Prime Minister Benjamin Netanyahu is supporting lower income tax rates for employees in the NIS 20,000-30,000 tax bracket. The initiative is unrelated to the issue of how to use the tax revenue surplus; it is part of a measure designed to increase the competitiveness of the Israeli economy versus other markets, especially the US. Underlying the plan is concern that many people in this tax bracket who work in the high-tech sector will consider emigration to the US, because the tax burden there is substantially lighter than in Israel.
The initiative has not yet been presented to the Bank of Israel, but can be predicted that the Bank of Israel will strongly oppose it. First of all, the Bank of Israel believes that taxes should be raised, not cut - a view that received unusual support late last week from the International Monetary Fund (IMF). Secondly, and more specifically, the initiative runs counter to the view of the most senior economist at the Bank of Israel, who last year published a study that found that cutting taxes has a minimal effect on the tendency of high-tech employees to emigrate from Israel.
The initiative followed a probe by the National Economic Council, headed by Prof. Avi Simhon, which found that 40% of those earning NIS 20,000-30,000 a month are engineers, a profession identified with the Israeli high-tech industry. This sector, which accounts for 9% of Israeli wage earners, is responsible for 38% of all income tax payments and a third of national insurance and health tax payments.
According to the current tax brackets, a person earning NIS 19,901-41,410 pays a 35% marginal tax rate. When combined with 7% national insurance payment and 5% health tax, a taxpayer earning NIS 20,000 pays almost 48% of his or her income in taxes. In other words, the taxpayer pays half of every additional shekel earned in taxes.
This burden is substantially higher than the tax burden on people with similar salaries in the US; the National Economic Council probe found that their tax burden is only 28%. The high-tech sector has been regarded as the economy's main growth engine in recent years, responsible for Israel's economic miracle, reflected in relatively high growth rates, large-scale foreign currency revenue (as a result of successful exits and deals like this year's acquisition of Mobileye, among other things), and the economy's good performance in recent years.
The initiative's supporters argue that cutting taxes is necessary in order to preserve the Israeli economy's competitiveness and encourage growth. They assert that cutting taxes will increase growth, thereby paying for itself and more in increased tax revenues.
A study by recently appointed Bank of Israel Research Department director Prof. Michel Strawczynski, however, refutes the main thesis of the initiative's supporters. His study, conducted together with Tel Aviv University Prof. Yoram Margolioth and Tomer Blumkin of Ben-Gurion University of the Negev, with support from the Tel Aviv University Pinhas Sapir Center, examined how the tax cuts in Israel in the first years of the 21st century affected emigration from Israel, with an emphasis on preventing brain drain.
The study shows that cutting taxes did reduce emigration from Israel, and that a bigger cut persuaded more people to remain in Israel. The researchers found, however, that the cost of reducing emigration from Israel by cutting taxes was far lower for low-tech employees than for high-tech employees.
According to the findings, tax cuts for low-tech employees have 10 times as much effect in preventing emigration from Israel than tax cuts for high-tech employees. "In order to achieve a similar result among high-tech employees, the tax cut needed is far more 'expensive' from a governmental standpoint," Strawczynski wrote in a "Globes" article.
In order to highlight the figures, a NIS 1,000 tax hike increases emigration from Israel by low-tech employees by 150%, compared with only 14% among high-tech wage earners.
Since the study was conducted, the salaries of high-tech employees have continued to grow rapidly, and salary gaps have widened. According to Central Bureau of Statistics figures, the salaries of high-tech employees have risen at the fastest pace of any economic sector. Since 2011, the salary of employees in communications and information jobs (in which the high-tech professions are included) have gone up by over 35%, compared with 7% for financial services employees and 10.6% for real estate sector employees.
In addition to its specific opposition to tax cuts for high-tech employees, the Bank of Israel is expected to opposed an income tax cut in principle. The Bank of Israel frequently expressed view on this question was recently supported by the IMF. An IMF position paper published yesterday ahead of its annual conference in Washington stated, "There is no strong empirical evidence showing that progressivity has been harmful for growth."
The document reveals that the top tax rates in advanced economies fell from 62% in 1981 to 35% in 2015. "Advanced economies with relatively low levels of progressivity in their personal income tax (PIT) may therefore have scope for raising the top marginal tax rates without hampering economic growth," the IMF writes, adding, "An alternative, or complement, to capital income taxation for economies seeking more progressive taxation is to tax wealth… Adequate taxation of capital income is needed to protect the overall progressivity of the income tax system by reducing incentives to reclassify labor income as capital income and through a more uniform treatment of different types of capital income."
Published by Globes [online], Israel Business News - www.globes-online.com - on October 15, 2017
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