners and wasting valuable partner time.

It is therefore understandable that managing a law firm has been compared to herding cats.

The Billable Hour

Recording time spent of behalf of clients was originally supposed to help law firms bill clients and allocate resources more intelligently. The practice of law is labor intensive, so the profitability of different clients, practice areas, and lawyers should be measured in the ratio of time spent to income received. However, law firms today do not use recorded time as one factor to consider in billing clients, but use recorded time as the sole factor in billing clients. This has so many adverse effects that the “billable hour” has become a Frankenstein monster, now threatening to destroy the lawyers who have nourished it.

Using time spent as the sole basis for all billing is a complete disincentive to any practice organization or practice efficiency. Consider, for example, something as simple as a research retrieval system. If a law firm had no research retrieval system, then each client problem would have to be assigned to a lawyer (probably an associate) for analysis and research, and the client would be billed for the associate’s time. If the firm had a research retrieval system, the associate might first check that system and discover a recent opinion on the same subject for another client. The associate’s time would therefore be limited to checking and updating the prior opinion, with a considerable savings in time and, based on time alone, a considerable reduction in the fee to the client.

Expressed in that way, the research retrieval system does not sound that bad, because the fee was reduced for the second client but the level of profitability for the firm remained the same (assuming that the associate had other work to do and that the firm still collected the same hourly rate for the time spent). If there were no impact on profitability, a firm might still wish to have a research retrieval system in order to reduce errors (such as conflicting opinions on the same issue) and in order to serve more clients in greater volume, even at the same level of profitability. However, a research retrieval system is not without its costs. The research to be retrieved must be collected, indexed, stored, and maintained. This will require attorney time, staff time, and physical resources such as office supplies and office space, or even computer hardware and software. If the firm has no way to bill clients for these costs, the adoption of a research retrieval system will make the firm less profitable, not more profitable, or will cause the firm to increase its billing rates, which may make the firm less competitive with other firms.

More complex automation applications provide even clearer examples of the disincentives to efficiency. It is possible to create computer systems which will draft complex documents very accurately and very quickly. However, if the firm has no way to bill a client except through billable time and if automation reduces billable time, then the hardware, software, and configuration costs become net losses to the firm, with no increase in profitability.

These examples show that the dependence on the billable hour provides a disincentive to any automation or other management efforts to promote efficiency. The billable hour also promotes organizational inefficiencies.

Because firm revenues are based on billable time, associates are rewarded for recording large amounts of billable time and punished (subtly or overtly) for recording small amounts of billable time. Even without committing any misrepresentation or fraud, associates learn quickly how to maximize their billable time. More to the point, they have no incentive to adopt any time saving measures, and may actually strive for overly time-consuming (but legally justifiable) steps in order to record the largest possible amount of time.

The more clever among the partners may also recognize that law firms enjoy diseconomies of scale. As was observed in The Mythical Man-Month, by Frederick P. Brooks Jr. (Addison-Wesley Publishing, 1982), adding workers to a project will slow it down, not speed it up, because additional time will be needed to educate the new workers, communicate among all workers, and coordinate all of the tasks. In other words, if one associate can research and write a brief in fifty billable hours, it may take two associates a total of seventy billable hours to do the same research and write the same brief. This is partly due to duplication of effort and partly due to the time required by the two associates to coordinate their work. Partners therefore have an incentive to assign the largest justifiable number of associates to a case in order to create the largest possible number of billable hours.

Observation: Most clients are businessmen and already know all these things. That is why they often don’t like bills from lawyers, particularly bills with large amounts of time recorded by attorneys in the same firm talking to each other.

Law firms have spent large amounts of time and money on computer and administrative systems to record billable time and have trained many clients to accept billable time as the sole basis for fees, so changes are unlikely in the near future. However, lawyers interested in alternative billing methods should see Beyond the Billable Hour, edited by Richard C. Reed and published by the ABA Section of Law Practice Management (1989).

Attribution

There is a joke among managers which is intended to show the problems which occur when a single business factor dominates decisions. The joke is that a business has been suffering from flat profits, and so the president decides to hire a new advertising agency. The new agency designs and carries out a new ad campaign, and sales increase. Unfortunately, profits go down, not up. The president therefore fires the ad agency and hires another ad agency.

More and more law firms now recognize the value of new business, and attorneys who can bring in new clients are important to a firm. Unfortunately, most of these legal “rainmakers” are not satisfied with increased compensation, but have demanded (and received) increasingly larger roles in the management of their law firms. The net effect is about the same you would expect if General Motors were run by the car salesmen. Disproportionate attention is focused on the things the rainmakers know and do best, such as bringing in new clients, and in things which serve the interests of the rainmakers, such as bringing in new clients which increase the attribution of the rainmakers. Relatively little time, attention, or firm resources may be allocated to things the rainmakers may do not do well, such as maintaining the quality of legal services, financing the practice, recruiting and training new lawyers, employee relations, automation, or any of the many other problems affecting law firms. This may weaken the long term (or even short term) profitability of the firm.

An attribution system can have two other adverse effects on a firm. The profitability of the firm may be adversely affected if the clients brought in by the major rainmakers are not in the practice, geographic, or economic areas most profitable to the firm. The attribution system might also become a self-perpetuating system in which the increasing importance of a lawyer provides the political leverage necessary to increase his importance, stifling or alienating other partners important to the firm.

