Finance Minister Benjamin Netanyahu did not expect Bank of Israel Governor David Klein to disagree with him. Netanyahu thought that Klein would stand by him concerning the lowering of taxes, but it turned out this week that Klein wants surplus tax collections (if there are any) to be channeled for reducing public debt rather than lowering taxes.
A closer look at the accompanying graphs show that Klein seems to be correct. The graphs show that from the perspective of debt, we are in a relatively poorer position. When, however, every salaried employee looks at his own pay slip, he sees the tremendous tax burden.
The combined income tax, National Insurance Institute premiums, and health tax on a middle-class income of NIS 11,000 per month amounts to 37 percent. The tax burden on an income of over NIS 20,000 per month jumps to 53 percent. These rates are unparalleled in the United States or Europe. Why are taxes in Israel so high?
It is the average that is behind the problem. The tax burden of 39 percent is misleading. It is composed of a compilation of several distortions. Israel's income tax brackets rise too fast and encourage people not to work. Therefore, a considerable segment of the working public works "under the table," another segment does not want to enter the labor market at all and prefers living on allowances, and another segment is eligible for various benefits that in 2004 amounted to the vast sum of NIS 27 billion - look, for example, at the Capital Investments Encouragement Law.
Another distortion is the indirect tax. Israel is the world champion in this field. Value-added tax is too high (and encourages evasions), and the same goes for purchase taxes and excessive excises, which are regressive taxes that harm the level of equality in the economy.
The big advocate of reducing the public debt is former Finance Ministry director-general Avi Ben Bassat. For over a year now, he has been arguing that the large debt is dangerous, and is liable to drag the economy into a financial crisis similar to that in June 2002, when Israel could not raise a single dollar worldwide. The large debt likewise dictates high interest rates that are drawn from budgets and investments. For this reason, we must first reduce the government's deficit in order to reduce the debt burden.
Netanyahu, however, does not fear a financial crisis. The U.S. guarantees have removed that danger, and his consistent policy of reducing government spending has contributed to stability. This is why he views the huge debt as a secondary problem. Netanyahu wants to return the economy to high growth as fast as possible; lowering taxes on work is indeed the right move toward that end, and why should we not follow the U.S. example?
The whole issue also has a political side. Lowering taxes is much more popular that reducing debt. Lower taxes are felt quickly in everyone's pocket. So when Netanyahu says that he will lower taxes for low- and middle-income earners, it sounds great. What is popular, however, is not necessarily correct.
The most convincing argument for lowering taxes is the political reality. The moment government ministers find out that there are increased revenues from taxes, they will apply pressure to increase spending. For this reason, it is imperative to use the money immediately, and the fastest way to spend the money is to lower income tax and VAT. The economy is going to grow anyway, and the gross domestic product will rise. As a result, lowering the relative weight of the public debt to the GDP will give us the best of both worlds.
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