More social services mean more taxes
Israel spends less per citizen than almost any other developed country, but if Israelis want more they'll have to pay for it.
At first glance, Israeli government spending amounts to 43 percent of GDP, close to the average 44 to 45 percent of GDP for all developed countries. But government spending includes the annual defense budget, to which Israel devotes several times more of its spending than all other developed countries. Putting defense spending aside, Israel's deeply depressing situation becomes clearer – the state devotes less to civilian spending per capita than almost any other developed country.
How much less? Well, it depends on how you count. If we just subtract defense spending from overall government spending, we find Israel dedicates 36 percent of its GDP to civilian spending – placing it in fourth from last place on the per capita list, ahead of only Australia, Switzerland and South Korea.
But the interest rate Israel pays on its government debt is extremely high – a risk premium due to the country's security situation. If we count interest payments as part of the state's defense burden and subtract them from the civilian budget, we find Israel only really devotes 32.4 percent of its GDP to civilian spending. This lags significantly behind the 41 to 44 percent typical of developed countries, placing Israel in second to last place, ahead of only South Korea.
So there we have it, the statistics provide a basis for the claims made by the social justice protesters. The State of Israel really does invest very little in its citizens. In particular, it invests very little in its citizens' welfare – much less than the average of the rest of the developed world.
The erosion of government-provided services brought hundreds of thousands of citizens into the streets to protest last summer and continues to stir discontent this summer. The Israeli public clearly demands the government start investing more in its citizens – in their welfare, education and health. The people asking for the more spending tend to belong to the middle class, which shoulders most of Israel's tax burden in return for very little in the way of social services from the government.
The social justice protests' one crystal-clear message is that Israel must increase spending and overcome some of the gap between itself and other nations in providing services to its citizens.
It is a worthy message. But the public must understand the price of demanding more from the government. A state that spends more on its citizens is also, by necessity, a state that demands more from its citizens, because there is no way to increase spending without simultaneously increasing revenues.
That is to say, there is a way to increase spending without raising government revenues: running budget deficits and increasing government debt. But there is a limit to how long this approach can go on for. At some point, the debts pile up until the country's economy simply collapses. Look at Greece today, or if you prefer, Israel on the eve of the 1985 economic stabilization program.
A month ago, the Israel Democracy Institute's Caesarea Conference asked whether it was time increase the Israeli government's civilian spending at the price of hiking taxes. The panel of economists, led by former deputy governor of the Bank of Israel Zvi Eckstein, discussed increasing government spending from 42 to 43 percent of GDP to 45 percent by 2016. The consensus among committee members was that it was economically feasible and morally legitimate for the public to set its own priorities and demand a greater provision of government services in return for paying higher taxes.
The question is what price the public will have to pay for these services. In practice, every additional percentage point of GDP in government spending requires an additional NIS 10 billion in tax receipts. An increase in government spending by three percent of GDP would mean that government tax receipts would also have to increase by NIS 30 billion. How would the government collect an additional NIS 30 billion in taxes? Well, here are a few possible answers.
For every percentage point increase in the value-added tax, which targets consumption, the government earns an additional NIS 4 billion. A percentage point increase in personal income tax rates, across all tax brackets, would add another NIS 3 billion to the national treasury. Every percentage point increase in the corporate tax rate brings in another NIS 700 million for the state coffers. All of these combined would still not reach the NIS 10 billion necessary for the proposed increase in spending on social programs. To come up with the rest of the NIS 10 billion, it would be necessary to do the politically impossible and raise gasoline excise tax by at least 40 agorot per liter.
There are other combinations of tax hikes that could cover the gap. It's fairly clear that an increase in the marginal income tax rate for the highest tax bracket (a tax on the rich) won't do the job. At most, it will increase government tax receipts by several hundred million shekels. It's also clear that Israel's room for maneuvering with respect to the corporate tax rate is limited when the average corporate tax rate around the world is 26 percent. Israel cannot exceed this rate by too much if it wants to remain an internationally competitive place to do business. It's also fairly clear that Israel's VAT is relatively high compared to the international average. As a regressive tax, the VAT disproportionately hurts Israel's poor. So the government probably cannot institute a VAT hike of more than one or two percentage points.
There are several tax alternatives that haven't already been mentioned. One option is an inheritance tax, but it isn't clear how much, if any, revenue this would generate. Another possibility would be to cancel tax exemptions, such as tax-exempt pension plans, tax-exempt employee professional training funds, Eilat's VAT-exempt status, the VAT exemption on fruits and vegetables and the capital investment promotion law. All these tax exemptions cost Israel NIS 40 billion in potential tax revenue, and at least three of them – those for Eilat, fruits and vegetable purchases and employee professional training funds – do not serve any real social or economic purpose. However, cancelling these exemptions would require that the government take on some powerful political interests, like the Histadrut labor federation. If the public doesn’t demand that the Netanyahu government cancel these tax exemptions, it's doubtful the government will take action on their behalf.
So what remains? The government could tack a few percentage points on to the VAT and the corporate tax rate and hike the personal income-tax rate a lot – five percent or more – for all tax brackets. Yes, a tax hike that affects those in the middle income brackets. This is the heavy price that Israeli citizens must pay if they want to see increased government spending.
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