The increased attention and importance attached to bringing in new business and “attribution” is, therefore, not necessarily business-like, and will not necessarily make a firm more profitable.

Firm Instability

The increasing instability of law firms is a corollary of the dual roles of the partner as both an owner and an employee.

In a free market economy, employees will always come and go based on market value. If an employee is offered a better salary by another employer, the employee may leave and go to work for the other employer. There is, therefore, always some instability in business organizations. However, in most business organizations, the employees may change, and even the management (officers) of the organization may change, but ownership remains relatively constant.

Law firm partnership shares are based primarily on the value of the services of the partner, not capital contributions, so partners can “shop” their services (or clients) to the highest bidder, just like other employees. Therefore, all compensation disputes involve a risk of partial (or total) partnership dissolution, and the movement of partners from firm to firm is a change in the ownership of the firms, as well as the work force of the firms.

Good management requires an investment of time and money and the investment does not necessarily pay immediate dividends. Like a capital investment, the benefits of good management may be realized only over an extended period of time. The owners of a corporation or other business organization will expect to see the results of good management eventually. However, the partners who own law firms have come to see their positions as primarily those of employees terminable at will, rather than owners of a capital investment. This means that the partners will invest time and effort only in those things which are portable. Close contacts with clients and good legal skills can be taken to another law firm, but good employee training, efficient organizational operations, sound financial practices, and other types of good management cannot be picked up and carried away. (Whether substantive systems, such as legal forms or checklists, can be moved from firm to firm depends on issues of intellectual property rights beyond the scope of this article. However, it is possible that things which can be photocopied or copied onto a computer diskette are portable, at least as a practical matter.) There is, therefore, a disincentive for partners to invest in good law firm management.

Unless lawyers can develop partnerships which promote institutional stability and a sense of institutional loyalty, those partnerships will not be well managed.

The Legal System

The very nature of the legal system makes it difficult for lawyers to cooperate and work efficiently with each other, or with non-lawyers.

The Adversary System

Law is an adversary system, and the attitudes of the system affect the attitudes of the lawyers within it.

After a long day (or a long week) of arguing with opponents in court or negotiating with the other parties in a commercial transaction, a lawyer will return to the office to meet with his or her partners. Unable to psychologically “shift gears” or “shift roles”, the lawyer will continue to think and act like an adversary, and will proceed to argue with his or her partners or negotiate with them instead of cooperating with them.

Professional Ethnocentrism

While litigators who specialize in medical malpractice do not often try to perform surgery, the same sense of modesty is not shared by labor lawyers, commercial litigators, and other corporate lawyers, all of whom feel competent to make business decisions for which they have no training and, in most cases, no aptitude. There are several factors which may contribute to this attitude.

One factor is the attitude of law schools. In law school, lawyers are led to believe that what they are learning is very important, very difficult, and very special. The study of law goes back hundreds of years and has engaged some admittedly brilliant minds. The decisions of courts, and the constitutions and statutes framed by lawyers, have changed the course of nations, major corporations, and the rights and lives of most citizens. By contrast, therefore, every other profession or occupation becomes less important, less difficult, and less special. This makes it difficult for lawyers to have respect for, or consult with, professional managers.

As noted above, law school curriculums are also academic and devoid of any mention of the practicality of a legal practice. Having gone through their formative years in an environment in which the ability to add and subtract, or cooperate with their peers, were not particularly valuable skills, lawyers may be excused if they do not place a high value on those skills after graduating.

Another potential source of the “legal ego” lies in the nature of legal representation. In a lawsuit or a business negotiation, lawyers are often required to learn new facts and concepts, and learn them quickly. In order to cross-examine the defendant’s medical expert, a litigator may need to learn medical terminology and medical concepts. In order to negotiate reasonable work rules during strike talks, a labor attorney may need to learn enough about the client’s business to know what rules the client can live with and what rules will be unworkable. When a lawyer succeeds, the lawyer may become very impressed with his or her mental skills and perhaps feel a little superior to the so-called experts who have worked so long acquire the same knowledge the attorney acquired in a few hours.

For whatever reason, most lawyers have great respect for themselves and for other lawyers, and very little respect for other professions or vocations. It must therefore come as an insult to a partner with years of experience practicing law to suggest that he or she is not competent to manage his or her own law firm. Admittedly, the firm now has 40 partners, 60 associates, and 120 staff positions, annual gross income in eight figures, offices in three states, and $1.5 million in computer hardware and software, while the partner has never balanced a checkbook, but it simply can’t be that difficult. It’s all just a matter of common sense, right? There’s surely no need to hire some outsider who has only an undergraduate degree from a state school and who will earn more than any associate just to do what amounts to bookkeeping?

Lawyers will never be able to manage themselves, or allow anyone else to manage them, until they have learned that the law is not the source of all knowledge, that lawyers are not inherently able to solve all problems, that the problems of law firms are not unique and not beyond the scope of accepted management theory, and that professional managers have valuable skills and knowledge which deserve attention and respect.

The Crisis Addiction

Legal problems are often crisis problems, and the time demands of legal representation may lead lawyers to ignore management issues. In the eleventh hour of a trial, a settlement, or a negotiated settlement, there may be no room for any discussion, consideration, or distraction other than the matter at hand, and certainly no time for a decision on the adoption of a new office procedure.

