Netanyahu's Economic Adviser: High Growth Is Israel's New Normal

In the clash over tax cuts, Prof. Avi Simhon takes the view that there’s little risk in lowering rates because the reductions will pay for themselves

Prof. Avi Simhon heads to a cabinet meeting, July 2016.
Prof. Avi Simhon heads to a cabinet meeting, July 2016. Alex Kolomoysky

Over 400 American millionaires and billionaires plan to send a letter to Congress this week asking lawmakers to vote against President Donald Trump’s plans to reduce taxes on the wealthy, which they say would increase the budget deficit and exacerbate inequality.

The letter shows the great interest that taxes hold for Americans. In Israel, by contrast, Finance Minister Moshe Kahlon’s plans to use the budget surplus amassed this year to cut taxes are of interest to only a handful of officials and politicians.

Officials, led by Bank of Israel Governor Karnit Flug, mainly oppose the cuts, saying the fiscal surplus is temporary and shouldn’t be the basis for lowering taxes. Politicians, including Prime Minister Benjamin Netanyahu, are backing the cut.

And giving them expert backing is Prof. Avi Simhon, the chairman of the National Economic Council and an enthusiastic supporter of cuts. He is convinced that lower taxes spur economic growth and are almost always a good thing.

Indeed, the Israeli economy is so strong that the risks the treasury and Bank of Israel warn about are small.

“When I taught students 10 years ago about the link between taxation and growth, I pointed to theoretical proofs that lower taxes speed growth and said there was no empirical evidence,” he told TheMarker. “Today there is a lot of clear evidence of the connection,.”

He points to the work of Christina Romer and David Romer tracking the impact on growth of changes in taxation from 1945 to 2007. It found that each 1% reduction in taxes yielded 1% increase in economic growth, while each 1% tax hike cut growth 3%.

The Romers’ paper drew a lot of attention because of its rich use of data but also because Christina Romer had chaired President Barack Obama’s Council of Economic Advisers.

The tax-growth link is still the subject of much debate, but Simhon said he has applied the Romers’ conclusions to Israel and found similar results, so the risk of a tax cut is minimal: The lost revenue is recovered through faster growth, which boosts tax collection.

“It’s true there’s a point where the tax burden is so low that further tax cuts will only hurt growth, but we’re very far from this point,” he says.

Simhon takes issue with the central bank and the treasury’s view of Israel’s rapid economic expansion.

“The Bank of Israel errs in thinking we’re in an economic boom now, a boom that’s fated to end so we won’t enjoy a tax surplus in the years ahead,” Simhon says. “We’re not in a boom, we’re simply in a period of average long-term growth. If we act correctly, we’ll continue to see growth at the rates we’ve seen in recent years.”

A mergers and acquisitions deal like Intel-Mobileye, which was worth $15.3 billion and is generating a huge tax windfall, isn’t a one-time phenomenon but something likely to happen regularly every few years. Israel’s high-tech boom is a fixed feature of the economy and policy makers should get used to it.

“Israel is a state with a debt-to-GDP ratio close to 60%, a current account surplus and foreign currency assets that exceed debt by more than $100 million,” he says. “We should get used to the idea that the economy is in good shape, so there’s no major risk in reducing taxes.”

In any case, Simhon is not proposing that the entire tax surplus go to cutting taxes, just 2 billion to 3 billion shekels ($560 million to $850 million) of the 20 billion shekel surplus, and to cut taxes on salaries under 30,000 shekels a month – wages typical of younger high-tech engineer.

“Many salaried workers making up to 30,000 shekels are paying taxes today of 40% and it’s critically important that we keep them here in Israel,” he explained.

He isn’t bothered by the fact that tax relief should be reaching up to pay levels like that, which is three times the national average. “In recent years we’ve done a lot to reduce inequality and have succeeded. We raised the minimum wage and introduced negative income taxes at significant rates, so that today pay for the lowest earners in Israel is about at the same relative level of those in France. A decade ago it was 60% of France,” he said.