Want Social Justice? Raise Taxes

Leah Achdut cautions against Israel losing its economic achievements in a populist wave.

Oren Majar
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Oren Majar

The vision of reviving the welfare state is right, says Leah Achdut. But magic wands don't exist and it will take time, warns the professor.

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Israelis attending a social justice protest in Haifa, August 13, 2011. Credit: Hagai Frid

Achdut, a member of the Economics and Management Department at the Ruppin Academic Center, a member of the Economics and Society Program team at The Van Leer Jerusalem Institute and former deputy head of the National Insurance Institute, is also part of the Israel 2021 endeavor. Asked about the social protest, Achdut agrees that the government needs to change its priorities, but warns against Israel losing its economic achievements.

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"Fiscal discipline and the smallness of the deficit must be preserved," she says. "From what I hear, I don't think the protesters understand that to have a welfare state, you need to pay taxes."

TheMarker: Some of the protesters belong to the richer classes yet still feel short of money. Will their situation improve?

"Even if we revive the welfare state, that doesn't mean everybody who wants something from the state will get it," Achdut says.

"Many members of the middle class demand more than in the past, for instance to give birth at hospital in a private room, or free daycare from three months. Why three months? Let's start free education from three years or four," she says.

"When you look into who pays and who gets, things get muddy," Achdut goes on. "Who is the middle class? Some 65% of employees in Israel make up to the average wage, NIS 8,500 a month. Only 30% - the highest three deciles - gross more than NIS 9,000. Can it be that people who gross NIS 20,000 subsidize everything the rest want? If taxes are lowered, on cars and VAT, there will be no welfare state.

"They can't have their cake and eat it too - free education and low tax on gasoline. The welfare state has limits," says Achdut.

"In Scandinavia, social solidarity takes the form of the richer paying more tax, benefiting the poor and middle class. Right now, there is no vision in Israel for how things should be," Achdut says. "But that's okay. The murkiness will drive processes."

When did the welfare state disappear?

"The extent of a welfare state is measured in public expenditure as a function of GDP. Israel began reducing that ratio in 1985," Achdut says. "It had to be done because public expenditure had reached 70% of GDP; but by the start of this millennium, that ratio had been reduced to 50%.

"From 2002 to 2003, the government continued to cut back, citing the recession. Politically it was possible with Ariel Sharon as prime minister and Benjamin Netanyahu as finance minister, and the Shinui party supporting these processes.

"I was VP of research at the National Insurance Institute at the time, and remember we had doubts and shouted out against the cutbacks, the cuts to welfare for the unfortunate and support for the unemployed, ending rent subsidies and discounts on public housing," Achdut says, adding that the government halted training programs to help people gain skills and earn more, and that poverty grew among the working classes as well.

"The middle class didn't realize it would start with the poor but reach them too. They may not need income subsidies but they need child allowances, and some need help with rent, or reasonable unemployment benefits they could live on."

Growing more distant from the OECD

What is our situation today relative to the world?

"Today, public expenditure as a function of GDP has fallen to 42%. In practice, excluding defense costs and interest payments, disposable income for spending on services to citizens has fallen to 33%, compared with the OECD average of 40%," Achdut answers.

"In other words, we're trending downward and going farther from the OECD average to which we aspire. It shows in every criteria - expenditure on education per pupil, expenditure on healthcare, the amount the government has to reduce inequality in the labor force through allowances. These are very low percentages. It's not surprising that a government with such low public expenditure can't provide good services to the citizens."

The government claims that's how to achieve economic growth.

"International comparisons show that countries that spend a lot and also collect a lot of taxes don't grow any less than countries that charge little tax and spend little," she rebuts. "The Scandinavian countries grow perfectly well with high expenditure and taxation."

During the last two years Israel's prosperity filtered down through job creation: unemployment is very low, which is good for all. Yet one cannot ignore that much of GDP originates in capital and profits, while the proportion generated by labor has been shrinking, Achdut says.

"During the past 10 years, inflation-adjusted wages have barely increased. The tycoons earn more and pay less tax, which is why inequality has increased," she notes.

What could be done in the short run of a few years, and what is the long-term solution?

"Since public expenditure as a function of GDP has shrunk so much, there's room to increase it without imperiling the economy," she says. "Immediate steps can be taken regarding tax, such as canceling the tax cuts Netanyahu planned by 2016. We need the tax income to pay for services. So don't lower corporate tax to 18%, which would be the lowest rate in Europe. Don't lower income tax, because that would help only the richest. Don't continue raising indirect taxes through gasoline and the like. Freeze indirect taxes where they are," says the professor.

"Maybe VAT on food could be abolished, but all in all, the tax burden shouldn't be lightened, it needs to be increased to increase the resources available to the welfare state. Meanwhile, the mix of direct versus indirect tax should be rethought.

"Over time, canceling tax discounts won't suffice. People grossing NIS 100,000 a month should pay more tax. Even tax on capital isn't high enough or progressive enough. The social security system needs to rethink increasing participation by employers: They should provision more to National Insurance Institute. Until 1997, employers financed the health system, paying 5% for each worker. That doesn't exist any more. It did make employment costs less onerous, but there's nothing for free in economics."

Can the incumbent government institute such change?

"The protesters are right to demand that fundamental concepts of state management change," answers Achdut. "I don't know how Netanyahu will change his spots and adopt a policy that opposes his blind faith in small government. Therefore, to change things, you need a gradual process that strengthens the public's faith in the leadership's desire to change things - and that can do it. Faith is critical. Can the present management change its spots? I doubt it. It will take a different leadership."