Lapid's 1.5% Income Tax Hike Isn't the Problem

Nor can social gaps be narrowed just by taxing investments.

The data on wealth in the United States are chilling. The latest figure is that 40% of the wealth is concentrated in the hands of 1% of the population.

And what about Israel? We have no idea, for the trivial reason that data on assets aren't collected here. Since there is no obligation to report such figures to the tax authorities, we have no idea how wealth is distributed.

But the authorities do know something about the people's income. According to a report published Sunday by the State Revenue Administration, the top 1% took in 12.7% of the income in 2011.

Is that a little or a lot? Apparently it's not a lot compared to the United States – there the top 1% takes in 17.4%. Even compared to yesteryear it's not a lot – the State Revenue Administration's 2001 report showed that the top 1% took in 13.6% of the income. So over the past decade the top percentile's percentage of the wage pie hasn't changed much.

We could use this statistic to contend that social gaps aren't expanding too quickly, but we could also conclude that without the statistic on wealth, the income number is pretty meaningless.

In 2001, well before the global financial crisis and before Benjamin Netanyahu launched tax cuts as finance minister, 43% of the top percentile's income was paid in direct taxes (meaning income tax, national insurance and health tax, as opposed to indirect taxes such as VAT). According to the State Revenue Administration's 2011 report, the top 1% currently pays 36% of its income in direct taxes. Thus it can be said that a gap has increased in Israeli society.

But in 2001, the fifth decile of income earners paid 10% tax on their income, while now this rate doesn't hit anyone under the seventh decile. Netanyahu's tax reform made rates particularly low for people who earn low to moderate salaries – not for those earning high salaries.

After the Finance Ministry's planned tax reform takes effect, Israel's highest income tax bracket will be 51.5% – in 2014. In 2001 it was 50%. Plus, following the implementation of the Trajtenberg reforms, which called for tax credits for fathers of small children, the percentage of Israelis who pay no income tax hit 52.3%. In 2001, before Netanyahu's big tax reform, the figure was only 43%.

The example of the self-employed

So despite the popular perception, lower wage earners were the big winners from Netanyahu's reform. And raising marginal income tax by 1.5% for every bracket – part of the Finance Minister Yair Lapid's plan – isn't unreasonable.

The top percentile's advantage in the income-tax regime stems from how its income is divided. Put otherwise, it stems from the non-reporting of assets. Though the State Revenue Administration does not include figures on wealth, it includes figures on how the self-employed divide their income. The self-employed face higher reporting requirements than others, so more information is available on them.

These figures are particularly interesting due to what they say about the top percentile – the only percentile in Israel where the people derive most of their income from investments. While the remaining 99% derive most of their income from wages or revenues from a business, the top percentile of the self-employed derive most of their income from their assets. Some 65% of their income is from capital gains, dividends, interest, rent and other forms of asset-based revenue.

This also means that the top percentile is affected only marginally by income tax rates. Instead, these people are hit by taxes on capital – capital gains tax, betterment tax, dividend tax, and tax on rental payments. All these taxes are significantly lower than income tax rates – capital gains tax is between 25% and 30%, dividend tax is 25%, and betterment tax and rental income tax is in effect zero.

As a result, the top percentile of the self-employed earned on average NIS 442,000 a month but paid only 29% of this as direct tax. This is less than the tax paid by the ninth decile of self-employed, who earned on average NIS 28,000 a month. In this respect, Israel's tax pyramid is inversed – the rich pay the least tax.

Why are taxes on capital lower than taxes on labor? There are several reasons. Some of them are economic (capital gains and dividend taxes are a second layer of taxes, alongside corporate tax.) And some of them relate to global norms (capital is liquid and easily moved, so the competition for it creates lower tax rates).

But some have no explanation whatsoever. For instance, it's not clear why people who own apartments are exempt from paying taxes – both on rental income and on betterment tax when the apartment's value appreciates. This problem should be fixed, and property owners should at the very least be brought in line with people who own shares in companies, at least as far as tax is concerned.

Given the situation around the world whereby people pay lower taxes on their investments, our ability to reduce social gaps through tax reform is probably very limited. Of course, we can address the low tax rates paid on assets by equalizing tax rates for labor and capital.

That's what's done in the United States, where taxpayers are required to fully report their income sources. But we should also remember that the top tax bracket in the United States is relatively low – 39%. We also should remember that the U.S. approach hasn't exactly reduced social gaps there.

Tomer Appelbaum