Why Tax Cuts Isn't What Israel Needs Now

Public deserves proper debate on how best to spend tax revenues the treasury has accumulated, not Moshe Kahlon’s fait accompli to drop tax rates and prioritize haves over have-nots.

Moshe Kahlon and Benjamin Netanyahu during a weekly cabinet meeting, June 13, 2016.
Israel Mark Salem

Week after week in recent months, Finance Minister Moshe Kahlon has arrived at his office in the morning and found himself with the kind of problem we’d all love to have. Reports from the Israel Tax Authority kept insisting that tax revenues were higher than expected, well beyond the budget estimates. Poor Kahlon had to scratch his head and think what to do with that money.

So what did he decide? First of all, to keep his cards close to his chest. It’s true that the figures were not secret: the treasury reports them each month. But Kahlon chose not to broadcast the surpluses, not to raise the issue for public debate.

Second, he made a decision: To use that money to lower taxes, hoping the supply continues in the future – corporate tax and income tax, plus the tax paid by high-tech companies and startups.

Kahlon finally announced his plan last week. Granted, the last details need to be ironed out (or weren’t revealed to the public). We still don’t know, for example, how each tax bracket will be tweaked. Therefore, we don’t know how the tax cuts will affect us all personally.

But the principle is clear: income tax rates will be dropping. To quote Kahlon, he is “giving the people their money back.”

People adore tax cuts, but one has to question whether it’s the best move for the economy in general, and Israeli society in particular, at this time. The answer: It may well not be. Here are five reasons why Kahlon’s tax cuts could prove to be a mistake in the long run.

1. Government policy shouldn’t be shaped with the aim of hiding money from coalition partners.

Why, actually, did Kahlon keep mum on the tax surpluses for so long? Why didn’t he come to the cabinet, report the state of affairs and summon his fellow ministers for a debate on the significance of the money and how best to invest it? Maybe it should be handed out to the poor? Or invested in infrastructure? Or given to the army, so they can finally buy new protective vests for all combat soldiers without picking and choosing who gets one? Maybe the health minister would finally convince the government that “life itself” prevails, so at least some of the cash could go to the hospitals?

That is what budget debates are: To determine how the government sets and implements its priorities. But Kahlon deliberately chose not to have that discussion. He may have feared that his colleagues in cabinet would get their mitts on the moola and use it for purposes that are not compatible with his worldview and political aims.

Maybe he was afraid the money would find its way to the religious, the settlers, army pensions, or other powerful interest groups. From his perspective, it may have been a sly case of Realpolitik. But from the loftier perspective of proper management of the state, that isn’t how decisions are supposed to be made.

2. Forecasts are being ignored.

It’s true that tax income surpluses (relative to expectations) have built up, and are likely to continue doing so for some months. But lowering tax is supposed to be a move for the medium- to long-run, and Kahlon’s present move is in stark contrast to the economic forecasts for the medium- to long-term.

Many forecasters suspect that the global economic slowdown will, inevitably, reach Israel too – and sooner rather than later. Exports and high-tech are already contracting. What economic growth we have been enjoying has resulted from rebounding private consumption by the public, and from a process of increasing employment rates, which is pretty much played out (Israel is roughly at full employment). . This does not look like a sustainable formula.

In other words, we seem highly likely to face slowdown soon, perhaps even layoffs. Tax revenues will diminish and suddenly, instead of tax surpluses, there will be holes.

If you think this is okay because the finance minister can always jack up taxes again, just like he’s cutting them – you’re wrong in two ways: First, that’s not how to create certainty and the desire to invest, which depends on long-term certainty in the business sector. Zigzagging tax policy isn’t helpful. And second, tax hikes just as the economy approaches recession just make things worse.

Economic theory recommends that countries manage their economies “against the trend.” When things are good, save; when times turn bad, use the money. Tax cuts now are the opposite of that wisdom. It’s saying, everything’s great now, let’s party! And when times turn rough and we have no money, Kahlon will simply hike taxes to pay the government’s bills and worsen the recession. Is that smart?

There’s another purely economic matter. Money that reaches the pockets of the well-off goes partly toward savings, not creating economic activity. Money that reaches the poor goes entirely on goods and services, and encourages further growth.

3. Tax cuts are regressive. Since about half of the population doesn’t earn enough to pay tax anyway, tax cuts help the richer half of the population. The poorest half remains the same. This outcome is regressive and, for all the slogans, it widens the gap between the haves and have-nots.

Although Kahlon has named reducing inequality as his top priority over time, and even set numerical Gini index goals, his decision to reduce taxes goes in the opposite direction.

Kahlon is also betraying his electoral base: right-wing voters in the middle and lower deciles who agree with the political line of Likud, but are angry at Prime Minister Benjamin Netanyahu and oppose his socioeconomic policies.

4. Israel’s social services are not wonderful.

When Israel is compared to developed Western countries, one problem that’s immediately clear is its low investment in civilian public services. The Trajtenberg Committee, empaneled to analyze the demands of the social-justice movement in 2011, made one key recommendation: To reduce the defense budget and put the money saved into social services. That did not happen.

Many Israeli economists think that the tax breaks companies get here are already generous enough. By international standards, our corporate tax rate isn’t particularly high. Instead of lowering corporate taxes, Kahlon could take the tax bonanza and strengthen social services – for example, by buying more beds for our overcrowded hospitals, an area in which Israel is one of the worst among developed countries.

5. A safety net goes to waste

Remember when the Israeli government squabbled long and hard about whether budgets should be for one year at a time or two? Netanyahu wanted a two-year budget for 2016-7. He himself wasn’t sold on the logic of biennial budgets, but Israeli governments rise and fall on the budget and he wanted to avoid hazardous votes to 2018. Kahlon twisted, turned, objected, delayed, said he wasn’t comfortable about preparing a two-year budget ... and then prepared a two-year budget, to which he was committed in the coalition agreement anyway.

The problem with two-year budgets is their rigidity. They tie the government’s hands, preventing it from adapting the next single-year budget to changes in realities such as slowdown, crisis or war. The finance minister had this bonanza of extra tax income and had the opportunity to create an emergency national slush fund. And what does he do? Gives the money to the richest third of Israeli society.

What should he have done?

Like anything in economics, we can only know the outcome of moves after they occur. Tax cuts have upsides. Israelis will spend even more on private consumption, thereby increasing total consumption. It could encourage local and foreign companies to invest more in Israel, or at least abandon thoughts of moving their operations to cheaper countries.

Who knows, maybe the global economy will suddenly pick up, peace will descend on the Middle East and the Israeli public will focus on economic activity, efficiency and growth rather than religious struggles, culture and the other differences dividing the many tribes living in the Holy Land. Maybe. If not, the finance minister’s decision to lower taxes right now is a political one, a cold one that does not sit with the promises he made to his voters, and contrasts with his obligatory duty to hold a transparent public discussion on a simple question: Who exactly should get the tax monies paid by Israeli citizens and now piling up in the Tax Authority’s cellars?