More importantly, many lawyers, and in particular many important and therefore influential lawyers, actually thrive on that type of total concentration, and cherish their roles as auteurs as much as a skilled surgeon or a prima donna. In the courtroom, the client may be financially ruined or imprisoned by an adverse decision. In the negotiating room, fortunes may be won or lost on the outcome of negotiations. Can any lawyer who has experienced the heady thrill of that kind of brinkmanship ever again be satisfied with the boredom of a partnership committee meeting? Lawyers are therefore often unable or unwilling to tolerate the daily and petty distractions of routine office management.

Closure

Most attorneys are consulted only when something goes wrong, or a specific transaction is contemplated. For that reason, most attorneys see controversies or negotiations as something with a beginning, a middle, and an ultimate end. Whatever the resolution of a matter may be, whether it is a judgement, contract, or tax return, it is eventually completed, filed, and moved into storage. One way or another, all matters achieve some sort of closure.

Attorneys really see only small parts of the lives of individuals and businesses. An attorney may advise a client to change a part of the client’s written employment policies, and may advise the client on how to implement the change. In most cases, that will be the end of the matter for the attorney. For the client, however, the work has just begun. The new employment policy must be remembered and enforced day after day, week after week, month after month, and year after year until something happens to require a revision in the policy. Management is, therefore, not a decision or an event, but a constant process of planning, implementation, evaluation, revision, and replanning. Attorneys expect to make decisions and then move on to something else. They do not expect to take small steps or to monitor a situation over an extended period of time.

The desire for decisive solutions becomes particularly obvious, and particularly absurd, in the area of automation. A firm of litigators which has never progressed past electric typewriters may look to automate. However, they will not be content to begin installing some PC’s as word processors, planning to progress later on to a networked solution for other applications. No, they want it all. They want a fully-automated, state-of-the-art, turn-key, no-additional-software-will-ever-be-necessary solution. The result is often disappointing, if not a disaster.

Other business decisions of lawyers may become disasters due to a lack of attention to the process of management. A decision to open a branch office in another city, or begin a new practice area, may be a good decision on paper, and made with the best of intentions, but the office or practice area may fail unless someone monitors the day to day progress of the operation and does whatever is necessary every day to make the operation a success.

Attorneys will never understand or appreciate management until they can stop thinking of decisions and results and start thinking of long term goals and the step by step processes which will be needed to reach those goals.

The Good News

Not every lawyer or every law firm enjoys all of the character traits I have described, but there are enough lawyers in enough law firms with enough of these traits to assure me that law will not be practiced as a business any time soon.

What is the good news? The good news is that things have gotten worse. Competition among law firms for clients is greater than ever. Clients are more critical consumers, spending more time questioning law firms about their services and about the size and nature of their fees. Associates have also gotten to be more sensitive to qualitative issues such as quality of life and the psychological demands (and perhaps rewards) of a legal practice. Law firms are being squeezed as the economic and qualitative demands of clients, partners, associates, expanding technology, and increasing operating expenses place ever greater pressures on law firm profitability.

Sooner or later, something is going to give. Some lawyers, or some law firms, are going to start managing their practices in new ways, with new techniques and new attitudes, and will attract large numbers of clients and associates. Other law firms will either learn from them or dissolve.

Well, at least one can hope.

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Wills, Trusts, and Technology
An Estate Lawyer’s Guide to Automation, Second Edition
By Daniel B. Evans

The science of estate planning — identifying, weighing, and selecting the absolutely best alternatives and clauses for each individual you serve — calls for the finest technology you can bring to the situation. Wills, Trusts, and Technology: An Estate Lawyer’s Guide to Automation, Second Edition guides you through the process of automating your estates practice.

Written for both the computer novice or the experienced “techie”, this guide:

• explains why you should automate your estates practice

• identifies what should be automated

• teaches you how to select the best software for your practice needs

• helps you get your law office up and running with the software you select.

Written by a veteran estate lawyer and computer expert, Wills, Trusts, and Technology covers all the essential areas that relate to your estate practice — from software on estate tax planning, charitable and split-gift planning to fiduciary accounting and probate document preparation. Learn how you can plan and administer your clients’ estates with the most current system available.

[Additional Information]
[Corrections and Additions to the Second Edition]

Published jointly by the Real Property, Probate and Trust Law and Law Practice Management Sections of the American Bar Association.

2004 – 264 pages – 7×10 paper
ABA Product Code: 5430448
ISBN: 1-59031-281-3
$89.95 (RPPTL & LPM Section member price) – $99.95 (Regular price)

By Mail:

ABA Publication Orders
P.O. Box 10892
Chicago, IL 60610-0892

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800-285-2221 (Mon.-Fri. 7:30 a.m. to 5:30 p.m. CST/CDT)

By Fax:

312-988-5568

On-line:

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Common Level Ratios for Pennsylvania Realty Transfer Tax

(Current through June 2014)

When preparing and filing a Pennsylvania realty transfer tax affidavit, it is necessary to report both the assessed value of the property and the “common level ratio factor,” which is based on the average ratio between the assessed value and fair market value of real estate in that county. If the transfer is not exempt from tax, the tax is based on the greater of (a) the actual consideration for the transfer and (b) the product of the assessed value and the common level ratio factor.

The common level ratios are calculated by the State Tax Equalization Board based on sales data, and both the common level ratios and factors based on the common level ratios are published each year in the Pennsylvania Bulletin. (The common level ratio factors are the mathematical reciprocals of the common level ratios.)

