"I'm surprised at Israel Securities Authority Chairman Shmuel Hauser for talking about reducing the tax on the stock market. This is a huge mistake and must be stopped." With these words Prof. Avi Ben-Bassat, president of the Israeli Economic Association, concluded his response last week to Hauser’s suggestions, which were presented as part of a comprehensive plan to spur trading volumes on the Tel Aviv Stock Exchange.
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Indeed, the committee appointed by Hauser for improving trading and increasing the stock market’s liquidity, which includes economists and accountants, really does intend to recommend this step. On page 105 of the interim report it presented two weeks ago, the committee wrote: "Along with the many reforms, despite about two years having passed since the last reform, reducing the tax rate for investments by Israeli residents in the stock market … will have an encouraging effect on TASE trading." It concludes: "Therefore the committee recommends that the government consider reducing the rate of capital gains tax. A reduction in the tax rate will encourage companies to raise capital on the stock market and could actually lead to an increase in government tax revenues."
But the committee's conclusion doesn't rely on economic logic or on experience, and certainly not on ethical considerations. First, Israel's tax rate on capital gains isn't high by international standards. Right now, it is about the same as in other countries. In fact, it was raised twice over the past decade precisely for the purpose of reaching the same level, thereby ending the historical anomaly that led to speculative investments being more worthwhile than others.
Second, assuming Hauser isn't thinking about doing away with the capital gains tax entirely, a reduction of several percentage points isn’t likely to affect public behavior and stock market trading. How do we know? Because at the beginning of 2012, following the Trajtenberg Committee recommendations, the capital gains tax was raised five percentage point to a nominal level of 25%, and the increase wasn't felt in activity, in trading volumes, or in the willingness to put away savings. Therefore it can be assumed that a reduction of several percentage points won’t have any effect in the other direction either.
Billions for the rich
Even economic theory and consensus don't support the proposed move. As explained by Ben-Bassat, in the academic world it has been demonstrated that taxing income earned on financial assets has hardly any effect on the public's willingness to save. "The rate of savings isn't influenced by changes to the return on savings, and I assume the ISA chairman's intention is to convince the public to save in the stock market thanks to a slightly larger return after the tax goes down. But it doesn't work this way. The willingness to save is mainly influenced by everyone's life cycle and their consumption decisions."
Ben-Bassat also warns against the danger of making tax rate decisions for addressing localized problems like the drop in stock market activity. "We spat up blood to arrive at a situation where the tax rate on capital gains from the stock market would be identical to what is accepted worldwide. Does anyone promise we can raise the tax back up once the stock market has recovered? Will we start lowering and raising capital gains tax according to stock market turnover? That's ridiculous.”
But if Ben-Bassat finds economic flaws with the security authority's proposal, it doesn't take an economist to understand the proposal fundamentally defective from a moral standpoint. Even today at 25%, the capital gains tax is an enormous benefit to the rich. The ones who enjoy it are the wealthy with money to invest in securities and other financial assets. The rest of the public, however, pays tax on its earnings – mostly from labor – where the rates are much higher. The marginal tax on income from work can reach 48%, or even 49%.
In principle there shouldn't be any difference between taxes imposed on work, capital, real estate, interest or anything else. There is no moral or basic difference between them. What should be done is combine all sources of income for each person into a lump sum and then tax it at a uniform rate, according to progressive tax brackets.
But calculating capital gains can be complicated. Not every country wants to apply mandatory annual reporting and force its citizens to file tax returns. So many countries, including Israel, have chosen to solve the problem by means of a uniform 25% tax on capital gains. This is a lousy solution; it gives a great advantage to people of means and is responsible to a great degree for the skyrocketing gap in income and assets between the 1% (and mainly the 0.1%) and the other 99% – but it was chosen in any case for practical reasons.
And now Hauser comes and wants to reduce the 25% rate, in one swoop giving the rich another gift worth billions of shekels. Why? Because if capital gains tax, which in any case is low compared to the tax on work, drops to 20%, or to 15%, or to 10%, the ones who will gain are mainly those who have most of their money invested in securities.
In most countries it is commonly thought that a tax is "just" as long as it is progressive. The tax rate increases as income increases so that people with high earnings pay more tax than those with low earnings. Any tax that isn't like this is regressive: The poor pay at a relatively higher tax rate than the wealthy. The chairman of the securities authority, with his proposal, is making the tax system in Israel more regressive and in favor of people of means.
If Hauser's solution were to bring about the desired results - an increase in stock market trading and in the process enabling new and promising companies to tap the bourse for finance - there would be at least some logic in holding a public debate on the proposal. But even this isn't true. The declining volumes in trading is a global trend, and markets several times more developed than ours – the ones Hauser wants to mimic – have also suffered a drop in liquidity. There is no logical explanation or economic experience to indicate that lowering the capital gains tax for the stock market leads to more activity or any significant rise in prices.
The last time the tax on capital gains was changed, the effect on activity was marginal at most. The proposal of solving the stock market's liquidity problem by reducing the tax is therefore a mistake. The only assured result will be the widening of the gap between the rich and everyone else.