Fundamentally Freund: Tax and spend, Israel-style

Just when Israel’s economic situation is facing some increasingly difficult challenges, along comes the Finance Ministry with plans to make things even worse.

With forecasts indicating that the country’s budget deficit in 2012 will come in more than 60 percent higher than previously anticipated, the number-crunchers at the Treasury are anxiously looking for ways to close the gap. Alarmed by a sharp drop in tax revenues, they have decided to do what bureaucrats with calculators do best: punch in higher figures and make the public toss yet more money into government coffers.

Marshaling all the obtuseness at their disposal, the Treasury has floated a proposal to raise Israel’s value-added tax from 16% to 17% on July 1. This, they say, would bring the government a windfall estimated at NIS 2 billion this year, as well as a whopping 4 billion NIS in 2013.

Now at first glance this might not sound all that bad. After all, what is another 1% between friends? But that argument simply does not wash.

If a normal household experiences a drop in income and finds itself spending more than it takes in, the natural thing to do would be to reduce its outlays.

Why should government be any different in this regard? Is our bureaucracy so lean and efficient that there is simply no place left to cut? I doubt it.

Moreover, you do not need an advanced degree in economics to realize that increasing VAT will reduce consumer spending. When prices rise, demand falls. This means fewer jobs and less growth, which naturally results in... you guessed it: less government revenue down the road.

But the Treasury doesn’t appear to be giving much thought to “down the road,” preferring instead to focus on a short-term fix, even at the expense of long-term stability.

Indeed, raising VAT will only encourage greater tax evasion, driving more economic activity underground and under the table. It creates a greater incentive to cheat, further eroding standards of honesty and morality in the commercial sphere.

And then there is the question of fairness. VAT is essentially a tax on consumption.

But the government already taxes Israeli breadwinners on their income. In other words, it isn’t enough that the taxman takes from you when you earn money, he also wants a larger piece of what you have left when you choose to spend it on something.

And as many economists have pointed out, VAT is what is known as a regressive tax.

Since low-income individuals spend a larger proportion of what they earn on basic items needed for subsistence, a rise in VAT ends up hitting them harder.

If the Treasury does go ahead with the planned hike, it would be the third time in the past three years that the VAT rate has been changed. In the summer of 2009, it rose from 15.5% to 16.5%, before being lowered back to 16% at the start of 2010.

These erratic fluctuations also exact a price, as they make it harder for businesses and individuals to plan their economic horizons.

To be fair, the primary concern driving the Treasury is the desire to prevent Israel’s public debt from ballooning. In recent years, it has fallen steadily as a percentage of GDP to under 75%. But there are far better and more urgently needed ways to tame the deficit than to stick the taxpayers with a higher bill.

Israel still suffers from a bloated and inefficient public sector where waste is rampant, and our economy is being choked by monopolies, oligopolies, over-regulation and an overall lack of competition.

Hence, the Treasury would do best to wield an axe in the direction of the budget, and compel our 30 government ministries to tighten their belts.

Cutting the red tape and unleashing the entrepreneurial power of the Israeli public, rather than taxing them to death, would go a long way towards reinvigorating the economy.

In these challenging times, the Finance Ministry would do well to recall the words of Ronald Reagan, who told an audience at Kansas State University on September 9, 1982, that “Balancing the budget is a little like protecting your virtue. You just have to learn to say ‘no.’” The last thing we need is another round of taxing and spending, Israel-style.

If the Treasury is serious about cutting the deficit, then let it stop squandering money it doesn’t have before they dare to reach still deeper into peoples’ pockets. In this case, a little bit of fiscal discipline can go a long way.