The table below shows the factors which have been in effect for the last six years. The factor to apply to a particular transfer is based on the date the document is “accepted,” which is rebuttably presumed to be the date specified in the body of the document as the date of the instrument. (See 61 Pa. Code § 91.102, relating to acceptance of documents.) When two factors are provided in the table for a range of dates, the second one is a revised factor reflecting a change in the assessment ratio or assessment base, and is effective from January 1 of the second year.

Common Level Ratio Factors
County	7/1/03 to 6/30/04 (33 Pa.B. 2560)	7/1/04 to 6/30/05 (34 Pa.B. 3074)	7/1/05 to 6/30/06 (35 Pa.B. 3365)	7/1/06 to 6/30/07 (36 Pa.B. 2875)	7/1/07 to 6/30/08 (37 Pa.B. 2778)	7/1/08 to 6/30/09 (38 Pa.B. 3337)	7/1/09 to 6/30/10 (39 Pa.B. 3245)	7/1/10 to 6/30/11 (40 Pa.B. 4041)	7/1/11 to 6/30/12 (41 Pa.B. 4262)	7/1/12 to 6/30/13 (42 Pa.B. 5309)	7/1/13 to 6/30/14 (43 Pa.B. 3599)
Adams	2.65	2.89	3.28	3.98	4.53	4.55	4.51	4.22	1.00	0.85	0.84
Allegheny	1.03	1.07	1.10	1.10	1.15	1.16	1.14	1.16	1.17	1.17/1.00[10]	1.00
Armstrong	2.36	2.52	2.56	2.70	2.79	2.87	2.76	2.77	2.65	2.40	2.32
Beaver	2.87	3.11	3.23	3.31	3.41	3.43	3.36	3.35	3.06	2.93	3.18
Bedford	4.48	5.13	5.00	5.47	5.81	6.45	5.59/1.00[8]	1.00	1.28	1.28/1.00[10]	1.00
Berks	1.11	1.16	1.25	1.33	1.47	1.52	1.48	1.43	1.37	1.28	1.28
Blair	11.91	12.66	11.91	12.20	12.20	12.05	12.66/9.50[8]	8.43	6.67	5.59	6.25
Bradford	2.20	2.31	2.43	2.63	2.68	2.79	2.77	2.94	2.99	3.00	2.98
Bucks	28.57	32.26/8.07	8.93	10.10	10.99	10.64	10.31	9.17	8.85	9.26	9.09
Butler	8.93	9.62	9.90	10.20	10.42	10.75/ 8.06[4]	6.25[6]	7.30	5.24	5.88	7.41
Cambria	6.29	6.14/3.07	3.57	3.60	3.22	3.01	3.03	2.82	2.99	2.91	3.09
Cameron	2.83	2.68	2.81	3.08	2.96	2.85	2.99	3.08	2.44	2.31	2.25
Carbon	2.22	2.32	2.52	2.74	3.12	3.20	3.01	2.72	2.33	2.18	1.94
Centre	2.53	2.68	3.04	3.24	3.41	3.62	3.47	3.46	3.56	3.47	3.52
Chester	1.35	1.47	1.65	1.82	1.93	1.93	1.89	1.81	1.79	1.70	1.66
Clarion	4.98	5.26	5.10	5.38	5.65	5.16/3.87[4]	3.70[6]	3.80	3.38	2.89	3.45
Clearfield	4.88	5.24	5.13	5.47	5.75	5.68	4.74	5.29	4.95	4.95	4.67
Clinton	3.55	3.53	3.73	4.24	4.46	4.51/1.00[4]	1.00[6]	1.03	1.01	1.03	1.06
Columbia	2.92	3.05	3.26	3.47	3.55	3.76	3.69	3.69	3.79	3.60	3.55
Crawford	2.83	2.95	2.87	3.02	3.04	2.98	2.85	2.78	2.68	2.43	2.55
Cumberland	1.05	1.11/1.00	1.00	1.14	1.22	1.26	1.26	1.25	1.00	1.00	0.97
Dauphin	1.07	1.14	1.24	1.33	1.40	1.46	1.42	1.42	1.36	1.38	1.31
Delaware	1.15	1.26	1.38	1.55	1.64	1.72	1.63	1.56	1.48	1.39	1.35
Elk	5.00	5.05	5.26/2.18	2.18	2.65	2.49	2.61	2.52	2.36	2.16	2.06
Erie	1.00*	1.09	1.13	1.18	1.20	1.21	1.26	1.22	1.18	1.18/1.00[10]	1.00
Fayette	1.00*	1.03	1.10	1.14	1.17	1.17	1.22	1.23	1.21	1.25	1.23
