Israel's Finance Minister Wants Tax Cuts, but It’s a Secret

The aim of cutting the corporate tax rate is to increase competition among Israeli companies, in the face of foreign competition and in international markets.

Finance Minister Moshe Kahlon, left, and Prime Minister Benjamin Netanyahu.
Reuters

Finance Minister Moshe Kahlon dropped a bombshell last week during discussions on the national budget: He favors tax cuts in 2017 and 2018. His top priorities: reducing income and corporate taxes. And then he told the completely shocked treasury officials not to tell anybody. Shh! Keep it top secret, especially from Prime Minister Benjamin Netanyahu, who then had the pleasure of hearing about his finance minister’s plan from a television news broadcast.

Netanyahu and his top people often quarrel over credit. Cabinet ministers gripe that the prime minister steals credit for measures that they proposed and brought to fruition.

The credit issue is particularly sensitive when it comes to relationship between Netanyahu and Kahlon, who split from Likud before last year’s general election to form the Kulanu party.

Last week’s tactic – sitting tight on the tax cuts plan, then leaking it to the media – was designed to guarantee that Kahlon got full credit for the idea. Especially since elections could be a lot sooner than anybody had thought.

Kahlon explained that tax revenues have been higher than expected this year, a trend expected to persist in 2017 and 2018. (He is planning a long-term budget for both years). Kahlon knows that if money accumulates, the parties in the coalition and everybody associated with them will covet it and find uses. He would rather use the money first, to lower taxes. He could yet pull it off, especially as economic circles expect Netanyahu to support the move, never mind that the prime minister hadn’t been consulted.

Kahlon wants to reduce the corporate tax rate to 23% or perhaps 23.5% from 25% and to lower income tax in all brackets by 1% to 2%. Alternatively, treasury officials are examining possible tax cuts for the middle class (that is, on gross wages of up to 20,000 shekels or perhaps 25,000 shekels a month, or around $5,2800 to $6,500).

Cutting corporate tax by 1% would cost the state 800 million shekels in lost income a year. Cutting all income tax brackets by 1% would cost 3.5 billion shekels a year.

If only the three lowest tax brackets are cut (gross monthly salaries of up to 13,860 shekels), the cost to the state in lost income is 2.2 billion shekels a year.

Speaking at a Kulanu caucus on Wednesday, Kahlon vowed to lower taxes by billions of shekels in the 2017 to 2018 budget. There were plenty of howls about the previous cuts to corporate and value added taxes last year, he pointed out, but added: “but the move proved to be the right one. The people who attacked then are now admitting they were wrong, and we are still seeing surplus tax income” compared to projections.

The budget bill for 2017 and 2018 contains two main avenues of growth stimulus, the finance minister told his party colleagues in the Knesset: investment and tax cuts. Tax revenue belongs to the people and should be returned to them when possible.

The aim of cutting the corporate tax rate is to increase competition among Israeli companies, in the face of foreign competition and in international markets. Kahlon also hopes it will attract foreign investment, as Ireland’s corporate tax rate of just 12.5% has done.

Road maps and potholes

Tax revenue reached 142 billion shekels in the first half of this year, 4 billion shekels above initial treasury estimates and over 6% higher than in the same period in 2015. Finance Ministry officials anticipate that tax revenue will surpass estimates by at least 6 billion to 10 billion shekels for the year as a whole.

In March, Finance Ministry Chief Economist Yoel Naveh kicked up the official tax revenue forecast for 2016 to 277.9 billion shekels, and everybody is expecting the real figure to be considerably higher, possibly north of 285 billion shekels.

At the same time, the figures for export of services (for 2016, and the final amount for 2015) are also expected to exceed forecasts. Economic growth in 2015 was probably around 2.8%, close to treasury estimates.

The Finance Ministry’s tax collection targets are 290.2 billion shekels for 2017 and 305.2 billion shekels for 2018. Kahlon feels these figures are low and can be met easily. Hence, his tax-relief plan in 2017-2018.

Israel Tax Authority Director Moshe Asher supports Kahlon’s plan, but some of the finance minister’s own people are not onboard.

The main opposition is from the Budget Department itself. Its director, Amir Levy, reminded Kahlon that the 2017 budget has a gigantic pothole, a deficit in the neighborhood of 14 billion shekels to 15 billion shekels, and the 2018 budget has an 8-billion-shekel hole. Before anybody cuts any taxes, insists Levy, ways to fill these holes need to be found.

Kahlon says the treasury has shown skill in filling holes before and he isn’t worried. He means to get around the shortfall by raising the planned budget deficit.

The Israeli budget deficit for 2015 was just 2.15% of gross domestic product, and the trend seems to be persisting. Also, from the start of the year, the deficit in the government’s activity is a very low 3.4 billion shekels. The accrued deficit going back 12 months (July 2015 to July 2016) is just 2.1% of GDP, like last year. The deficit planned for 2016 is higher: 2.9% of GDP, or 35 billion shekels.

A law caps the 2017 deficit at 2.5%. Kahlon and Netanyahu would both prefer a deficit of 2.8%, which would give them an additional 4 billion shekels to play with.

The Bank of Israel is not amused

We have seen Kahlon’s view, and that of opponents within the treasury. Then there’s a third view, that of Bank of Israel Governor Karnit Flug.

When tax revenues exceeded expectations under the previous governor, Stanley Fischer, he pressed for the entire surplus to be used to lower Israel’s debt (relative to GDP).

The lower Israel’s debt relative to GDP, the better Israel’s sovereign credit rating, in theory; the better the credit rating, the lower the interest Israel has to pay on its debt. In other words, the government is forking over less on interest payments. That leaves it more money for other things.

As head of the central bank, Flug has emphasized spending on social issues and infrastructure. She believes the state needs to adjust its priorities and to spend more on health, education and welfare, on narrowing social gaps and reducing poverty. So when she is asked what she thinks should be done with extra tax income, we know what she’s going to say, and it isn’t “tax cuts.”