Fueling the engines of growth
An impressive increase in tax collecting in the first five months of the year once again generates debate between the central bank and the treasury - what to do with the money. Bank of Israel Governor David Klein believes the money flowing into the state coffers should be used to cut the budget deficit and thus help to lower interest rates by reducing Israel's enormous public debt.
An impressive increase in tax collecting in the first five months of the year once again generates debate between the central bank and the treasury - what to do with the money. Bank of Israel Governor David Klein believes the money flowing into the state coffers should be used to cut the budget deficit and thus help to lower interest rates by reducing Israel's enormous public debt. This is a dangerous debt that could drag Israel into serious financial crisis similar to June 2002, when Israel couldn't raise even one more dollar abroad.
But Finance Minister Benjamin Netanyahu is not so excited about the deficit or the debt and has no fear of a financial crisis - American guarantees pushed that aside, along with his policy of cutting government spending and implementing reforms. Netanyahu wants to return the economy to rapid growth as soon as possible and the moment that happens, the relationship between the debt and the gross domestic product will drop anyway.
"The strongest engine for growth is lowering taxes - it's a jet engine," said Netanyahu. This indeed is true - lowering taxes on labor encourages people to work and build more production lines; lowering company taxes encourages new investment; lowering VAT (value added tax) encourages private consumption. All of these together lead to growth.
Contributing to the debate, the central bank recently published a study claiming that the tax burden in Israel (39 percent of GDP) is identical to the average in the 30 OECD (Organization for Economic Cooperation and Development) countries and there was therefore no point in focusing on tax cuts.
This sent ripples of excitement through social groups that saw it as bolstering their position that taxes should never be lowered, but only raised, so as to collect more money from "the rich" and transfer as much social security, child allowances and guaranteed income supplements as possible to "the poor."
The problem was, the central bank study looked illogical, contradicting intuition and the common wisdom that the tax burden in Israel is higher than in Western democracies. This question also troubled Michael Sarel, head of the economic department at the Finance Ministry. Sarel examined the matter more closely and found it is intuition that is still correct.
It turned out that the Bank of Israel's research department knowingly chose the 20 wealthiest countries in the developed world and compared Israel to them - although the bank called them OECD countries, they are not so.
The department removed the poorest countries from its list and added rich countries like Norway and Switzerland - and then made its comparison. The richer a country, the better health, education and welfare services it provides, and therefore the higher taxes it levies. In this distorted comparison, Israel landed right in the middle. When Israel is compared to all 30 OECD countries, however, without any deletions or tricks, their average tax burden falls to 37 percent, making Israel 2 percent higher than the OECD.
That's not even the whole story - neither did the central bank calculate a weighted average. Is there any rationale, for example, in calculating the simple average between Switzerland, with 7.3 million residents, and the United States, with 285 million? Obviously, the number of residents in each country must be taken into account.
Sarel made that adjustment and discovered that the average tax burden fell to just 32.5 percent. Now the results look more reasonable. Israel has higher public expenditure so the tax burden is also 6.5 percentage points higher than in the OECD countries.
But why even aim for the average? Why copy the mistakes of other countries that choose to endure a high tax burden? All studies show that countries with lower taxes enjoy higher growth over time. Why not follow the example of Ireland (population 3.5 million) where the tax burden is 30 percent of GDP and growth has been especially rapid in recent years?
While mentioning Ireland, it is worth noting that its accelerated growth in recent years didn't just come from lower tax rates - the main influence was the Good Friday peace agreement signed six years ago that ended 30 years of violent ethnic strife that cost the lives of 3,200 Catholics and Protestants in Northern Ireland. That's part of the Irish lesson, however, that Netanyahu does not like to hear about.