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PDF FormatThis claim, however, falls apart as soon as one compares labor taxes in Israel and in the OECD nations—a group whose two dozen members include most of the European states. Consider, for example, the textbook case of a married man with two children, whose gross salary is equal to the per capita GDP in his country (that is, roughly average for that country). According to a study by Adi Brender of the Bank of Israel’s Research Division, such a worker in Israel paid a marginal tax rate of 40 percent in 2002—a full 26 percentage points more than was paid by his counterpart in Germany, 14 points more than in France, 10 points more than in Norway, and 7 points more than in Sweden. Similarly, an Israeli whose income is twice the national average is taxed at 55 percent, a rate exceeded only by two Western countries, Denmark and Belgium.
But even this analysis downplays the degree to which the Israeli tax burden is high. For starters, taxation in the leading welfare states of Europe includes substantial set-asides for pensions, whereas Israeli workers have to fund their own pensions. Taxes in many European countries also fund crucial services for which Israelis must pay extra: In Sweden, for example, education is free of charge, whereas Israeli parents have to pay for school supplies, books, field trips, and “supplemental” classes for their elementary, middle, and high school-age children. Swedish university studies are likewise covered by the government, whereas college-bound Israelis have to foot the bill for tuition, room, and board.
Given all this, it is hard to escape the conclusion that Israelis are among the most highly taxed people in the Western world. And when it comes to the middle class—upon whom any hope of sustained economic growth ultimately depends—Israel may well have the most onerous taxes anywhere.
The devastation caused by Israel’s tax burden plays itself out in a long string of disincentives that quash economic activity at every turn. High taxes on labor undermine the individual’s incentive to work harder, while discouraging employers—who typically must give the government one dollar for every dollar they add to the net income of an employee—from promoting workers or hiring new ones. These same taxes also stifle capital development, since they leave Israelis with little disposable income to save or invest. And, by raising the expenses of companies both for labor and for the procurement of goods and services, high taxes are a formidable obstacle to Israel’s competitiveness internationally.
All this is bad enough, but it may not be the worst of it. High taxes dramatically increase the incentive to cheat, as anyone who has ridden in Israeli taxis quickly discovers. The reason the meter is typically “broken” is that cab drivers prefer not to run it, as it produces an official record that will be used for calculating income tax and VAT payments. In the same way, Israeli teachers often supplement their income by teaching private lessons after school hours, for which parents pay with personal checks on which the payee line is left blank. Virtually the entire industry of home additions and repairs likewise operates on a cash basis, which entails the creation of “unofficial” receipts given to the customer, but not to tax authorities. The prevalence of illegal economic activity, driven in large part by exorbitant tax rates, turns hundreds of thousands of otherwise law-abiding citizens—most of whom unhesitatingly leave their families to serve their country in army reserve duty—into tax cheats, accustomed to duplicity in their economic transactions.
But perhaps the worst result is that Jews from Western countries are deterred from moving to Israel, while many Israelis—including some of the country’s most skilled workers and entrepreneurs—are driven to emigrate. Statistics in this area are notoriously difficult to obtain, but anyone familiar with California’s Silicon Valley or Boston’s Route 128 high-tech belt knows what an extraordinary price Israel has already paid, and continues to pay, in economically motivated Jewish emigration. But there is nothing surprising here. As Alan Reynolds of the Hudson Institute points out, “Although good tax policy alone does not ensure a good economy, world history offers no examples of economies that prospered with punitive tax rates…. Just as so-called ‘tax havens’ attract investment and skilled immigrants, countries with punitive tax systems face chronic capital flight and brain drain.”
Instead of encouraging Jews to come to Israel and take part in the ongoing effort to build a Jewish state, the current tax regime creates every possible incentive for Israelis to leave. As such, it is nothing less than a threat to the success of the Zionist enterprise.
Israel must make deep cuts in the national budget, and the government, led by Finance Minister Netanyahu, deserves praise for facing this necessity head on. But that is not enough. Israel’s leaders must come to grips with the fact that high taxes also bear a large share of the blame for the current crisis. A comprehensive effort to introduce broad-based reductions in taxes must be viewed not only as one element within the government’s efforts to get the economy back on track, but as perhaps the most crucial vehicle for fueling desperately needed growth.
