Israel Already Has Two States - One Rich and One Poor

Four out of five local governments in Israel fail to balance the books yearly, but a wealthy few enjoy a healthy surplus. Can anything be done to make things fairer?

A new building project in Herzliya, central Israel. Local government in outlying areas can't sell rezoned land at the same rate as in central Israel.
Eyal Toueg

Where do you live? The answer to this innocent question reveals many important aspects of your life. For example, it contains a great deal of information about the level of education your children will receive, and your access to places of employment, and leisure and cultural activities. The reason is simple: There’s a close link between these services and the financial strength of the municipality where you live.

It’s customary to think that a city’s economic status is derived mainly from the quality of its administration – elect a mayor who understands finance and has initiative and creative ideas, surround him with high-quality senior officials, and the economic situation of the authority will improve. But quality administration is not enough to provide residents with high-level services. Data published by the Interior Ministry show that the most important factor in determining a city’s economic situation is actually its geographical location, and that the five wealthiest local governments in Israel – with the exclusion of Haifa – are located in the center of the country.

The relative wealth of a local government in this ranking is calculated by the “equalization model” – in other words, the formula by which the state decides how to cover a municipality’s deficit. The formula calculates the difference between the anticipated expenditure of a local government for the purpose of providing a suitable level of services for its residents (the expenditure required per resident multiplied by the number of residents), and the authority’s expected income from local property taxes (arnona, in Hebrew). In deficit-ridden authorities – most of Israeli’s municipalities – there is such a gap, which the government covers through the balancing equalization grant.

In several dozen municipalities, the result of the equalization model is actually negative – i.e., the total income from property taxes is higher than the expected level of expenditure – and in such cases the local government is left with a surplus. These are the communities with balanced budgets, which the government doesn’t have to fund.

Tel Aviv leads in this ranking, with a budgetary surplus of about 2.11 billion shekels ($548 million) in 2016, according to the equalizing calculation. Other cities with a surplus are Haifa (about 1.17 billion shekels), Petah Tikva (about 400 million shekels), Herzliya (about 290 million shekels) and Ramat Gan (about 277 million shekels).

What do all these local governments have in common? Well, they all have a large number of industrial, labor and commercial zones, which pay the business (or nonresidential) property tax. This is the most desirable type of income for a local government, since it makes the difference between a profitable and deficit-ridden municipality.

A calculation by the Finance Ministry demonstrates that in order to achieve a budgetary balance, a city needs a ratio of 11:9 between residential and commercial areas (55 square meters for housing, 45 square meters for commerce in every 100 tradable square meters). In order to achieve this ratio, the municipality must plan and build areas for employment and commerce, and there must be suitable demand for such areas.

Many local governments do work according to this model and look to promote spaces for offices, commerce and employment. But the demand for such areas is lower in outlying parts of the country than in the center. A regional council on the periphery that wants to be financially strong must regulate the rate of housing construction in its area, as well as the rate of its population growth. The general rule is that construction for housing, in effect, builds the deficit, since the property tax paid by householders to the local government cannot possibly cover all the services it provides to its residents.

In times of increasing housing shortages, both the treasury and Construction and Housing Ministry argue that a substantial percentage of the well-to-do municipalities are not making enough effort to increase the housing supply, or advancing a sufficient number of residential construction plans in their areas – even though, financially speaking, they are able to handle a significant population increase.

Among the 10 local governments suffering from the worst operational deficit according to the equalization model, the most prominent are those belonging to the ultra-Orthodox or Arab communities, and councils in the outlying areas or beyond the Green Line (i.e., settlements in the West Bank).

However, the list is headed by a city that is actually located just to the east of Tel Aviv – Bnei Brak – with a deficit of 75 million shekels. Closing the list is another town in the center that is neither ultra-Orthodox nor Arab: Bat Yam, south of Tel Aviv. Overall, more than 200 of the 254 local governments in Israel don’t have a balanced budget and need equalization grants from the state – which allocated about 3 billion shekels for this in 2016. That may sound high, but in effect it’s the minimum needed by the municipalities in order to continue functioning.

Balancing the budgets

Prof. Eran Razin, head of the Institute of Urban and Regional Studies at the Hebrew University, studies the funding of local governments. He says the disparity in the level of income from nonresidential property taxes plays a key role in the inequality, but it’s not the only reason. The difference in real estate values between the center and periphery also affects the ability of regional councils to balance the budget, says Razin, since the value of the land is a central component in determining the amount of betterment taxes the municipality receives when it rezones land for construction.

