Why Those Paying the Most Taxes Are the Happiest

Moshe Kahlon's anticipated nomination as finance minister is an excellent time to reexamine taxation as a tool for reducing income disparity.

Tomer Appelbaum

Last month, The Economist magazine published a graph showing the self-reported happiness scores of people in European states, with the Scandinavians topping the chart. In first place, and not for the first or second time, was Denmark. But Denmark also tops a different chart, one that would seem to contradict a high happiness quotient – that of the countries with the highest tax levels. A presentation published recently by Bank of Israel Governor Karnit Flug contained a graph showing tax rates in Organisation for Economic Co-operation and Development member states, and here, too, Denmark was first.

Looking solely at these two graphs, one might conclude that the more taxes people pay, the happier they are. But before the Israel Tax Authority adopts this model, it’s worth adding a third graph to the mix – yes, Denmark tops this one, too: government spending on social services (health, education, welfare, etc.) as a percentage of gross domestic product. Now it seems reasonable that the Danes are the happiest. This is where the equation pays off for citizens: You pay high taxes; we’ll see to education, health, pensions, vocational training and nursing homes.

It’s not the only explanation for the Danes’ high levels of happiness. There’s also the fact that economic disparity in Denmark is among the lowest in Europe. Successive social-democrat governments in Denmark and neighboring Nordic states have built tax regimes that create a more equal distribution of incomes than in countries such as Israel and the United States, where income disparity is very pronounced. Low inequality levels (in progressive welfare states) increased the happiness of their citizens and builds solidarity among social groups.

All of the above is the background for the issues the next Israeli government must address: inequality, the level of social services, the tax system and Israelis’ level of satisfaction with their lives.

A raw deal

Israel is not among the countries with the highest tax rates. At 30.6% of GDP, the tax burden in Israel, including both direct and indirect taxes, is below the OECD average of 34%. On the face of it, therefore, we have nothing to complain about on this score. But here, too, a single graph doesn’t tell the whole story. When we look at state spending on social services as a percentage of GDP, the gaps widen – and not in Israel’s favor.

Israel’s public social-spending-to-GDP ratio is 30.5% (it rose 0.5% in 2013), compared to an OECD average of 43.1%. In other words, Israel spends on social services exactly what its citizens pay in taxes, whereas the average citizen in other OECD member states receives much more than they pay in taxes.

Taxation rates are an important parameter, but more important is what is done with the tax revenue and what the state provides to the public. Israeli taxpayers are clearly getting a raw deal compared to the OECD average, never mind Scandinavia.

The conventional explanation for this gap is Israel’s high defense spending. Every shekel that goes to the defense establishment is one less shekel for social services. Every shekel that goes into equipment and munitions and training and defined-benefit pensions for defense employees means more students in every classroom, longer wait times for appointments with specialist physicians or lower social-security payments for retirees.

Another common explanation is Israel’s large national debt, which comes with high interest payments. Israel’s debt-to-GDP ratio has been dropping for a number of years, but is still high: Israel spends around 40 billion shekels ($10.2 billion) a year just on interest payments.

The frequent military operations and wars of the past several years have kept actual defense spending billions of shekels higher than originally budgeted. Another thing we have come to realize in the past few years is that the government uses the tax system mainly in order to fix budget problems, and has proved incapable of using tax policy as a tool for reducing social inequality. The outgoing government even attempted to use the tax system as a means for reducing housing prices (the plan to eliminate VAT on some purchases of new homes), but former Finance Minister Yair Lapid’s problematic proposal was not put into effect. Nevertheless, it did put the idea of differential VAT on staple goods on the table. Shas has raised this as a demand in its coalition negotiations, and on the eve of last month’s election Prime Minister Benjamin Netanyahu said he supported the idea.

Resisting the quick fix

After the new government is sworn in, these issues will come to the fore once again – especially in the event of widening budget deficits, economic slowdown or budgetary pressures. The fear is that, in such circumstances, the government will take the measures that it can, not the ones that it should. For example, it’s easy to raise VAT by one or two percentage points. That’s exactly what the previous two governments did. A 1% rise in VAT adds 4.5 billion shekels to state coffers. It’s very tempting, since there are no lobby groups to oppose it. But just try eliminating exceptions to which Israelis have become accustomed, such as the exemptions on VAT for fresh produce and for purchases made in Eilat, or tax benefits on pension funds, etc., and watch the wars begin. The government would soon back down in favor of the easy way out – that is, raising VAT.

The formation of the new government and Moshe Kahlon’s anticipated appointment as finance minister offer an excellent opportunity to reexamine taxation as a tool for reducing income disparity, without increasing tax rates in the highest tax brackets – the people who, in any event, bear the brunt of the tax burden.

How can this be done? If the government were to examine the 50 billion or so shekels it extends every year in tax exemptions to various sectors, it would discover that most of them go to the wealthiest and fail to serve their original purpose. For example, the employee savings plan known as keren hishtalmut: What is purpose of giving tax benefits to permanent, unionized employees whose present and future are guaranteed, merely to encourage them to put money into savings? The money is not used for its stated purpose – for professional training – and usually is spent on foreign travel or buying a better car.

The new government must hit the ground running when it comes to creating vocational training frameworks that can address the problems of rapid technological development, higher life expectancy and declining job stability. That is a real time bomb, which for the moment is being ignored by everyone because of Israel’s low unemployment rate. There’s no guarantee that the next finance minister will be there at the ribbon-cutting ceremony of this long-term project. But in addition to the planned reforms in the housing market and reductions to the cost of living, there is a need to take a long, hard look at Israel’s future employment market, while ignoring the complimentary low jobless rates of the past few years: They make it too easy not to prepare for the years to come.

P.S.

The economic growth in the world in the past three decades is defined as skills-dependent. People with the right skills for the time pull down big salaries and leave unskilled workers far behind. That is one of the reasons for the growing income disparity throughout the world in the past 30 years. It raises questions about the level of inequality in modern economies and how to reduce it. What is clear is that it is impossible to stop progress, or the people who develop thanks to their skills and abilities. What can be done, however, is to give others the skills they need in order to ride that wave, and to find the formula that will enable the state to improve the level of social services it gives its citizens. In the absence of such measures, we will continue to see shoot-from-the-hip moves such as raising VAT on one hand and eliminating VAT on certain items on the other, which cannot bring about genuine change.