Bank of Israel Levels Attack on Finance Minister's Tax Cuts, Housing Program

Governor Karnit Flug says tax windfall should be used to boost government’s low levels of education, infrastructure spending.

Bank of Israel Governor Karnit Flug.
Emil Salman

Tax cuts and measures to rein in housing prices – two of Finance Minister Moshe Kahlon’s flagship economic policies – came under attack by Bank of Israel Governor Karnit Flug at a press conference yesterday.

Basing her critique on research appearing in the central bank’s annual report on the economy, Flug said the treasury shouldn’t be using a surge of tax revenues to cut taxes, and said Kahlon’s proposed tax on people owning three or more homes would only have a marginal impact on home prices, while raising rents.

“It is clear that we don’t want to lower taxes permanently because of increased collection from one-time factors, like the acquisition of Mobileye,” Flug told reporters, referring to the windfall the government is expecting after Intel agreed to buy the Israeli maker of self-driving-vehicle technology earlier this month for $156.3 billion.

“There should be a greater preference for investment in infrastructure and education,” Flug said. Spending on infrastructure is low relative to other countries and “negatively impacts on the economy’s growth potential,” Flug said.

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Her remarks come just two weeks after Kahlon and Prime Minister Benjamin Netanyahu announced plans for another round of tax cuts later this year. Kahlon, who cut the corporate income tax rate by one percentage point to 24% at the start of the year and also reduced personal income taxes, has portrayed his policy as giving back money to taxpayers that the government doesn’t need.

The Bank of Israel critique came in a report that otherwise lauded the Israeli economy’s performance last year. Gross domestic product grew a preliminary 4%, its fastest pace in four years, amid low unemployment and strong consumer spending. The economy’s only major weak point was exports, but the Bank of Israel attributed much of that to slower world trade.

Moreover, wages rose 2.9% last year, with all labor markets and income groups sharing in the gain. Businesses refrained from raising prices as returns on capital were close to record levels. They also faced competition from growing online shopping at overseas website by Israelis and low world inflation.

The strong growth boosted tax revenues last year way above the treasury’ s own targets, but Flug noted that not all of the windfall was due to the overall economy, rather to one-time factors, like a surge in car imports and the Mobileye deal.

Instead of using the excess revenues to lower taxes, Israel should be using them to ensure long-term growth by investing more in infrastructure, health and education – all areas where the government now under-invests relative to other developed economies, the central bank urged.

The report noted that Israel stepped up spending on things like sea and airports, energy, water and communications after 2007, but cut back sharply amid a sudden swelling of the budget deficit five years ago. Spending began to rise last year but is still well below earlier levels and is low by developed-country standards, risking long-term damage to the economy.

Israeli spending-per-student on education fell to as little as 70% of the average for countries belonging to the Organization for Economic Cooperation and Development in 2009. It has since risen, but only to 75% of the average as of 2013 and may have reached 82% in 2016, for which final figures aren’t available.

As a result, Israeli tests score on international exams of student performance have been poor.

The central bank said Kahlon’s tax on multiple-home owners, which is still awaiting Knesset approval, would have a small effect on lowering home prices, but would raise the cost of renting by encouraging property investors to sell homes they rent.

While home prices have risen steadily for the last nine years, including a 6.2% increase in 2016, rents have climbed no faster than wages and rose just 1.4% last year. Kahlon’s tax could upset that, the Bank of Israel said.

The bank also expressed skepticism about Kahlon’s other major plan for containing home prices – the Machir L’Mishtaken (Buyer’s Price) program, that sells state-owned last to contractors at a discount.

It noted that only 3.1% of all home buyers who entered the program’s lottery won rights to a home, and the rate was as little as 2% in the Jerusalem area and central part of the country.

The bank also found many winners had won rights to homes far from the current residence, suggesting they weren’t planning to live in them but rent them out.

An unnamed treasury official answered back to the critique, saying the Bank of Israel was using what it said would turn out to be erroneous information, for instance preliminary estimates for 2016 housing starts that history shows will probably be raised sharply higher later on.

“It bothers us when people write a report without talking or consulting with people in the field or professionals. The result is errors and internal contradictions in the report,” the official said.

With reporting by Reuters