Judged from this perspective, the income tax reform introduced by the government in 2002 and accelerated in the new emergency plan is hardly sufficient. At the end of the proposed reform in 2005, a worker earning $13,200 will still be saddled with a marginal tax rate of 36 percent, while a 47-percent rate will be levied as soon as a person’s salary reaches $47,200. Israelis will likewise see no reduction in the 18-percent across-the-board VAT, or in the bewildering array of other taxes that raise their cost of living substantially. Rather than offering a strategic change, the current plan would leave what is probably the economy’s worst problem largely intact.
A far deeper series of tax cuts is needed, but the possibility of even considering such a step has thus far been precluded by the widespread concern that Israel cannot afford them when it is grappling with high deficits, negative growth, and unemployment. In this light, it is instructive to consider three recent cases in which Western nations facing similar problems responded with substantial tax cuts, and achieved stunning results.
Shortly after Margaret Thatcher became prime minister in 1979, the British economy entered a deep recession, in which growth was negative for two straight years. Inflation reached 16 percent, unemployment climbed above 10 percent, and the government deficit consistently approached 3 percent of GDP. One leading cause for the stagnation was a minimum, “basic” tax rate of 40 percent (including national insurance taxes), coupled with a series of increasingly onerous tax brackets that culminated in a top rate of 83 percent. Within the next decade, Thatcher’s government reduced the basic rate to 33 percent, and cut the top tax rate in half, to 40 percent. In the ensuing years, Britain’s economy surged: Growth reached 4 percent annually, inflation shrank to 5 percent, and by the end of the 1980s, the government even succeeded in running a budget surplus.
When Ronald Reagan became president in 1981, the United States was suffering from what was popularly known as “stagflation,” a devastating combination of 13-percent inflation and 7-percent unemployment. Tax rates were high and climbing at almost all levels of income, and the top rate was 70 percent. In response, Reagan and the Congress slashed tax rates by a quarter across the board during the next three years, and ultimately cut the top rate in half, to 35 percent.In the ensuing six years, tax revenues, which skeptics claimed would drop precipitously, rose by $375 billion. During these same years, an estimated 20 million new jobs were created, and the standard of living of Americans at every income level rose. These tax cuts set the stage for 20 years of virtually uninterrupted growth, in which the U.S. economy expanded by more than a third, increasing the net worth of Americans by $15 trillion.
The same lessons come through even more clearly in the case of New Zealand. In the 1950s, this small nation was one of the five wealthiest in the world, but by the early 1980s its standard of living had fallen to nearly the bottom of the OECD. Economic growth was negligible, unemployment rose from almost nothing to 5 percent, and the budget deficit reached an astounding 9 percent of GDP. The government, under Prime Minister David Lange, began a series of sweeping reforms in 1984, which included not only deep spending cuts and a massive privatization effort, but also radical reductions in income taxes—including a halving of the top rate from 66 percent to 33 percent. Within a number of years, economic growth accelerated to a steady 5 percent, and in less than a decade the government ran a budget surplus of 4 percent of GDP. By the mid-1990s, New Zealand was ranked by the OECD as one of the ten most competitive economies in the world, and was likewise among world leaders in its standard of living.
Though success can never be guaranteed, there is good reason to believe that Israel’s economy can resume a pattern of growth if its government, too, recognizes the importance of cutting taxes broadly. Of course, as with any radical measure, it can always be argued that the timing is not right, and that Israel should first take smaller steps to end its current crisis. But this approach is mistaken: Tax cuts are in fact one of the best means for setting the country on the path to growth. The decision to wait would also reflect an error in political judgment, as there is no better atmosphere than one of crisis to spur policy-makers and the public alike to consider steps that might otherwise be rejected out of hand.
Severe recession and unemployment have inflicted much suffering on the Israeli public. But the current crisis, which has put economic policy at the top of a crowded public agenda, presents Israel with an opportunity to make strategic changes in the way the country does business. Such changes hold out the prospect of a Jewish state that would offer a decent living to its citizens and would be attractive to Jews everywhere. Such changes are at once an economic necessity and a foremost Zionist imperative.
Daniel Polisar, for the Editors
April 1, 2003
