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Death by Taxes

By Daniel Polisar




It is no secret that Israel is facing its most acute economic crisis since the days of 400-percent inflation nearly a generation ago. The country’s economy, which must expand more than 2 percent annually just to keep pace with population growth, has shrunk in each of the last two years, and a further decline is predicted for 2003. With unemployment over 10 percent, government welfare payments have swelled, while receipts from taxes have plummeted. As a consequence, Israel faces a budget deficit that, at its current rate, will equal 6 percent of the gross domestic product (GDP) in 2003—twice the level generally considered dangerous by international credit rating agencies. For Israel, a beleaguered country facing severe military challenges and increasing diplomatic isolation, the resumption of economic growth is an urgent, existential need.
Most economists and public figures have pinned the blame on the collapse of the world high-tech market, as well as the downturn in tourism and foreign investment since the outbreak of war with the Palestinian Authority in September 2000. Although these factors account for part of the economic malaise, they are far from explaining how these setbacks have succeeded in bringing Israel to the brink of financial ruin; and they are even less helpful in pointing towards a solution. To get to the heart of the matter, one has to look at a more systemic, long-term problem: The reckless spending and taxation policies of successive Israeli governments, which have relentlessly choked off economic initiative.
Last year, government spending in Israel constituted 55 percent of the country’s economic activity. This puts Israel three percentage points ahead of Sweden for the dubious distinction of having the largest public sector in the industrial world. And tempting as it is to blame excessive spending on the threats Israel faces, defense expenditures account for only one-fifth of its annual budget of $56 billion. The real problem lies with social benefits, transfer payments, and the bloated government payroll, which together comprise more than half the budget. In other words, even if it were possible to lower Israel’s defense spending to the level of a typical European country (3 percent of GDP, instead of 10 percent), the Jewish state would still rank with Sweden, Denmark, and France as a world leader in budgetary profligacy.
Though Israelis have been slow to acknowledge this long-festering problem, the current crisis has led to a growing awareness of it, especially since the appointment of Finance Minister Benjamin Netanyahu, who has made deep budget cuts the centerpiece of his ministry’s emergency recovery plan. “The problem,” he explained at a March press conference unveiling the plan, is that “the public sector… which does not create money and only consumes it… constitutes 55 percent of economic activity, while the productive sector constitutes only 45 percent.” In keeping with this assessment, the vast majority of the proposals in the 174-page plan slash spending in a wide variety of areas, including taxpayer-financed pension programs for Histadrut union workers, salaries for senior officials in government-run monopolies, and allocations for the Religious Affairs Ministry.
High taxes, on the other hand, have received relatively little attentionin the public debate, and tax reduction plays only a peripheral role in the emergency plan. In July 2002, the national unity government of Ariel Sharon passed a modest income tax cut, to be phased in by 2008, as part of a package that included new taxes of between 10 percent and 25 percent on savings, dividends, and capital gains. The first phase of that reform–which introduced the full weight of taxation on the capital markets, and only a symbolic reduction on income taxes–went into effect in January of this year. While the Finance Ministry has now declared its intention to pick up the pace, moving the target date for final implementation to 2005, this step is still a far cry from the deep reductions needed to get a catatonic private sector moving again.
Indeed, it might well be that the greatest problem facing Israel’s economy is not the size of its government, but the tax burden needed to fund it. It is here that Israelis at every level—workers, employers, and investors—face a grueling string of disincentives. Consequently, a systematic effort to reduce taxes is essential if Israel is to find a path to stable growth.
 
Just how high are the taxes Israelis face? In the two areas that wreak the greatest havoc in the life and work of the individual–taxes on labor and purchase taxes on goods and services–Israeli rates are among the highest in the world.
Consider, first, the bite government takes out of salaries. From every paycheck, employers deduct income tax, national insurance tax, and health tax, whose combined effect places a married Israeli man with two children and an annual salary of $13,200 (5,300 shekels a month) into the 38-percent tax bracket; a similarly situated woman would reach that bracket at a salary of $14,980 due to a higher tax credit given to women, while above that level, men and women alike pay the same high rates. At $28,300 (which is 11,400 shekels a month), an annual salary that is typical for Israel’s middle class, a worker reaches a marginal rate of 55 percent. Not even the best-compensated investment banker in Manhattan–who must pay substantial state and city taxes on top of his federal tax bill–is in as high a bracket. But this is still not the maximum rate Israelis face: At a salary of $50,300, an Israeli reaches the top bracket, at which 60 percent of his marginal income goes directly to the government.
These figures, however, tell only part of the story, as Israelis are confronted with a battery of additional taxes that sharply diminish the purchasing power of whatever is left of their earnings. Most burdensome among them is an 18-percent value-added tax (VAT) levied on virtually all goods and services, including staples like bread and milk. This means, for example, that a middle-class worker earning less than $30,000, who is already in the 55-percent tax bracket, loses another one-sixth of his net salary the moment he needs to buy something with it.
Yet VAT is only part of the problem, as many items considered essential in the industrialized world face punitive taxes and customs duties in Israel. Suppose that the middle-class worker from our example above decides to take a second, part-time job in order to earn enough to buy a car. Were he living in the United States, he could purchase a modest vehicle such as a Honda Civic for about $13,500, including taxes; and if he were taxed at American rates, he would need an additional salary of $20,000—no small feat, but feasible over a period of a year or two. In Israel, however, due to customs duties of 110 percent and VAT of 18 percent, the same car costs $25,400. To retain that much income after taxes, the Israeli would have to earn an additional $56,400–nearly three times more than his American counterpart would need.
But the tax burden faced by the Israeli car owner does not end once he has finished paying for his new vehicle. Since the sticker price is nearly twice what it is in the United States, car insurance in Israel is also far more expensive, costing about $1,600 annually for the Honda Civic. Gasoline is taxed even more aggressively; today, the price for a gallon of unleaded gas in America is around $1.80, while in Israel, due to a purchase tax of 190 percent (plus the omnipresent VAT), the same gallon costs $3.90. Thus, if the Honda owner were to drive 10,000 miles a year, gas alone would cost about $1,000 more than an American driver would pay. To add insult to injury, the Israeli even has to pay an annual tax of $25 on his car radio to help cover the costs of the deficit-ridden government broadcasting network. 
Nonetheless, it has often been claimed that Israeli tax rates are “reasonable,” as they are allegedly no higher than those in most European countries. Writing in September 2002, prominent Ha’aretz commentator Aryeh Kaspi averred that the Israeli public “is awash in misleading information suggesting that taxation in Israel is higher than the average in the West.” Shlomo Swirski, director of the Adva Center for Information on Equality and Social Justice, has likewise argued that, “The tax burden on individuals in Israel is not among the highest in the world. A comparison with figures published by the OECD [Organization for Economic Cooperation and Development] shows that Israel sits neatly in the middle.”


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