Forest	4.72	4.74	4.37	4.83	5.21	4.20	5.10	4.26	3.73	3.56	3.35
Franklin	6.45	6.90	7.69	9.35	10.20	9.62	8.62	8.13	7.63	7.04	6.80
Fulton	1.97	1.98	2.20	2.61	2.99	2.99	3.00	3.44	2.85	2.56	2.46
Greene	1.00*	1.13	1.21	1.21	1.16	1.24	1.40	1.18	1.20	1.35	1.41
Huntingdon	5.99	6.29	6.80	7.46	7.87	8.62	8.27	7.58	7.19	3.72/3.46[12]	3.46
Indiana	7.09	7.30	7.69/4.35	4.35	6.17	5.95	5.99	5.68	5.21	5.62	5.05
Jefferson	5.08	5.32/1.74	1.74	1.85	1.87	2.05	1.97	1.86	1.85	1.92	2.08
Juniata	5.69	5.65	6.41	6.21	6.25	6.33	6.90	5.88	4.74	5.43	5.35
Lackawanna	4.70	5.21	5.38	5.95	7.09	6.67	6.17	5.88	5.49	5.18	5.00
Lancaster	1.16	1.22/1.00	1.00	1.22	1.31	1.36	1.35	1.33	1.31	1.27	1.24
Lawrence	1.00	1.08	1.10	1.14	1.14	1.12	1.19[7]	1.18	1.05	1.03	1.03
Lebanon	11.91	12.20/6.25	6.25	6.80	7.35	7.41	7.46	7.04	6.33	6.14/1.00[10]	1.00
Lehigh	2.24	2.45	2.73	3.16	3.58	3.70	3.50	3.11	2.80	2.81/1.00[10]	1.00
Luzerne	13.89	14.71	15.39	17.24	20	20.83/1.00[5]	1.00[6]	1.00	1.00	0.91	0.91
Lycoming	1.52	1.60/1.00	1.00	1.10	1.16	1.25	1.19	1.21	1.21	1.25	1.26
McKean	4.41	4.44/1.06	1.06	1.09	1.11	1.13	1.31	1.18	1.16	1.11	1.09
Mercer	3.64	3.50	3.56	3.68	3.66	3.52	3.26	2.92	2.89	2.77	2.78
Mifflin	1.96	2.03	2.09	2.18	2.20	2.29	2.15	2.12	1.91	1.80	1.96
Monroe	4.95	5.59	6.14	7.09	7.81	7.81	7.41	6.33	5.95	5.15	4.55
Montgomery	1.30	1.46	1.66	1.87	1.97	1.97	1.85	1.78	1.72	1.61	1.58
Montour	10.31	11.36/8.82	8.82/1.00	1.00	1.14	1.18	1.37	1.23	1.23	1.16	1.20
Northampton	2.35	2.55	2.75	3.18	3.44	3.61	3.37	3.14	2.98	2.67	2.64
Northumberland	7.19	7.46/4.07	4.07	3.64	4.53	4.61	4.43	4.12	3.62	3.58	3.60
Perry	1.07	1.10	1.16	1.33	1.36	1.49	1.49	1.44	1.00	1.00	1.09
Philadelphia	3.39	3.66[1]	3.37	3.50	3.52	3.55	3.06	3.13	3.97[9]	3.27[11]	3.27[13]
Pike	4.10	4.41	4.76	5.47	6.17	6.17	5.85	4.90	4.67	4.05	3.88
Potter	2.38	2.37	2.53	2.72	2.80	2.86	2.91	2.55	3.21	2.73	2.52
Schuylkill	2.22	2.32	2.42	2.48	2.62	2.68	2.51	2.40	2.11	2.15	2.02
Snyder	5.71	6.10	6.29	6.58	5.32[2]	5.05	5.68	5.03	5.56	4.83	5.08
Somerset	2.34	2.47	2.63	2.71	2.91	2.98	2.99	2.81	2.51	2.45	2.57
Sullivan	4.10/1.00	1.00	1.19	1.52	1.40	1.55	1.66	1.48	1.44	1.54	1.43
Susquehanna	2.21	2.42	2.56	2.84	2.96	2.97	3.06	2.92	2.82	3.06	2.94
Tioga	1.06	1.11	1.18	1.25	1.33	1.37	1.41	1.36	1.36	1.36	1.49
Union	6.17	6.17	6.85/1.00	1.00	1.13	1.16	1.34	1.29	1.29	1.20	1.25
Venango	1.06	1.09/1.00	1.00	1.05	1.13	1.06[3]	1.10	1.07	1.11	1.06	1.06
Warren	2.70	2.72	2.81	2.93	2.93	2.96	2.89	2.94	2.89	2.80	3.02
Washington	6.17	6.49	6.94	7.30	7.52	7.58	7.25	5.71	4.69	6.80	7.87
Wayne	10.99	12.20/1.00	1.00	1.23	1.32	1.37	1.56	1.39	1.25	1.19	1.13
Westmoreland	4.51	4.74	4.88	5.10	5.05	4.90	4.57	4.33	4.20	4.41	4.67
Wyoming	3.97	4.22	4.39	4.59	4.95	5.03	4.76	4.57	5.08	5.00	4.93
York	1.17	1.24	1.33/1.00	1.00	1.31	1.32	1.27	1.25	1.19	1.16	1.12

