Why Israelis Will Never Attain Western Living Standards

Someone has to pay for Israel's heavy defense expenditure; the question is who.

A desperate act by Moshe Silman, a self-employed man who fell into financial straits and found Israel's welfare state hardly willing to offer assistance, has reminded us just how tight-fisted the system really is.

New comparative data from the Organization for Economic Co-operation and Development reveals that because of the global financial crisis, the developed countries increased welfare spending to 22 percent of GDP. In Israel, that's 16 percent.

Israel has always lagged behind the rest of the world when it comes to welfare spending. Since 2003, this gap has widened dramatically due to welfare-allowance cuts in Israel coinciding with higher welfare spending in the developed countries.

Israel has the perfect excuse for this historic gap: defense spending.

It bears remembering that defense expenditures include not only direct costs, but also indirect costs, such as interest. Israel pays double the interest rate of the other OECD countries -- a high security-risk premium charged by the world. As a result, the state has less spare cash to spend on social welfare.

This is a mathematical fact: The standard of living in Israel will probably never match that of other Western countries, because of the burden of its security expenses.

But an analysis by Professor Momi Dahan, head of the School of Public Policy and Government at Hebrew University, reveals that the security burden is only part of the reason for Israel’s low spending on of welfare. Dahan points out that since 2003 -- when then Finance Minister Benjamin Netanyahu instituted a policy of privatization, which reduced the government's contribution to GDP -- government spending has declined equally on interest, security and civilian expenses.

The reduction of government spending, especially on aid to vulnerable segments of the population, marked a turning point in the government’s policies (spending on security and interest has been declining since the 1980s).

The exception to this pattern is that the spending cuts on welfare, begun in 2003, where the result of Netanyahu's deliberate economic policy was to reduce government involvement in the economy. Therefore, together with cutting government expenditure, he also lowered the state's tax revenues through tax cuts.

This was a choice to lower taxes (for the stronger elements of society) at the expense of government services (for the poor).

"The surplus spending on defense had to be financed by imposing more taxes on Israelis or -- if we wished tax at the average rate of other developed countries -- by reducing civil expenditures on welfare and education.” writes Dahan.

Boiling down the question of priorities: Who will pay for the heavy defense spending, he says.

The underlying logic

Before we accuse the prime minister of concocting draconian economic policies that oppress the poor, we should recall the logic behind this policy.

First, Israel's spending on welfare surged at the start of the 2000s without helping to reduce poverty or boosting the participation rate in the labor force. So Israel, which has a huge problem of big population groups preferring to subsist on welfare rather than work – decided to tackle the issues by reducing welfare support.

Second, Netanyahu is a big believer in the idea that smaller government through tax cuts is the way to accelerate economic growth.

On the face of it, he's right. Following the massive job and tax cuts of 2003, Israel began a five-year period of accelerated growth. An analysis done at the National Insurance Institute (Israel's social security institute) did sharply narrow inequality (Israel's Gini coefficient - which measures this index measures the degree of inequality in the distribution of family income - declined significantly between 2002 and 2010). Netanyahu's economic view that the best way to help everyone (including the poor) is through growth, proved correct.

But this victory in reducing inequality (as a result of growth) was completely negated by the increase in inequality due to tax and welfare cuts.

The broader Inequality Index shows that inequality got worse between 2002 and 2010. This suggests that the policy of accelerated growth through budget and tax cuts is correct at its core – if adopted in moderation. Israel's problem is that starting in 2007, the state lost its sense of perspective – tax cuts led to yet more tax cuts and ultimately negated the achievements this policy had made in reducing social inequality.

Third, the whole working, tax-paying population (for the most part, the middle class) benefited from the tax cuts. For instance, Israeli citizens only contribute 5.6 percent of their incomes to national insurance, compared with 9.1 percent in other OECD countries. But given that we pay almost 40 percent less, is it any wonder we also get a lot less?

Also worth noting is the fact that Israel’s national insurance contributions differ most from those of other countries when it comes to employers. Israeli employers only pay 1.4 percent of their revenues to the NII, while other developed countries pay 5 percent. Because employers’ profits partly trickle down to their workers, this means reduced payments for everyone. But the saying “You get what you pay for” is also true when it comes to a welfare state.