Israel at an Economic-policy Crossroads

Israel chose the U.S. economic model of low taxes and high financial stability. As a result, spending on education and welfare is low — and poverty and inequality rates are high.

Israel has failed to tackle the problems of poverty and social inequality. The picture shows the mattress and bedding of a homeless person on a sidewalk in front of thedisplay windows of a trendy clothing store,
Moti Milrod

In the opinion of the Organization for Economic Cooperation and Development, Israel created appropriate conditions for rapid economic growth and full employment, through policies oriented toward economic stability, relatively low taxes and the encouragement of employment. However, Israel failed in the areas of inequality and poverty, education, health (gaps), old-age benefit payments and prices.

Presenting the OECD’s criticism separately from its praise is hypothetically wrong because Israel achieved its macroeconomic goals by deliberately making social sacrifices, at least as far as the national budget is concerned. Therefore, the things are related by causality.

During the last decade, Israel managed to reduce its national debt from 100% of gross domestic product to 65%. (1% being worth about 11 billion shekels, or $28.1 billion). It reduced the tax burden by 4.5% of GDP. Israel also created a reality in which the weight of civil spending is lower than the OECD average by 10% of GDP and social spending is lower than the OECD average by 5% to 6% of GDP, or by 60 billion shekels to 70 billion shekels a year.

I intend to show that the only economic ideological gap between the social democracy of the West and liberal conservatism is the question of how much of GDP should be devoted to civil spending, an issue that has implications for taxation as a function of GDP.

A model for a competitive global economy

Western social democracy after World War Two was characterized by a set of ideologies and policies that were pretty much opposite to American conservative liberalism.

The European social-democratic model of the time included support for protectionism, opposition to privatization, expansionary budgetary policy and policies that were biased toward trade unions (favoring tenure, job stability and social benefits).

Gradually, led by the northern European nations, the model adapted to the competitive global market. Today the model supports efficiency and competitiveness and therefore champions financial stability, supports a flexible labor market, measures privatization in terms of efficiency and reduces protections for domestic manufacturing.

The revised model retains one socialist principle: high public spending. Therefore, the tax burden is too heavy to fund it. European social democratic countries maintain a tax burden of between 40% and 45% of GDP. They operate as modern welfare states, with public systems for health and education (including higher education), generous stipends (including pensions), public housing and the like.

The conservative liberal model led by the United States has also profoundly changed. Originally it held that the commodities, currency and stock markets were almost completely free, with little regulation. The labor market was flexible, with limited worker rights, and public services were privatized. No more. Presidents like Bill Clinton and Barack Obama support social rights, health care reforms and heavy regulation of business. But one principle was maintained: keeping the tax burden low (about 25% of GDP), and low spending on pensions, public health, education and so on; these areas remain privately run.

The European model recognizes that high taxes impede efficiency and economic growth while inflating prices and costs. But it holds that equal opportunity for all in education, health care and pensions will result in quality professional forces in the labor market, which will boost economic growth. The American model considers low taxes and low government intervention key to growth, though equality of opportunity does suffer.

Israel chose the conservative model

Israel 2016 is an almost perfect mimic, though a modest one, of the American model. As in the United States, state civil spending in low, as is the tax burden when Israel’s high defense spending is taken into consideration, and its financial stability is impressive. The Israeli model, which also actively encourages employment, has achieved impressive gains in the last decade: Israel’s credit rating is high, it has been resilient in the fact of global economic crises and employment rates have risen significantly.

Over the past decade, Israel has taken on the characteristics of a wealthy society at all social levels, as more people joined the workforce, in parallel (and consequent to) policy to reduce civil social spending. Inequality and poverty have remained rampant. Education achievements among the poor are very meager. The gaps in health care are widening and the privatization of the health and higher education systems continues apace. The state has been gradually retreating from subsidizing public housing and is reducing its involvement in subsidizing pensions too. All this is in order to lower government spending.

The best model

Israel chose the American solution, which prioritizes financial stability and low taxes, but means that civil social spending low. Therefore, its social networks are relatively more privatized than is the norm in developed nations. Efforts to improve social expenditure in 2010-2011 and again in 2016 were mainly at the expense of increasing the deficit, so actually, no permanent solution has been found to improve the situation.

Israel has very limited ability to raise taxes. Indirect taxes are high, taxes on the wealthy and on companies are relatively high. About the only way to increase tax revenue is to increase taxes paid by poor and middle-class Israelis or employer contributions to the National Insurance Institute for their employees. Both measures are problematic, economically and socially.

In these circumstances, the only possible ways to obtain the added revenue needed to support increased state spending on health, education and public housing are the following:

1. Shift allocations from “priority” communities to underserved groups: from Jews to Arabs; from settlers, religious Zionists and ultra-Orthodox Jews to the population as a whole, through the introduction of a universal allocation model.

2. Abolish distortive tax exemptions, such as the value-added tax exemption for the city of Eilat, the VAT exemption on fresh fruit and vegetables and the exemption on tax from rental income.

3. Devote all of the increase in revenue to social spending, not tax cuts.

Adopting these measures would gradually enable government hospitals to add beds, improve health care and education, including increasing equality in the education system. It could contribute to public housing and to support for children and old people, it could improve income security and reduce unemployment, in part by funding vocational training.

In this way, Israel could keep its conservative liberal model while at the same time increasing quality of opportunity.

Yoram Gabbay is a former head of the Finance Ministry’s state revenues division.