Most councils explain that these taxes are calculated as half of the difference between the value of the land before and after the rezoning, which means they are dependent, to a great degree, on trends in the real estate market. While betterment taxes will reach hundreds of millions of shekels in central areas like Herzliya and Rishon Letzion, the sum for rezoning an identical space in the outlying areas will be significantly lower.

For example, in the most recent rezoning of agricultural land in Ra’anana (where the Neveh Zemer neighborhood is now being built), the value of betterment is estimated at 800,000 shekels per housing unit. In other words, for every apartment in the complex, the Ra’anana municipality will be paid a betterment tax of 400,000 shekels. Since 3,500 apartments are set to be built in this large new neighborhood, the city coffers will be boosted by billions of shekels. Local governments in the outlying areas have no chance of getting anywhere near these figures.

Razin notes that you also have to factor in the socioeconomic gaps between residents in the various local governments, which contributes to deepening the divide between the outlying areas and the center: A weaker population group requires more expenditure from the local government, whose income suffers due to welfare cases that are eligible for a property-tax exemption.

This inequality gives rise to a series of questions: Does the state have to do something to formulate new methods of distribution among the local governments, and if so, how? Do the strong municipalities in the center of the country get too much money? Is there “superfluous” money in Tel Aviv, Haifa or Petah Tikva that can and should be transferred to Dimona, Bnei Brak and Safed, by means of redistribution mechanisms?

These questions anger Golan Zrihan, chairman of the Union of Local Authorities’ finance directors and finance director of the Herzliya municipality. “The Interior Ministry’s formulas are outdated and don’t take into account many services that local governments must provide today – not to mention metropolitan areas that serve a large number of commuters on a daily basis,” he says.

“There is more garbage in these cities, and therefore the level of maintenance and cleanliness has to be higher. The level of inspection has to be stricter, too. That requires more manpower and more networks. Microsoft and Apple are located in the Herzliya industrial zone. The public space there has to be on an international level. Even if a specific city is in surplus, it’s a surplus of a million shekels, at best.”

Doesn’t it bother you that one municipality [Tel Aviv] finances grandiose events such as White Night and Opera in the Park, while others are fighting to give their residents basic services?

Zrihan: “Such cultural activities serve all the residents of the central region, and people come from all over the country. It’s the State of Israel that should be offering nationwide productions, but the state has imposed the task on the strong local governments, who do it gladly. It’s a good thing there are authorities that are capable of paying for such events. If all the authorities were poor, these things wouldn’t take place and everyone would lose out.

“That’s one of the jobs of a metropolis – to be a cultural center. Nahariya benefits from Haifa, and Dimona benefits from Be’er Sheva. Every central city serves its outlying areas.”

Zrihan adds that Tel Aviv has an “international reputation as a cosmopolitan city – that’s an Israeli achievement. It would be a shame for us if that brand were to suffer.”

No simple solutions

Despite the significant disparities between local governments and the structural injustice of the budgeting system, Razin claims there are no quick fixes. “There are some who propose nationalizing nonresidential property tax and redistributing it equally among the local governments,” he says. “That sounds wonderful, but who’s supposed to carry out the redistribution? It’s the government’s job, and herein lies a major problem: With all the criticism of local government, in the final analysis, most people in Israel live in cities that are much better run than the government ministries.”

The organizational and political instability in most of the ministries, he says, would make it difficult to carry out such a reform. The outstanding example of that is the Interior Ministry, where there have been no fewer than four different ministers in the space of two years. “Nationalization will transfer the responsibility from systems that are administered in a relatively successful manner – the municipalities – to failing systems.”

Another fear cited by Razin is that the redistribution won’t increase the total budget received by the weak local governments, since the state will use the money taken from wealthy municipalities as a substitute for the equalizing grants it provides at present. “Within a few years, this entire budget would be swallowed up and the result would be the weakening of the strong local governments without strengthening the weak ones.”

What’s the best solution?

“First of all, increasing the equalizing grants. They were cut significantly in 2002, and since then have been increased but still remain low. An equalizing grant cannot suffice for the really weak local governments, which have no employment zones. Another solution is expanding the arrangements for increasing income on a regional level. The interior minister went in that direction two years ago when a series of committees were appointed to redistribute income in the Negev.”

The Interior Ministry told Haaretz that the model for the equalizing grant “was proposed to the interior minister by a public committee. It’s an egalitarian budgeting model that takes into account the potential income of the municipality compared to the normative expenditure level required of it considering its unique characteristics.

“As a result of this model, many local governments are ineligible for an equalizing grant. However, the Interior Ministry is examining the need to make changes in the model, if necessary by forming professional examination teams, and thereby implementing the worldview of the Interior Ministry for a fairer and more equal distribution of income among the local governments.”