Israel's Triumph of Stupidity Over Experience

Finance Minister Yair Lapid says his zero VAT law for young couples 'is not meant for economists.' The problem is, the laws of economics don't follow his Facebook page.

Eran Wolkowsky

It is very rude and immature on our part, but we can’t stop ourselves from saying it: We told you so.

We said you are ignorant, negligent, superficial and stupid. We told you that, despite everything you think, it is impossible to reinvent the laws of economics. We told you that even Knesset laws cannot change the laws of economics. We said that you will cause enormous damage, and so you have...

Eleven months ago, Culture and Sports Minister Limor Livnat stood in front of the Knesset and told MKs: “This is an exciting moment for me, and an important day for Israeli culture and literature. After more than three years of stormy debates, emotions and opposition, and with the help of many people, the law for the protection of literature and authors in Israel has been approved by a large majority.” The emotional minister thanked her colleagues in the Knesset for having – under her leadership – passed one of the dumbest laws in the history of Israel. The Book Law was meant to increase the revenues of publishers and writers and restrict competition in the book market. Sales offers such as “Four books for 100 shekels [$29]” were declared a crime against humanity, and from the moment the law came into effect, bookstores were banned from offering new books at a discount.

Across the board, all economists – with the exception of a single voice from the National Economic Council in the Prime Minister’s Office – opposed the Book Law, for the simple reason that it could not possibly work. The strange idea that making books more expensive would somehow increase writers’ incomes - because the profits from each book would increase - ignored the most fundamental laws of supply and demand. When the price rises, demand falls, and the chances that authors and publishers will make more money in a situation of reduced demand was - and remains - rather unlikely. The honorable minister chose to ignore the economists’ warnings.

Eleven months later, when Israel’s largest bookstore chain, Steimatzky, is in financial disarray and has just been sold for a pittance, and Hebrew Book Week turned out to be especially weak, there is almost no one in the publishing industry who isn’t in mourning because of the horrible law.

The plunge in book sales after the law was implemented was so steep – the general public was so shocked by the sharp rise in book prices, it simply stopped buying new books – that the entire industry is now experiencing one of the worst crises in its history.

Writers, who before received much less per book for a lot of books sold – and complained about it – are now in a much worse situation and receive almost nothing. The plunge in book sales has led publishers to cut way back on the number of new books they release.

Nothing learned

The saddest thing about the “we told you so” concerning the Book Law is that precisely nothing was learned from this mistake. At least, nothing in relation to the arrogance and superficiality in rewriting economic laws. Livnat has still to clean the spots of failure off her clothes, yet another minister is now following in her footsteps. In this case, it is even worse, since the minister involved is responsible for Israel’s economy.

It is, of course, Finance Minister Yair Lapid, whose greatest personal achievement – the zero rate VAT exemption for first-time home buyers, on less expensive new apartments bought directly from contractors – was “not intended for economists.”

The cabinet approved Lapid’s proposed bill on Sunday and it will now go to the Knesset. Lapid plans to finish the legislative process and implement the new law by September 1. The law is expected to cost the state some 2.5 billion shekels ($725 million) a year in lost revenues.

We are unable to understand how the finance minister, all of whose staff are economists and whose ministry’s activities are all based on economic foundations, can take pride in leading the passage of a law that “is not intended for economists.” Just try to imagine the finance minister of a northern European country taking pride in the fact that he's promoting a central law in complete opposition to the professional staff of his ministry, and in complete opposition to the opinion of all other economists. To the best of our knowledge, in leading nations around the world such a minister would not remain in his post for one more day, since the government and public would eject him immediately.

In any case, the problem with the zero VAT law is not in Lapid’s public relations, but the fact that this is once more a law that thinks it can force the laws of economics to behave the way that politicians want. The cabinet and Knesset once again are pretending that they can bend the laws of economics to the laws of the Knesset, while exposing their complete economic ignorance to the public.

This is because the zero VAT law will do exactly the opposite of what is needed to be done: The proposed law will inflame the demand for new apartments – in a market where the entire problem was created in the first place by huge excess demand.

The proof for this can be found in the harsh critique of the program from the Finance Ministry's former chief economist, Michael Sarel, who quit his job there because of the zero VAT law. Sarel analyzed the development of housing prices over the past decade, and showed clearly that prices are continuing to rise - even with a significant rise in the supply of housing over the past two years. The price of homes is also clearly rising faster than rents – and the ratio of the price of homes to rent has reached an all-time high this year.

This last finding is especially important. If the problem was just a shortage of new homes and many young couples being left without a roof over their heads, we would also have expected to see a sharp rise in rents, similar to that in the price of homes for sale. In reality, rents went up, but much less than the price of homes for sale - which shows that there is not a serious problem of a lack of housing. What we have is a problem of owning your own home.

Sarel has a number of explanations for the great rush to buy apartments, including at the expense of living more cheaply in a rented apartment. The main explanation – besides the low interest rates – is the low level of taxation on real estate. Since 2003 – the year in which the relationship between the price of buying a home and renting one began to drift apart – when capital gains taxes were levied on capital markets, investments in housing remained tax free. Only this year was a capital gains tax introduced on those who own a second home, but first homes remain untaxed.

Sarel estimates that this exemption from taxes on most real estate – one of the largest and most damaging tax exemptions to the Israeli economy today – is what makes the public prefer investing in a home over investing in stocks. It also increases inequality, since it mostly helps the better off. Those with more money buy more homes, and more expensive ones too. It also harms the capital markets, and as a result restrains economic growth.

Even if you can debate this conclusion and claim that buying a home is a proper social goal that the state should encourage - though remember, those who benefit the most from the tax exemptions on real estate are those who are better off to begin with – there is certainly no room for the false claim that the solution to high and rising housing prices is expanding the tax exemption on homes to include VAT. Sarel’s findings strengthen the suspicion that the tax exemption on homes is the root of the problem, and now we are going to exacerbate the problem.

So, Mr. Lapid - who is not an economist or a manager, and is also lacking in a higher education and experience - thinks his new law “is not intended for economists.” The problem is that economic laws do not read Facebook posts, and it is rather unlikely that these economic laws will be impressed by the uneducated opinions of the finance minister.

It is much more likely that the economic laws will continue the way they always have – in other words, the new VAT-exemption law will increase demand for new apartments and, therefore, bring about even higher housing prices. The housing crisis will only worsen, the state will waste 2.5 billion shekels of taxpayers’ money, and the 2015 budget crisis will deepen.

We will all pay the price, but especially the less well off, who are the ones who rely the most on government aid budgets. The important thing is that Lapid continue to celebrate his ignorance of economic laws, while our prime minister – who actually understands economics quite well – continues to hide and stay silent.

Pool / Yedioth Ahronoth
Olivier Fitoussi