[1] Revised based on State Tax Equalization Board appeal decision, 35 Pa.B. 1308.

[2] Adjusted by the Department of Revenue to reflect assessment ratio change effective January 1, 2007.

[3] Revised by the State Tax Equalization Board, 38 Pa.B. 3563 (6/28/2008).

[4] Adjustments made by the Department of Revenue to reflect an assessment base change or assessment ratio change, 38 Pa.B. 6667.

[5] Adjustment made by the Department of Revenue to reflect an assessment base change or assessment ratio change, 39 Pa.B. 1365 (3/14/2009).

[6] Adjusted by the Department of Revenue to reflect an assessment base change or assessment ratio change effective 1/1/2009, 39 Pa.B. 3245 (6/27/2009).

[7] Adjusted by the Department of Revenue based on a Board’s decision effective August 18, 2009, retroactive to July 1, 2009, 39 Pa.B. 5373 (9/12/2009).

[8] Adjusted by the Department of Revenue to reflect an assessment base change or assessment ratio change effective 1/1/2010, 39 Pa.B. 7163 (12/19/2009).

[9] Adjusted by the Department of Revenue to based on a State Tax Equalization Board decision effective 4/21/12, retroactive to 7/1/2011, 42 Pa.B. 2866 (5/19/2012).

[10] Adjusted by the Department of Revenue to reflect an assessment base change effective 1/1/2013, 43 Pa.B. 106 (1/5/2013) and 43 Pa.B. 942 (2/9/2013).

[11] Adjusted by the Department of Revenue based on an updated common level ratio published by STEB at 43 Pa.B. 122, effective 7/1/2012, 43 Pa.B. 942 (2/9/2013).

[12] Adjusted by the State Tax Equalization Board to reflect an assessment ratio change effective January 1, 2013.

[13] Adjusted by the Department of Revenue based on updated common level ratio published by STEB in the Pennsylvania Bulletin January 5, 2013 (43 PaB. 106); effective for documents accepted from July 1, 2012 to June 30, 2013. The 2012 common level ratio is still to be determined by STEB; therefore, the factor shown above will remain effective until STEB certifies the 2012 factor.

Is the Pennsylvania Personal Property Tax Constitutional?

By Daniel B. Evans
Copyright © 1996-1998 Daniel B. Evans. All rights reserved.

[First published 4/10/96; last revised 10/10/98]

Is the Pennsylvania personal property tax constitutional?

No, according to Judge Smyth of the Court of Common Pleas of Montgomery County, but his recently published conclusions of fact and law, Interim Report, Annenberg v. Com. of Pennsylvania, Montg. C.P. No. 98-08615, Sup.Ct. Misc. Nos. 003 and 004 of 1997 (Oct. 7, 1998), may not provide any relief to any taxpayers in Pennsylvania.

The issue of the constitutionality of the personal property tax arose out of the decision of the United States Supreme Court in Fulton Corp. v. Faulkner, 516 U.S. 324 (1996), in which the Supreme Court found that a similar tax in North Carolina was unconstitutional as a violation of the Commerce Clause of the U.S. Constitution because it discriminated between the stock of corporations that did business in North Carolina (and paid North Carolina taxes) and corporations that did no business, the tax falling on the stock of the out-of-state corporations. Shortly afterwards, several residents of Pennsylvania (including Walter H. Annenberg) sued for refunds of the Pennsylvania personal property tax, relying on a statute in Pennsylvania allowing actions for refunds on taxes paid to counties (and other political subdivisions) within the preceding three years if the county was not “legally entitled” to the tax.

In an order issued April 7, 1998, the Pennsylvania Supreme Court agreed that the personal property tax is facially discriminatory, and remanded the issue to a trial court for hearings and a determination on whether the tax was “compensatory” and constitutional, or unconstitutional and, if unconstitutional, what remedy is appropriate for taxpayers who have paid the tax or have been billed for the tax. Annenberg v. Commonwealth, et al., Slip Opinion J-109-1997 (Pa. Supreme Court, 4/7/98). The hearings were held in Montgomery County before President Judge Joseph A. Smyth, who determined that the tax is not “compensatory” but that the exclusion for stock of Pennsylvania corporations could be severed from the rest of the tax, and that it was the exclusion that was unconstitutional, not the tax itself.

If adopted by the Pennsylvania Supreme Court, Judge Smyth’s determinations will probably mean that there will be no refunds for taxpayers, and that the counties may collect a personal property tax on all stocks, both of Pennsylvania corporations and of corporations operating outside of Pennsylvania.

What is the Pennsylvania Personal Property Tax?

The “personal property tax” is a tax on various forms of intangible personal property, such as stocks, bonds, and certain other forms of indebtedness. There are a number of exemptions, including an exemption for the stock of corporations which are subject to the Pennsylvania capital stock tax or franchise tax. Act of June 17, 1913, P.L. 507, §1. It is that exemption that causes the constitutional problem.

What is the Commerce Clause?

Article I, Section 8, clause 3, of the Constitution of the United States gives Congress the power to “regulate Commerce … among the several States….” That provision has long been interpreted as both giving power to Congress and restricting the power of the states. Congress has the power to regulate businesses and business activities that affect more than one state, and states are prohibited from enacting legislation that restricts or burdens commerce that crosses their borders from another states. As a result, a state cannot impose a tax that falls more heavily on businesses from another state than on businesses within the state.

The Fulton Decision

In Fulton Corp. v. Faulkner, 516 U.S. 324 (1996), the U.S. Supreme Court was asked to review the constitutionality of the North Carolina personal property tax. Like Pennsylvania, North Carolina taxed corporate stock, and distinguished between corporations already paying taxes to the state and those not paying any taxes. Under the North Carolina system, a corporation paid corporate income tax on that portion of it’s income attributable to operations in North Carolina. The stock of the corporation was then subject to personal property tax in the hands of the shareholders in the same percentage that the income of the corporation was not subject to income tax in the state. So the stock of corporation which operated entirely within North Carolina was not subject to the personal property tax, while the stock of a corporation which did not earn any income at all in North Carolina was entirely subject to the personal property tax. If a corporation earned 5% of its income in North Carolina, then 95% of the value of the stock was subject to personal property tax.

