Taking Stock / Happy Birthday, Sam!

Sam Bronfeld got a birthday present last week.

Three days after the 12-year manager of the Tel Aviv Stock Exchange griped to the press that Finance Minister Benjamin Netanyahu was hassling the TASE on its jubilee anniversary, the other minister at the Finance Ministry, Meir Sheetrit, accepted the plea of a delegation of brokers. Sheetrit decided to suspend implementing the resolution to lower tax on foreign investments from 35 percent to 15 percent, a move that would have equated it with capital gains tax on investments on the TASE.

Sheetrit's ruling was a major victory for brokers, bankers and their chief lobbyist, Bronfeld. It was also a stinging blow to investors and savers, whose fee payments keep Bronfeld and his buddies in clover.

Bronfeld - an economist by occupation, a former officer of the Bank of Israel, and a man who has penned many an objective analysis for this very publication over the years - knows perfectly well that discriminatory tax on Israeli and overseas investments is one of the most seriously warped things in the Israeli marketplace.

But for a long time now, Bronfeld the economist has kept mum, leaving the dais to Bronfeld the captain of the TASE and champion of the brokers.

Every novice economist, or tax expert, can explain why different tax rates on investments in Israel and investments elsewhere is bad for the tax system, and distorts the allocation of resources by channeling money to low-yield investments.

Imposing higher tax on foreign investments is essentially the same as slapping protectionist tariffs on imports to shield local manufacturers. But here the protectionist tariff doesn't protect a specific sector, it protects Israeli entities that raise money from the public to finance activities and investments.

Just as protectionist tariffs force Israeli consumers to pay higher prices, and save local manufacturers from the need to improve efficiency and be competitive, the protectionist tax protecting the local exchange comes at the expense of investors. It detracts from any incentive that companies and market players might have to become more efficient and competitive.

Staying close to home

The tremendous harm the different tax rates cause to the economy is not easy to see; but you don't need a degree in rocket science economics to see the damage to investors. Just look at the pathetic performance of the companies listed on the TASE, over the decades, and compare them with their peer companies listed on foreign exchanges. Now you know exactly what price this protectionism is exacting from investors.

Currently, only 10 percent of the general public's NIS 1.3 trillion financial portfolio is routed overseas. Leaving aside the general tendency of households to cling to the familiar home market, there is no economic justification for holding that big a portion of Israelis' investment portfolios in the bitty Tel Aviv arena, which is not exactly prime real estate on the global investment map, and where most of the companies fail to generate much value over the years.

Finance Minister Benjamin Netanyahu's decision to impose the same tax on Israeli and foreign investments from the start of 2004 could have been one of the greatest reforms ever carried out in Israel. It would certainly have been the biggest under his leadership.

The moment tax on Israeli corporate stocks and bonds is the same as tax on American or European companies, all the managements of all those companies listed in Tel Aviv will suddenly find themselves forced to toe the lines drawn by their peers abroad.

The moment the tax is made uniform, the managers of Israel's mutual funds, provident funds, pension funds and insurance companies will be forced to explain why they chose Koor Industries or IDB Holding Corporation shares or bonds over those of General Electric or Berkshire Hathaway.

The number of Israeli companies that could pass such a test is very small. The number of Israeli investment managers whose portfolios could pass the test of comparison with foreign companies is also vanishingly small. Bronfeld is directly representing the interests of not only the brokers and investment managers, but of the companies registered on the TASE too.

Living in dread

Gershon Salkind, manager of the Elco group, put it beautifully a year ago. He saw no reason to invest in Israel given the economic circumstances, he told us. Salkind, a businessman who operates via a corporation, quickly saw the obvious conclusion, which small investors forced to pay 35 percent tax on gains can't see so quickly.

Why did Netanyahu retreat from his tax revolution, which was supposed to kick off from January 1, 2004?

Perhaps because it wouldn't make good press like privatizing Bezeq (TASE: BZEQ) shares. But unlike selling shares in government companies via the TASE, which has become known for some reason as privatization, abolishing the shield protecting the local capital market would have been a dramatic structural reform.

Nor can we ignore the role of the biggest borrower the tax discrimination protects. Yes, it's the Israeli government, which finances its deficits by issuing bonds to the public. Could the government be quaking at the thought of the small investor having zero economic incentive to buy its bonds? Who knows? Maybe once the tax is flattened out, Israel's investors will prefer to invest in debt issued by other, more responsible governments.

And perhaps this would be the greatest contribution of flattening the tax. It would force not only the business sector but also the entire government establishment to compete with economic norms accepted the world around.