Analysis

Wanted: A Tax Policy for Israel's Economy, Not for Elections

Finance Minister Moshe Kahlon’s ban on tax hikes may be a crowd-pleaser but will lead Israel astray

Finance Minister Moshe Kahlon attends a ceremony for the signing of a housing agreement in Sderot, Israel April 9, 2018.
Amir Cohen/Reuters

“The finance minister’s position is that taxes won’t rise … his opposition to it is unequivocal.” That message was delivered by treasury Director General Shai Babad last summer in response to calls for raising the tax on tobacco, but the sentiments apply to any and all taxes. Over the last three years since Moshe Kahlon took over as finance minister, tax increases have never once been on the agenda. Not a single tax break has been rescinded.

Kahlon’s firm stance has meant that the Israeli tax system has undergone no significant reforms in the last three years. Tax thresholds were lowered, but the tax regime itself has been left untouched.

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The one major initiative he undertook, to impose a new tax on owners of three or more residential properties, was struck down by the High Court of Justice on technical grounds and legislation to pass the measure a second time never got off the ground. A plan by the Israel Tax Authority to tax the digital operations of internet giants like Google and Facebook has not gotten anywhere.

One of the most important steps Kahlon ministry did take was to adjust tax rates for companies that enjoy benefits under the Law for Encouraging Capital Investment, which was designed to ensure israel remained competitive tax-wise globally and to deter companies from moving production abroad.

Kahlon, generally speaking, has moved to lower taxes, reasoning that it would encourage investment and economic growth. He signed on to a one percentage point reduction in the value-added tax to 17%, cut the corporate income tax to 23% from 26% in stages; and rescinded customs and purchases taxes on consumer goods like electronics.

Likewise, he increased tax credits to working parents in the framework of his Family Net (as in net income) program. More recently, the Knesset with Kahlon’s backing expanded tax benefits for residents of the periphery over the opposition of treasury officials.

In light of these modest steps, Israel barely makes a mention in the latest report by the Organization for Economic Cooperation and Development surveying changes in member countries’ tax regimes.

“Among the countries that introduced the most significant tax reforms were a number of countries where tax reform was long overdue,” writes Pascal Saint-Amans, the head of the organization’s Tax Policy Center. At the head of the reforms’ list is the United States, followed by Argentina, France and Latvia. “Broad tax reform packages are consistent with the view that tax systems should be considered as a whole and that, as opposed to tax policies in isolation, the focus should be on the efficiency and equality effects of the overall tax system.”

In fact, Eran Yaacov, who became head of the Israel Tax Authority this year, has some ideas about reforming the system but if any of them include raising taxes, as they inevitably do, it seems he will need to wait until there is a new finance minister.

Saint-Amans notes in the OECD report that due to accelerated world economic expansion in recent years, there is no longer the same need to use tax reductions to spur growth. Instead, he joins the ranks of economists that are calling on OECD governments to take advantage if the relatively good situation to raise taxes. As much as needed.

Better to do it now, he urges, than to wait for a crisis when governments have no choice. “Fiscal policies should avoid the risk of an excessively pro-cyclical approach and be focused on medium-term challenges,” he writes.

In Israel’s case, the challenges include the need to improve labor productivity. The government could employ the tax system for that purpose and offer, for instance, incentives for skills training or to coax companies into acquiring state-of-the-art technology.

Another goal Israel has is to boost employment of Arab women, ultra-Orthodox men and the handicapped. The OECD praises countries that are using their tax regimes to upgrade their labor markets, especially through the use of negative income tax for lowest-paid workers. In fact, negative income tax is an area where Israel has made substantial progress in recent years by expanding payments, but the Bank of Israel thinks it could be doing more.

On the other hand, policy makers should be wary of focusing too much on the least skilled and lowest paid, as has happened in the last several years – it needs to fund new tools to encourage broader participation.

“The focus of tax reforms should … shift to supporting the longer-term drivers of growth and equity … in a manner that ensures their long-term sustainability,” says Saint-Amans.

That message echoes what Bank of Israel Governor Karnit Flug told Kahlon last year. She has warned that the government’s tax coffer are being filled by one-time tax windfalls and the treasury should avoid relying on them to fund long-term policies, like tax cuts. She rightly fears that the government will end up raising taxes when the economy suffers a downturn – the exact opposite of proper policy – and make things worse. That applies as well to temporary tax cuts, which the Bank of Israel warns inevitably become permanent.