The Supreme Court recognized that the tax discriminated between corporations that operated within the state and corporations that did not operate within the state. However, it also recognized that a tax may be applied to interstate commerce if the tax is “compensatory” and simply makes interstate commerce bear a tax burden already borne by commerce within the state. The classic example of a “compensatory” tax is a “use” tax imposed on personal property purchased outside of the state and brought into the state to be used there. A use tax that is equal to the sales tax already imposed by the state has been held to be constitutional because the consumer pays the same tax in each case, either at the time of purchase within the state or at the time the property is brought into the state from another state.

Based on earlier decisions, the Supreme Court declared that there were three conditions that a discriminatory tax must satisfy in order to be constitutional:

1. The state must identify the tax burden within the state for which the state is attempting to compensate;
2. The tax on interstate commerce must roughly approximate the tax on commerce within the state; and
3. The taxable events must be “substantially equivalent” for the interstate and intrastate taxes.

Applying those tests to the North Carolina tax, the court unanimously found that the tax failed all three tests.

Applying Fulton to Pennsylvania

The similarities between the North Carolina personal property tax and the Pennsylvania personal property tax suggest that the Supreme Court would hold that the Pennsylvania tax is unconstitutional as well. A review of the opinion of the court, and the discussions of why the North Carolina tax failed the three part test described above, shows that the Pennsylvania tax is no more constitutional than the North Carolina tax, and may be less constitutional.

• When comparing the intrastate tax for which the interstate tax is supposed to compensate, the court held that the intrastate tax must serve a purpose for which the state may impose a burden on interstate commerce. North Carolina claimed that the tax on the value of corporate stock compensated the state for the income tax it could not collect on out- of-state income. However, the court held that North Carolina had no right to tax incomes earned outside of the state. Pennsylvania personal property tax appears to be linked to the capital stock tax or franchise tax. The capital stock tax is a property tax on domestic entities, and the franchise tax is a privilege tax on foreign organizations doing business in Pennsylvania. However, both taxes are calculated in the same way, based on a series of formulas that calculate stock values from net worth and net income, then apportion the value between activities in Pennsylvania and activities outside of Pennsylvania. Like North Carolina, Pennsylvania has no right to tax property outside of Pennsylvania or the privilege of doing business outside of Pennsylvania, so the personal property tax on the stock of corporations doing business outside of Pennsylvania does not serve a purpose for which the state may impose a burden on interstate commerce.North Carolina attempted to justify the personal property tax on the grounds that the tax was a payment for the privilege of access to the capital markets of the state, which other corporations supported through payment of the corporate income tax, but Supreme Court rejected that argument, quoting from Oregon Waste Systems, Inc. v. Department of Environmental Quality of Ore., 511 U.S. ___ , ___ (slip opinion at 13, n. 8), (1994), holding that “(p)ermitting discriminatory taxes on interstate commerce to compensate for charges purportedly included in general forms of intrastate taxation would allow a state to tax interstate commerce more heavily than in-state commerce anytime the entities involved in interstate commerce happened to use facilities supported by general tax funds.” There is no reason to believe that Pennsylvania could distinguish itself from North Carolina on this issue, or advance a more convincing argument.

   

   

• The Supreme Court also held that North Carolina had failed to show that the tax on interstate commerce be shown “roughly to approximate” the tax on intrastate commerce. Although North Carolina attempted to show that the personal property tax burden might be similar to the corporate income tax burden, the Supreme Court rejected the argument as a comparison of “apples to oranges,” because a corporate income tax supports a wide range of government services, while the personal property tax was supposedly imposed to support capital markets in North Carolina, and the court held that North Carolina could not carry its burden of proving what proportion of the corporate income tax goes to support the capital market, or whether that proportion represents a burden greater than the one imposed on interstate commerce by the intangibles tax. Pennsylvania would have an even greater burden of proof, because the North Carolina personal property tax was at least proportionate to the income of the corporation outside of the state, while the stock of a corporation that is “subject” to the capital stock or franchise tax to Pennsylvania is wholly exempt from the Pennsylvania personal property tax even though the corporation pays little or no tax to Pennsylvania. For example, a foreign corporation that conducts a small percentage of its business in Pennsylvania will pay a franchise tax on a small percentage of its income and net worth, yet its stock will be entirely exempt from Pennsylvania personal property tax. However, the personal property tax will apply in full to the stock of an otherwise identical corporation with no operations in Pennsylvania. Within this statutory framework, it will be impossible for Pennsylvania to show any equivalence between the capital stock/franchise tax burden and the personal property tax burden. 
• Finally, the Supreme Court held that the North Carolina personal property tax and corporate income tax did not fall on events that were “substantially equivalent,” despite evidence that net income and stock values were closely related, because the taxes were “apparently different in a number of obvious respects, including the parties ostensibly taxed.” North Carolina tried to argue that a tax on shareholders could be equivalent to a tax on a corporation, but the court was not convinced, and expressed doubt that any such showing could ever be made outside the limited confines of sales and use taxes. Pennsylvania would have the same difficulties in claiming that the personal property tax and the capital stock/franchise tax are “substantially equivalent” because, like North Carolina’s taxes, the two taxes fall on different taxpayers. There are other differences between Pennsylvania’s taxes that could cause even greater problems. For example, there is a manufacturing exemption for the capital stock/franchise tax in Pennsylvania, but no equivalent exemption for the personal property tax. A corporation that derives all of its income from manufacturing in Pennsylvania would pay no capital stock/franchise tax in Pennsylvania, and its shareholders would pay no personal property tax. However, the personal property tax would apply to the shareholders of a corporation with the same manufacturing operations entirely outside of Pennsylvania. The capital stock/franchise tax and the personal property tax are simply too different to be considered “substantially equivalent.”

