The Israeli Middle Class Is Shrinking - but Only Slightly

If the government continues with its plan to cut taxes, it will mostly benefit the wealthy at this point, since it involves reducing the highest marginal tax rates, not the average tax rate

There's an old chestnut that in Israel one-third of the population works, one-third pays taxes and one-third serves in the reserves.

The problem is that it's the same one-third.

Assuming most readers of TheMarker are members of this third, then I have good news for them: You're a little less bad off than you may have thought.

I am referring to the bottom part of this third, the part that calls itself the middle class. The conventional wisdom is that Israel's middle class carries the country's entire economic burden on its shoulders, and that it is collapsing under the weight.

A study conducted in March by the Knesset Research and Information Center showed this is only partially correct. The middle class is indeed not that well off, but it is not much worse off than middle classes in other countries. And the somewhat good news is that while the middle class is eroding, it's doing so only slightly.

Definitions are critical

Of course we need to qualify these statements. The Knesset Research Center's study, prepared for MK Ruhama Avraham Balila (Kadima ), used a very broad definition of the middle class.

The accepted definition in the U.S. is people who earn between 75% and 125% of the average wage.

In Israel, because of the high poverty rate, the average wage is depressed and only 25% of Israeli households fall under the American definition of the middle class.

Therefore, the Knesset Research Center broadened its definition to include people who earn between 75% to 200% of the average wage, or in shekel terms, people with gross monthly incomes of NIS 7,300 to NIS 20,000.

This definition covers 43% of Israeli households - and these are the people that in this article, I will call the middle class.

Based on this definition, the lower class makes up 37% of the population and the upper class, 20%.

The research paper notes several interesting facts about this 43% called the middle class.

First, it includes a slightly smaller percentage of the population than the average in the Organization for Economic Co-operation and Development, but only slightly. This means that despite Israeli society's heterogeneous nature, it has a similar proportion of middle-class citizens to other OECD countries.

Second, the wages within the middle class have been eroding for years, but not dramatically. In 2004-2008 the income of the middle class eroded by 2%, while the lower class's income fell 3% - and upper-class incomes increased 3.5%.

This is certainly not encouraging, but it is also not a tragedy: The middle class is being eroded all over the world.

Taxes matter - but only to some

Third, it turns out that this 43% of households receives 40% of national income before taxes. The lower class takes 12%, and the upper class, 48%. After taxes, the middle class does slightly better - its share of income rises to 47%, while the upper class receives only 40% and the lower class's share increases slightly to 13%.

But the post-tax improvement of the middle class's situation affects only the upper-middle class, those earning NIS 12,000 to NIS 20,000 a month. They are the ones whose relative income increases, thanks to the fact that they pay lower tax rates than the upper class.

Income tax breaks do almost nothing for the lower-middle class, those earning NIS 7,300 to NIS 12,000 a month. The reason is the very high tax threshold in Israel: Large portions of the lower-middle class, using our definition, do not pay much income tax, if they pay at all, and therefore they receive the same wages before and after tax. For example, a woman with three children pays no income tax until she's earning at least NIS 8,800 a month gross, which would put her deep into our definition of middle class. Even a man who earns NIS 8,000 a month, about the average monthly wage, pays only NIS 500 in income tax.

Therefore, additional tax breaks or benefits won't do much to help these people.

What can be done?

Then how can we help out Israel's middle class? First, by recognizing that income tax policy is not the solution. The tax reforms until now have improved the situation of the middle class, but only because they aided the upper-middle class. Sticking with the tax reforms scheduled through 2016 will mostly improve the status of the upper class, since they mostly cut marginal tax rates for the highest wage-earners and not the average tax rate.

The future tax reforms will only erode the middle class' share of the national income pie. That is why we need to convince Prime Minister Benjamin Netanyahu to forgo the rest of the tax cuts.

Second, we need to examine the aid the state offers the middle class, of which there is not very much, all told.

As a modern social-welfare state, and not a particularly rich one at that, Israel focuses its aid almost completely on the lower classes. This is a wise policy, but the middle class derives almost no benefit from it - yet pays a price for it.

The Knesset Research Center says the lower-middle class receives transfer payments worth only 2% of its income - not very much at all. And the upper-middle class pays about 8% more in taxes than it receives back from the state in transfer payments.

It is not clear that Israel has enough resources to expand its social-welfare policy for the middle class, but it would certainly be appropriate to consider a policy to ease the cost of critical expenses borne by the middle class, such as preschool education.

Currently, 15% of government subsidies for day care go to lower-middle class families. Families at the upper end no longer get anything.