The Child Benefits That Worsen Israel’s Poverty Problem

In its 2014 annual report, the Bank of Israel says the roots of the country’s inequality lie in the large number of children in poor families.

Gil Cohen Magen

There’s no doubt: The ultra-Orthodox parties and the Bank of Israel don’t see eye to eye. These parties’ main demand in the coalition talks is the return of child allowances to where they were before the cuts of 2013. This would add around 2.5 billion shekels ($640 million) to the state budget.

The Bank of Israel opposes an increase in child allowances, though in its customary caution this opposition is well hidden, both in the central bank’s 2014 annual report and in the wording. And that wording doesn’t come until page 216. There you find the tortuous few sentences below.

“Our findings pose a dilemma for policy makers. On the one hand, increasing transfer payments independent of means testing may encourage larger families and non-employment, especially among poor families — this could perpetuate the condition of poverty. On the other hand, increased allowances may increase the living standards of people who have little ability to integrate into the workforce.

“One way to balance these considerations is to increase transfer payments for working families only; for example, in the form of a negative income tax. But this requires the exclusion of individuals whose ability to earn wages is particularly low.”

Don’t worry if you find all this hard to follow. The Bank of Israel shuns blatant statements that, heaven forbid, might irk politicians. But the message is clear and accompanied by a graph and clear numbers: The bank believes that Israel’s root of inequality derives mainly from the large number of children in poor families. Therefore child allowances should not be raised.

To arrive at this conclusion, the bank analyzed inequality gaps in Israel and the countries in the Organization for Economic Cooperation and Development, of which Israel is a member. It compared the difference in household income between the top and lowest fifths of the population. This was done for three different categories of income.

Stingy welfare system

The first comparison was done for gross income. This showed that a household in the top fifth earns 13.3 times the gross income of the bottom fifth. This might seem high, but in the OECD the number stands at 11.9, so among developed countries Israel isn’t doing so badly.

The next comparison was of disposable income: net income — after tax for the rich and after the payment of allowances to the poor. Here the top fifth earns 6.2 times that earned by the bottom fifth; in the OECD the number is 4.7.

This is a greater difference, exposing the first part of our inequality problem: the very stingy welfare system. Israel is third from the top in poverty rates among developed countries, but fifth from the bottom in welfare spending. Other countries do better reducing inequality through taxation and welfare payments.

The third measure was disposable per capita income, as opposed to disposable income per household. This is the Bank of Israel’s glaring finding. Per capita, a person in the top fifth enjoys an income 8.2 higher than a person in the bottom fifth. For the OECD the number is 4.8.

So Israel’s per capita inequality is almost double that in the OECD. The Bank of Israel finds that inequality dwells in per capita income, which stems from poor people’s large family size.

This finding is unique to Israel. In developed countries the number of children is the same among the different fifths of the population; the average is 2.5 people per household. But in Israel, it’s 2.75 people for the top fifth and four people for the bottom fifth. In other words, in Israel, the poorer a household, the more children, greatly worsening the poverty problem.

In the Bank of Israel’s terms, 22% of inequality in Israel stems from market forces, namely gross incomes. Meanwhile, 25% of the inequality stems from Israel’s stingy welfare system, which increases the gap in net incomes. And 54% of the inequality stems from demographic differences — the fact that poorer households are the larger ones.

The bank had already done a similar analysis, which in turn is similar to one done by the National Insurance Institute. That study was on the “employment miracle” that took place between 2003 and 2014. There was enormous growth in poor people joining the labor force, a trend that greatly reduced poverty.

The Bank of Israel notes that from 1999 to 2012, per capita disposable income grew for every fifth of the population; for the bottom fifth incomes rose 1.5% annually in real terms, compared with 2.1% for the entire population. But most of the increase came between 1999 and 2003, when child allowances rose, followed by sharp drops the following years.

Since 2005, the increase in disposable income for the bottom fifth has been very large: 2.6% annually, above the average of 2.3% (and the top fifth’s 2.1%). According to the bank, the increased income for the bottom fifth stemmed from a massive entry to the labor force. The number of breadwinners climbed 42%, the number of hours worked rose 39%, and income from work surged 72%. The percentage of allowances in household income tumbled to 40% from 70%.

‘Smart allowances’

Thus, since 2003, poor households have exchanged income from allowances for income from work, significantly reducing poverty. This was a direct result of policies encouraging people to seek work, launched in 2003, along with sharp cuts to allowances and income tax (which helps people who work, though the indirect-tax regime was kept largely in place, stinging people who are unemployed).

So it’s not hard to understand that the bank comes to the following conclusion: “A culture of allowances, particularly those that don’t encourage people to seek work, can encourage increased family size and unemployment.” Of course, child allowances fit this definition precisely.

Given all this, the bank expresses concern at the intolerable gaps caused by the tight-fisted welfare system. It therefore supports “smart allowances,” the kind that encourage employment and support the working poor, such as a negative income tax.

The bank ends its recommendations with an unclear phrase on the need “to exclude from the group individuals whose capability of earning wages is particularly low.” The intention is not to focus only on allowances that encourage employment, because there are people who can’t work and need assistance unrelated to the labor market. The bank thus wants to increase allowances like the one guaranteeing a minimum income, conditional on verification that recipients truly can’t work.

The main program that figured out who can’t work was the welfare-to-work Wisconsin Plan. Interestingly, this plan has not come up in any stretch of the coalition talks.