For Finance Minister Benjamin Netanyahu, the blow that came from the direction of Bank of Israel Governor David Klein was unforeseen. Netanyahu believed that Klein would take his side in the matter of lowering taxes. But this week it became clear that Klein wants to channel surplus tax revenues (if there are any) to lowering the public debt and not to lowering taxes.
Income tax rates in Israel are rising too quickly. They discourage work, with one large segment of the public prefering not to declare income, another sector prefering to go on the dole rather than enter the labor market, and yet another group is receiving a strange variety of tax benefits. Indirect taxation is another distortion; Value Added Tax (VAT) is too high, encouraging evasion, and so are purchase taxes and duties.
Former Treasury Director-General Avi Ben-Bassat is the great champion of reducing the public debt. As long as a year ago he argued that a heavy debt is risky, it may throw the economy into a financial crisis and it engenders a heavy interest burden, which draws funding away from social and investment budgets. Therefore, the government deficit must be reduced first, to decrease the burden of public debt.
Netanyahu, however, is not afraid of financial crisis, and to him a large debt is the lesser problem. He wants to restore economic growth as quickly as possible, and lowering taxes on wages is a step in the right direction. There is a political aspect to the issue as well: Cutting taxes is much more popular than reducing debt.
However, the most convincing reason to reduce taxes is political reality. The moment ministers realize that tax revenue has increased, they will exert pressure to up government spending. The money must therefore be mopped up immediately, and the fastest way to do so is to use it to lower income tax and VAT. In any case, if the economy grows and the Gross Domestic Product rises, the portion of the public debt in the GDP will be smaller and thus we will enjoy the best of both worlds.
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