Warning: A More Social Israel Means Higher Taxes

Netanyahu may have gotten carried away when he cut government spending in the past 15 years, but adopting a model of bigger government will require higher taxes and civil-service reform.

In 1995, government spending constituted 52.7% of Israel’s gross domestic product. That percentage remained above 50% until 2003, the year Israel was slammed by the most severe recession since the early years of austerity.

It was 2003 when Benjamin Netanyahu became finance minister and promoted the idea that the economy was like a fat man riding on the back of a thin man. He meant that the fat public sector was weighing down an emaciated private sector.

Netanyahu deserves credit as finance minister for making good on his words and acting precisely as he said he would.

In 2003, he instituted a daring policy of reducing government spending to about 40% of GDP. Israel has been at about that level since 2010, and in 2014 in all probability finished the year with spending of about 40.3%. This figure prompts two comments.

Frugal ones: South Korea and Israel

First, the figure is lower than that of the governments of most developed countries.

And when Israel’s defense spending and debt-service costs (two budget lines that don’t contribute to the public’s well-being) are excluded, Israel is second lowest in government spending among members of the Organization for Economic Cooperation and Development, which groups most of the world’s developed economies. Only South Korea spends less on its citizens.

The masses of Israelis who took to the streets in the summer 2011 social-justice protests expressed their growing dissatisfaction with the country’s declining social, educational and health services.

Secondly, this level of spending carries benefits, not just costs. It is directly related to how much of Israelis’ earnings are collected by the government in the form of taxes.

In the 1990s, the tax burden in Israel was about 37%. Following the 2003 crisis and Netanyahu’s economic program, the tax burden declined to 30%. And this year, it apparently will be 31.2% after a round of tax hikes in the past two years.

Providing a wide range of services requires the government to have a lot of funding at its disposal, meaning a lot of tax revenue. The bigger government is, the more it needs to increase the tax burden, while smaller government requires a lower tax burden.

That’s the essence of the ideological differences about the economy in the world today. In marked contrast to the accepted view that there are stark differences in the developed world between socialist and capitalist economies, the reality is much more subtle.

Government presence in economy

All the developed world’s economies, including Scandinavia’s social democracies, tout free enterprise. But even the more capitalist-oriented segments of the developed world help the weaker segments of their populations with financial and other assistance.

Social-Security payments and food stamps have existed in the U.S. since the 1930s, and within President Barack Obama’s so-called Obamacare health-care reform are the beginnings of greater government funding in that sector.

The disparities are all a matter of proportion: the extent to which a country can and must provide services to its citizens and the extent to which taxes must be collected to pay for them.

In Scandinavia, for example, people expect a wide range of quality public services and are ready to pay taxes much higher than those in the Anglo-Saxon world. In the U.S. people prefer smaller government and more limited government services, but they also expect Uncle Sam to be sparing in taking money out of their pockets.

Israel vacillates between these two extremes. Netanyahu favors the American model of smaller government, low taxes and a lower level of services.

That’s entirely legitimate and doesn’t work badly. The economic-growth rate in the U.S., and in South Korea, is high. But it comes at the price of increased economic inequality.

In contrast to Netanyahu, some parties competing in Tuesday’s election are advocating a more social-democratic model of high taxes for a high level of services. That is also an entirely legitimate model; it’s backed by excellent evidence, certainly when it comes to reducing social disparities, in Scandinavia, for example.

The social-democratic model isn’t just a matter of higher taxes. It requires efficient government because nothing’s worse than a country that collects a lot of taxes but provides meager services in return.

Israel’s breaking point

This was the breaking point Israel faced in 1985, just before the government instituted a stabilization program that not only conquered hyperinflation but cut the government’s size.

The government failings of the 1970s and `80s were rooted in the change in the country’s socioeconomic policy, along with the shift from the social-democratic approach to a neoliberal one.

In the course of the current election campaign, one senses that things got a bit too carried away when it comes to spending cuts.

Israel’s rank as second lowest by this measure (and second lowest in welfare spending despite having the second highest poverty ranking in the developed world) is a problem. True, Israel is weighed down by its defense burden, which clearly crimps spending on civilian services, but it does not need to be that small.

That’s the reason that since 2010 Israeli government spending has stabilized. It’s also the reason that Netanyahu’s daring tax-cutting program was scrapped in 2009 and that a large number of taxes that were due to go down have since gone up.

Even Netanyahu himself has acknowledged that the trend toward smaller government had reached an end, as evidenced by his reconsideration of his tax-reduction plan. His associates say he is now prepared to consider raising taxes, for example, by eliminating some of the exemptions on pensions.

But from now on any decision regarding larger government will require the public’s readiness to pay higher taxes and the government’s concerted effort to be more efficient.

Burden falls on middle class

This will exact a heavy price on Israelis, particularly the middle class.

The idea that the government can spend generously on schools and hospitals simply by taxing the rich is mistaken. Higher taxes means mostly taxing the middle class, either by eliminating exemptions on pensions, continuing-education funds, fruits and vegetables and other things, or through higher tax rates on middle-class income.

The income tax for the middle class has dropped substantially since 2003 while income taxes on the top 10% of earners have already gone up.

By the same token, the idea that government can be made more efficient simply by cutting the salaries of top administrators is also misguided. More efficient government requires huge efforts to change how work is approached and salaries are paid.

Government work cannot advance without increasing labor productivity, which requires effective evaluation procedures and financial incentives along with differential wages and at least some managerial flexibility.

The model that protects public-sector jobs at all costs — a holy of holies — must change if the Israeli government and economy are to improve.

Being social-justice-minded means above all being prepared to pay the price, both with respect to taxes and job security. If people want to receive, they also need to be ready to give.