Taking Stock / Tax Reform Kaputa

Meir Kapota, the man in charge of the state's tax revenues, filed his annual report on the State Revenue Administration this week. The report, which relates to 2002 and 2003,

provides accurate, final data for 2002 and preliminary estimates for this year. Given that Finance Minister Benjamin Netanyahu has staked his name on cutting taxes, Kapota's report is of interest.

1. The latest figures put tax collection at NIS 143 billion in 2003, NIS 15 billion less than the treasury's estimate on which its 2003 budget, prepared in 2002, had been based. The tax people blame the gap on unexpectedly low economic growth, negative inflation and the deferral of tax refunds from December 2002 to January 2003.

2. But the truth is that the main reason for the gap was the treasury's unrealistic growth forecast for 2003. If officials had acknowledged the true situation when formulating the budget in 2002, they'd have had to slash the figures much more cruelly, or raise the deficit target, which they didn't want to do for fear of reactions from the market and rating agencies. Their solution? Base the 2003 budget on impossible tax revenue projections.

3. For 2004, the treasury expects tax revenues of NIS 149.4 billion, an increase of 4.3 percent in real terms compared with the estimated take in 2003. That forecast assumes 2.5 percent GDP growth next year, a 1.7 percent increase in prices, and an extra NIS 800 million tax take due to legislative amendments. And what happens if those rosy forecasts prove misguided? See (1) above.

It's a miracle!

4. The most intriguing headline in Kapota's report was that in 2002 and 2003, the tax burden in Israel fell, after years of increases.

That miracle had nothing to do with cutting taxes. Far from it. In the last two years, a long list of direct and indirect taxes were raised. The drop in the tax burden is due to a well-known phenomenon, namely that when economic activity contracts, tax collection contracts faster.

5. More impressive than the bombastic declaration regarding the shrinking burden is the fact that the Israeli's tax burden is no greater than that of its peers in OECD countries. The locals wouldn't buy that, firmly believing we pay much higher tax here.

Hmm. Let us look at the details. The calculation of tax in Israel does not include deposits by employer and employee for severance pay, pensions and insurance beyond the framework of the National Insurance Institute. In most western countries, such deposits are part and parcel of social security payments.

Paying high social security payments in the West enables pensioners to maintain a high standard of living. Israel's social security payments are very low. Anybody trusting their future to NII stipends is doomed to a steep drop in standard of living after retirement.

If we add deposits in pension programs to the tax burden, in order to validate the comparison with other countries, then our burden rises by 5 percent to 45 percent of GDP. And that boosts Israel to nearly the top of the tax burden list, second only to Scandinavian countries.

6. The tax reform designed by the Rabinovitch panel was supposed to gradually reduce tax on labor by 2007. Finance Minister Benjamin Netanyahu explained that tax on labor is too high in Israel, and announced he would make every effort to expedite the reduction.

Whither the tax burden after tax on labor is reduced? Back to where we were in 1996.

It transpires that the Great Tax Reform, purporting to portend lower tax on labor, is a mere correction of the surge in tax in the late 1990s, when tax brackets were left bereft of updates.

7. A reminder, for dessert. Those tax brackets are the most prominent example of the warps in Israel's tax system. Even after the reform, marginal tax on labor rises to 45 percent from a salary of NIS 11,300 a month.

There are other countries where marginal tax maxes at 50 percent. But there is only one where you're considered wealthy enough to quality for a 45 percent rate of marginal tax from a wage of $2,500 a month.