Periphery Abandoned to Its Misery in the New Investments Law

Opponents also howl at the sweetheart tax rates given to big business, leaving the full tax burden to helpless small businesses, and you.

The Knesset last week approved the "trapped profits" bill, ending a thorny debate about taxing the NIS 120 billion in profit that large corporations are sitting on in Israel.

One idea was to charge every possible tax on it, bringing in about NIS 27 billion. Another was to compromise and take only NIS 3 billion. Led by Finance Minister Yuval Steinitz, the government chose the latter.

Social-justice activists and opposition Knesset members howled. MK Zahava Gal-On (Meretz) told Knesset: “This is robbery of the public."

Steinitz shot back: “The people who oppose the law are either ignorant or liars."

The "trapped profits" are earnings built up over years by multinationals in their Israel operations. Companies such as Teva Pharmaceutical Industries, Israel Chemicals and the software multinational Amdocs sit on the money rather than export it and use it outside Israel, which would force them to pay dividend tax on it.

The decision to compromise enraged many, because it preserves an unequal system. Huge corporations get tax breaks, while smaller businesses and average Joes pay the full rate.

“It’s mind-boggling,” says Roby Nathanson, economist and director of the Macro Center for Political Economics. “I work for a non-profit organization and also own a small business – a financial consultancyWhy should I pay the full amount of tax while a giant company gets a discount?”

Naturally, the giant corporations, especially the ones that patiently squatted on their money, are tickled pink.

“Now they have the opportunity to export that money and use it," says Henriette Fuchs, a partner at Barnea & Co. law firm and head of its tax department.

Other companies are less pleased, because they had put the money to use doing things like distributing dividends, and so paid the full tax. Fuchs, for one, feels the law is good for Israel.

“What’s important to foreign investors in Israel, beyond the benefit that the state gives them, is the stability of the tax system," she says. "So it’s very important that the law be clear."

But does it work?

The Encouragement of Capital Investments Law has been fiddled with repeatedly since it was passed in 1959. Twenty years ago, studies cast serious doubt on whether it encouraged employment in general and in the periphery in particular, which was one of its key goals. The latest amendment leaves the periphery on its own, giving big breaks to companies in the center too.

The law helps companies in two ways. It provides Ministry of Industry and Trade grants covering part of the investment in starting a new business. And it gives tax breaks, courtesy of the Finance Ministry.

During the 1960s and 1970s, after the law was passed, quite a few firms, mainly textiles companies, built plants in peripheral development towns. But studies conducted in the 1980s and 1990s cast doubt on the law’s effectiveness. In the most recent comprehensive study, published in 2009, Guy Navon and Roni Frish of the Bank of Israel concluded that the law was a dud. Investment in the periphery did not grow and jobs were not created, so the law did not narrow gaps between the periphery and the center in terms of living standards and salary.

“This law created a great many problems," says Avi Ben-Bassat of the Hebrew University, the College for Academic Studies and the Israel Democracy Institute

"Its aim is to boost employment in development areas, but the incentive it provides is for investments. Thus, capital-heavy facilities were built in the periphery. This creates a distortion: Each shekel invested in the center of the country generated more than did each shekel invested in peripheral areas. That's why economists have begun calling this law a machine-distribution law instead of a population-distribution law.”

Fooled by the Finance Ministry?

In the 1990s, the government tweaked the law, reducing the government's maximal grant from 38 percent of the total investment (the company puts up the other 62 percent) to 24 percent. The government intended to use the money it saved to enhance infrastructure in development towns.

“The people at the Finance Ministry did a number on us,” recalls Adi Eldar, the mayor of Carmiel, who served for years as the chairman of the Union of Local Authorities. “The money never came. The periphery gets much less benefit from this law than it did in the past.”

“Eldar's right,” says Ben-Bassat. “Money that had been allocated to raise the standard of living in the development areas vanished from the budget. We have to go back to this concept: fewer incentives for capital and more incentives for raising the standard of livingI remember meeting with the late Shaul Amor when he was mayor of Migdal Ha’emek. He told me that although the residents were happy about the new factory that Tower Semiconductor had built there, they were much happier when the first supermarket opened.”

Then the government changed tack. It kept the concept of supporting big business, but in the form of tax breaks.

For all practical purposes, the law resulted in companies paying much lower corporate tax. In 2009 and 2010, companies that averaged NIS 72 million per year profit and were eligible for inclusion in the law paid 8 percent tax instead of 25 percent corporate tax. This information became known when the Finance Ministry provided data in reply to a parliamentary query by MK Zahava Gal-On. It also became known that the large corporations with turnovers of more than NIS 1 billion paid a mere 6.8% tax on average.

Ehud Olmert and the law

As the government agency allocating grants to business, the Investment Promotion Center is subject to a great deal of pressure from without. Over the years, the state comptroller has reported on quite a few scandals involving politically motivated grants. The most prominent of them was Ehud Olmert’s conviction of breach of trust four months ago. As the industry minister in Sharon’s second government, Olmert dealt with companies that hired his friend, attorney Uri Messer, to represent them, thus placing himself in a position of conflict of interest. Olmert was given a light sentence: community service and a suspended prison term. The state is appealing.

In addition, the Investment Promotion Center has difficulty dealing with companies that broke the rules but never gave back the money. In 2010, the Movement for Quality Government in Israel sued, asking to know why the state was not collecting the debt of NIS 2.5 billion in such money. The Investment Promotion Center allowed more than 600 companies to keep such money, the movement claimed, and in 90 percent of the cases never even asked for it back.

In early 2011, the law was profoundly revamped, formally prioritizing tax breaks over grants, and all but killing help for the periphery. Companies making more than 25 percent of their turnover from exports would get a tax break. Eligible companies in the periphery will pay 6 percent corporate tax (instead of 10 percent) and companies in the center will pay 12 percent (instead of 15 percent). So why would any entrepreneur in his right mind invest in say Maalot rather than Tel Aviv? asks the mayor of Maalot, Shlomo Buhbut.

Finance Ministry officials say, behind closed doors, that there are no alternatives. Israel must compete to attract big companies. As Intel proved in choosing Ireland over Israel reportedly because of more generous support – there will always be another country purring a siren song. On the other hand, the budget deficit is reaching NIS 10 to 15 billion and after the election, it is likely that public services will be cut back and taxes will be raised to fill the hole.

Edrey sees shoals ahead. “Ireland gave out huge benefits and ended up in crisis in 2008. I think the lesson is that the Encouragement of Capital Investments Law should be completely abolished. It was right for the young country we once were, a state that had no resources. But since then, we’ve built magnificent industry and become a light unto the nations, particularly in high-tech. Continuing these benefits means cutting back on social services and education. That means fewer good people will live in Israel in the future – the very people who are the reason why the giant firms want to invest here in the first place.”

Michal Fattal