When Israel Taxes the Rich, the Rich Play Tricks

Taxing the wealthy would be a good way to increase revenue if the wealthy weren’t so good at finding loopholes.

Tomer Appelbaum

Could a solution to Israel’s economic problems come from high taxes on the wealthy? It’s no secret Prime Minister Benjamin Netanyahu doesn’t think so, but such a tax was forced on him following the social-justice protests of the summer of 2011. Then came the recommendations of a special committee headed by economist Manuel Trajtenberg, who’s now entering the Knesset on the Zionist Union ticket.

As a result of the Trajtenberg committee’s recommendations, the top rates for income, corporate and capital-gains tax were increased and a tax on high earners was imposed. That was a 2% surtax on anyone with income from wages or capital topping 800,000 shekels ($200,000) annually.

The surtax brings the maximum income-tax rate on wealthy Israelis to 50% and the maximum capital-gains rate to 32%. Both are among the highest rates in the developed world.

The surtax was imposed more out of a desire to project a “see how we’re fighting the rich” message than to significantly boost tax revenue. Either way, the Tax Authority estimated that the surtax would bring in an additional 600 million shekels a year, based on the number of Israelis with more than 800,000 shekels in annual income as of 2011.

That’s 18,000 to 20,000 people, who if they don’t change their ways for tax purposes would pay an additional 700 million shekels a year. But to be conservative, the Tax Authority pegged the number at 600 million shekels and didn’t impose more than a 2% surtax.

There was a reason for such caution. Experience has shown that high wealth taxes make the rich get down to business in a different way: They find a way to avoid wealth taxes.

Wealth taxes are pretty new in Israel. In 2002, at the height of the second intifada that dragged the country into its deepest recession ever, the government imposed two wealth taxes. One was a direct tax that raised the income-tax rate by 0.5% for anyone earning more than 360,000 shekels. (The tax was less sophisticated than the surtax; it was only imposed on wage income, not capital gains.)

A second tax raised the ceiling on income on which payments to the National Insurance Institute had to be made. These two steps were temporary; they were expected to boost the government’s 2002 tax take by 2.2 billion shekels. In the event, they brought in only 700 million shekels.

Just form a company

Galit Ben Naim, an economist at the Finance Ministry’s State Revenue Division, tried to find out why the projections were so off the mark. She found that wealthy Israelis indeed took the necessary steps to preserve their money. One was to incorporate; their income would thus not be subject to the higher National Insurance Institute ceiling.

Also, the number of people reporting income above 360,000 shekels or 417,000 shekels, the two levels with ramifications for a NII-ceiling, tumbled 7% and 14% respectively in 2002. The people whose wages most drastically decreased were executives in insurance, finance, business services and construction.

Ben Naim attributed this to the fact that the wealth tax was supposed to be temporary. So it was worth it for the wealthy to earn less in 2002 knowing that the following year they could make it up.

The authorities didn’t make the same mistake when they imposed the recent surtax. In 2013 it was made permanent — again, that was the effort to bring in at least 600 million shekels a year.

But those hopes were dashed. The rich knew that the surtax was on the way, so in 2012 they did their hocus-pocus and the potential tax revenue shriveled to 420 million shekels.

Ultimately, Tax Authority findings show that in 2013, the first year of the surtax, about 18,000 people reported income above the ceiling. These people would be expected to owe about 340 million — just over half the 600 million shekels. Thus the surtax can be seen as a failure, just as the wealth tax was a decade earlier.

People at the Tax Authority say the wealthy are again setting up corporations as a loophole, so the authority has proposed legislation to close the breach. Tax officials are now hoping that if the newly elected Knesset passes the bills, the revenue generated by the surtax will increase.

Also, this is only the first year of the tax, so that's only a one-year hit on the wealthy  when they reduce their salaries or eschew dividends. But it’s doubtful that as the years go by they’ll stick with 66,000 shekels a month. It’s reasonable to assume they’ll increase their salaries or dividend income.

So the hope is that the collection rate on the surtax will improve in the coming years. Still, it’s clear that whether the hike is 0.5% or 2%, the rich will do anything to avoid being taxed. So taxing the wealthy is a dubious tool for increasing tax revenue.