There is, therefore, no reason to believe that Pennsylvania’s personal property tax is distinguishable from the North Carolina tax (at least not in ways that are helpful to Pennsylvania), and every reason to believe that Pennsylvania’s personal property tax is unconstitutional.

Judge Smyth’s Determinations

In the hearing before Judge Smyth, the counties of Pennsylvania that had been imposing the personal property tax attempted to prove that the tax was “compensatory,” meaning that the tax on the stock of corporations not doing business in Pennsylvania was roughly equivalent to the capital stock or franchise tax paid by corporations doing business in Pennsylvania. In his recently published Interim Report, Judge Smyth concluded that the Pennsylvania personal property tax was not “compensatory,” because the capital stock and franchise was not part of a comprehensive scheme of taxing corporations, it does not roughly approximate the personal property tax, and imposes a tax based on “events” that are not similar to the personal property tax.

In its 4/7/98 opinion and order, the Pennsylvania Supreme Court concluded that the personal property tax was discriminatory and unconstitutional unless it was “compensatory,” and Judge Smyth concluded that the tax was not “compensatory.” However, Judge Smyth also concluded that it was not the tax that was unconstitutional, but the exclusion from tax of the stock of corporations not doing business in Pennsylvania. There is a general law that declares that the provisions of statutes in Pennsylvania are “severable.” See 1 Pa.C.S. § 1925. This means that, if a provision of a statute is invalid for any reason, only that one provision should be invalid, and not the entire statute, unless the entire statute cannot (or was not intended to) exist without the invalid provision. In this case, Judge Smyth found that the personal property tax existed in Pennsylvania for more than 50 years without the exemption for the stock of corporations that are subject to the capital stock or franchise tax (i.e., corporations doing business in Pennsylvania), and so the tax could exist without the exemption. Judge Smyth also concluded that the Pennsylvania legislature would have enacted the tax without the exemption if it had known that the exemption was invalid. (Interim Report, page 25.)

What does Judge Smyth’s Decision Mean?

If the personal property tax itself is constitutional and only the exclusion is constitutional, does that mean that the counties not only don’t need to refund any money, but can now go back and collect additional taxes on the value of stocks of Pennsylvania corporations and corporations doing business in Pennsylvania? Not according to Judge Smyth, who said the ruling should operate “prospectively only,” and that the counties can collect a personal property tax on stock of domestic corporations only after adopting new tax resolutions or ordinances.

This portion of Judge Smyth’s report, dealing with the remedies of taxpayers and the powers of the counties, is the most troubling. Judge Smyth concludes that “Since the exclusions are unconstitutional, leaving a valid tax, counties should be permitted to retain and collect the personal property tax on stock that is not subject to the capital stock or franchise taxes.” (Interim Report, page 26.) In other words, counties can keep the money already collected and can even continue to collect the tax. By why? Why are the counties allowed to retain monies collected under a tax system that is admittedly unconstitutional? Even more puzzling is why counties can continue to collect a tax imposed under an unconstitutional system. The only explanation provided by Judge Smyth is that counties and taxpayers “have planned their financial affairs” on the assumption that the tax was constitutional. (Interim Report, page 26.) Is that it? The fact that the Constitution has been violated, and continues to be violated, is all right because the counties had relied on it? Despite the legal and logical flaws in Judge Smyth’s opinion, it is quite likely that the report will be adopted by the Supreme Court of Pennsylvania, and quite likely that the Supreme Court of the United States will not hear any appeal on this dispute.

What Should You Do?

Although it is likely that there will be no refunds of Pennsylvania personal property tax, taxpayers who want to preserve the possibility of a refund must find a claim for a refund, because the present action by Walter H. Annenberg, even if ultimately successful, will not eliminate the need for each taxpayer to file a separate refund claim, and will not stop the statute of limitations from running on refund claims.

In order to obtain a refund of personal property tax to which a county or other political subdivision is not entitled, the taxpayer must file a written claim for refund within three years after the tax is paid. Act of May 21, 1943, P.L. 349, § 1, as amended, 72 P.S. § 5566b. Therefore, if you have paid any personal property tax within the last three years, you can file a refund claim before the end of the three year period.

Taxpayers who did not pay the personal property tax and are now facing collection efforts by the counties also face a difficult choice. It is possible that the Pennsylvania Supreme Court might distinguish between refund claims for past taxes and collection actions, holding that the counties do not need to pay refunds but cannot force a taxpayer to pay a tax that is admittedly unconstitutional, but it is more likely that the Supreme Court will follow the lead of Judge Smyth and agree that the counties may continue to collect the tax for past years. In that case, continuing to delay payment may result in nothing more than additional interest (and possible penalties).