Taxation in Israel - myths and facts

Adrian Filut

It is already important to make clear: raising VAT, the main indirect tax, by 1 percentage point is a fait accompli.

1. After Prime Minister Benjamin Netanyahu and Minister of Finance Yuval Steinitz were persuaded that there was no choice but to raise taxes, their moment of truth arrived: a decision about which taxes to raise. This question requires an immediate answer, and the public debate is heading in that direction. In the best tradition, populist proposals are percolating to the surface which sound wonderful, but which will cause further damage, or will miss their objective.

It is already important to make clear: raising VAT, the main indirect tax, by 1 percentage point is a fait accompli, and Netanyahu and Steinitz had better implement it as soon as possible, in order to top up the state's dwindling coffers now, and minimize future tax hikes. The only problem is that this tax hike is not enough (generating about NIS 4 billion of the at least NIS 12 billion needed), so there is no choice but to raise direct taxes.

2. One proposal coming from the social protest leaders, and which has the support of quite a few MKs: raise taxes on the rich. The proposal is just, but impossible to implement. According to Ministry of Finance figures, raising the income tax on the top income bracket (people earning more than NIS 42,000 a month) by 1 percentage point, will generate NIS 180 million at best.

Therefore, if the Ministry of Finance needs to raise at least NIS 4 billion in direct taxes, it will have to raise the tax rate for this bracket by 20 percentage points. This would quickly bring the marginal tax rate (income tax, plus health tax, plus national insurance levies) to 80%, wiping out disposable income and eliminating demand (and the economy), and the actual tax collection will be close to zero (tax planning and avoidance).

There is a similar idea, called the surtax (a tax on people who earn more than NIS 2 million a year from capital and labor combined), which is supposed to generate NIS 200-400 million in revenues a year. In this case, it would be necessary to levy a tax rate of 20%, not the 2% proposed by the Trajtenberg Committee, to cover part of the hole - a situation that is wholly undesirable. Therefore, the proposal is just, but far from sufficient.

3. An equally populist idea was made last week by top financiers who previously served in key positions at the Ministry of Finance: avoid direct tax hikes altogether. There were several explanations for this argument. A former accountant general said, "The tax burden in Israel is too high."

The facts tell another story. According to the latest State Revenues Administration report, as of 2008, Israel was ranked 13th among the 31 OECD members states in its tax burden as a percentage of GDP. In other words, 18 countries have a higher tax burden.

Moreover, direct taxes in Israel are among the lowest in the OECD, at 17.5% of GDP, compared with the OECD average of 22.3%. Another claim is related to the economic theory which Netanyahu adheres to, which says that raising direct taxes on individuals will wipe out consumption and investment (savings) and will not generate even one shekel in extra tax revenues.

There is no doubt that raising taxes has a negative effect on disposable income, and as a function of that, on individual consumption and investment. However, the tax rates on individuals could return to their levels of 2006 or 2007 - similar to the levels in the OECD - years in which Israel had record growth rates in excess of 5%, and money flowed into the Treasury with no problem. By the way, not raising taxes means a budget deficit of 4.5% of GDP, in other words, a financial crisis.

4. There is an initiative to raise the companies tax. First, each 1% of the companies tax generates just NIS 700 million. This is little money compared with the size of the whole. To make the measure meaningful, the companies tax would have to be raised by at least 4-5 percentage points to 30%. This is already a problem, because in addition to the tax hike already made as part of the Trajtenberg recommendations, countries compete against each other to provide a light tax environment to attract companies and investors. For companies that plan their tax environment several years in advance, this is a death blow, as well a blow to Israel's credibility. A companies tax at this level means a strong probability of not seeing even one shekel in revenues, and thus the size of the blow to the economy.

5. Consequently, there is no choice but to raise the income tax on individuals - on everyone, at every tax bracket. The Ministry of Finance is beginning to move in this direction. Each income tax point will generate NIS 3 billion in revenues. But here is where another myth crops up: raising the individual income tax for all tax brackets is regressive (benefits the rich and hurts the poor).

Firstly, Israel's direct tax system is one of the most progressive in the OECD, including Scandinavia. The reason is simple: most Israelis don’t reach the tax threshold, so already the "rich" already pay most taxes.

According to Ministry of Finance figures, 44% of salaried employees belong to the first tax bracket, which includes the bottom 30%. Raising the income tax rate by 1 percentage point hypothetically means a net reduction of NIS 52 at most (1% of NIS 5,200), a negligible amount. In the case of parents, the credit points obtained under the Trajtenberg recommendations will equal the reduction. Therefore, the statement that raising income taxes mainly hurts the poor is a myth and is not true.

6. If we move on to the second tax bracket, which includes 24% of salaried employees, who belong to the middle 40%, the tax hike will add an additional average payment of NIS 70. Here too, parents will barely feel the weight.

More importantly, notwithstanding everything, the bulk of the burden will fall on the top 40% (the last three tax brackets) - not just proportionately, but completely. They will be the ones who will pay all (or most) of the additional tax at each tax bracket. Another point: raising income taxes, even by 2 percentage points, will return the tax levels to what they were in 2008, which are completely reasonable tax levels.

7. A small comment to Ministry of Finance officials: to fully block the budget hole, you are depending on eliminating loopholes. Eliminating loopholes means going to war against the army and the defense minister, against the strong unions, and the chairman of the Histadrut (General Federation of Labor in Israel). In other words, heroism, courage, and leadership are needed - characteristics that Netanyahu and Steinitz have not shown for a long time. Therefore, to avoid the myth of eliminating loopholes, the Ministry of Finance and the Bank of Israel had better consider new alternatives.

Published by Globes [online], Israel business news - - on July 2, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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