How Much Does Israel's 1% Really Earn?

Those at the top of the income ladder don't pay much higher rate than ordinary Israelis.

The top 1% of Israeli income earners made an average of 122,000 shekels a month (or about $35,000 at the current exchange rate) in 2011, according to data recently released by the Finance Ministry’s State Revenue Administration. That amounts to an annual gross salary of almost 1.5 million shekels.

Israel’s 1% earned 12.7% of the country’s total income before taxes and took home 10% of its net income. The 1% paid a larger share of direct taxes -- 22% of the total, including income tax and National Insurance Institute payments. The effective tax rate for those top earners was about 36%, considerably higher than the 20.6% for taxpayers across the income spectrum.

But this pretty picture of progressive taxation gets more complicated when one takes a closer look at those who own their own businesses or self-employed.

The self-employed are richer, earning an average monthly income of 399,000 shekels in 2011, more than three times that of top 1% as a whole -- and these top-top earners actually paid less in tax. The group’s share of the tax bill was 23% in 2011, which was low relatively to what the group as a whole was earnings. The effective direct tax rate of this more select group is just 29%, which was less than that paid by the top 10% of income earners in 2011—those with average monthly incomes of 38,000 shekels, just a 10th of what the self-employed 1% were making.

And even this refinement in the picture doesn’t fully reflect the reality because Israel does not have a blanket requirement for reporting on capital assets. The government does not have complete information about the assets held by the 1%. The Income Tax Authority relies on income reports, meaning money earned from wages, interest, rent, capital gains and dividends. It does not include assets that did not produce direct income, including, for example, an a person’s stake in company profits not distributed as a dividend.
Company owners

The ranks of the top 1% are naturally occupied in large measure by the owners of major companies. They are more likely than not to engage in tax planning through the use of endless tax shelters and tax loopholes. As a result, a large portion of corporate profits, particularly in the high-tech sector, are not distributed as dividends. As a result, the 1% are much richer than what is reflected in the data, which only enhances suspicions that its share of the tax burden is actually much lower than what is reported.
Data on the subject are hard to come by and even then it’s only partial.

Galit Ben-Naim, an economist from the State Revenue Administration, published an article a few weeks ago in the Israeli Tax Quarterly in which she dissected the income of the top 1%, including income earned by companies they control. The analysis was limited, however, because of the absence of complete reporting, forcing her to make a large number of assumptions. In addition, much of the wealth is theoretical as long as the shareholders don’t take it in the form of dividends.

Nonetheless, no one can ignore the tens, perhaps hundreds, of millions of dollars locked up in these undistributed profits just because so many of the companies avoid distributing their profits as dividends to avoid tax.

Ben-Naim’s study of the 1% broke out the approximately 112,000 people in the 1% who own companies. Some of the companies obviously lose money but as a group they are still fabulously wealthy compared to the rest of Israel. Within this group, 1,120 had average earnings of 19 million shekels in 2011, including profits that were not distributed as dividends. Of those, the top 112 had income of 83 million shekels.

All told, company owners’ share of total national income was 30% in 2011, a figure that jumped in the eight years before from about 22%. In 2008, as the global financial crisis was setting it, their share was 25%. In other words, the richer were getting richer, and quickly. The social gaps that have been so widely cited in Israel don’t just relate to the poor but to the rich as well, who have been distancing themselves from the country’s middle class.

Worrying trend

This is a worrying socio-economic trend that must be addresses through tax policies, namely by increasing the tax burden on the wealthiest to narrow income gaps.

The average tax burden in Israel equal 20.6% of income and 35.6% for the top 1%, but for the owners of companies the rate was 24.6%, mot much more than the nationwide average and about the same level as that paid by those in the top 10%, whose average income is just 16,000 shekels a month.
Why is the effective tax rate for Israel’s wealthiest so low?

First of all, it is because most of their income is earned on capital, such as interest income, dividends and capital gains, and not from wages. The top tax rates on capital gains is just 32% compared with 50% on salaried income. The logic is that companies themselves are paying tax as well, amounting to 25.6%, so those earning capital gains have already paid a tax once and together they exceed 50%. The other reason is that capital is highly mobile: The rich can invest it elsewhere, so the state has to be careful about how much it taxes it.

The problem is that the government has trouble collecting corporate income taxes and taxes on dividends because of tax shelters and other tools designed to minimize the rates.

The government is trying to address the problem of profits that are never distributed this never taxed by imposing tax liabilities on money paid out by so-called “wallet companies,” businesses set up for the sole purpose of paying their sole employee/shareholder. It is a problematic and draconian measure. If it succeeds, the effective tax rate for those wealthy company owners will certainly exceed the 2011 level.
 

Ofer Vaknin