Fighting tax evasion

There is a real danger that some might try to use Bank of Israel’s report to stoke a new socioeconomic protest.

March 29, 2012 22:36
3 minute read.
Bank of Israel Governor Stanley Fischer

Bank of Israel Governor Stanley Fischer 370. (photo credit: Sasson Tiram)

On the occasion of the release of the central bank’s annual report to the government, Bank of Israel Governor Stanley Fischer had many words of praise.

“The Israeli economy is in good – if not excellent – shape,” noted Fischer. And this was in large part thanks to a steady reduction in government expenditures which have led to a low fiscal deficit and debt-to-GDP ratio.

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But there were also words of criticism. Employment rates among populations that have traditionally not worked – haredi men and women, Arab women and the uneducated – have been growing. But while the gaps between rich and poor have been shrinking, this trend has been negatively impacted by our taxation system, which has become less progressive than in the past. After deducting taxes – both direct ones such as income tax and indirect ones such as Value Added Tax – the gaps between the rich and the poor have been exacerbated.

Unfortunately, there is a real danger that some might try to use Bank of Israel’s report to stoke a new socioeconomic protest in favor of higher taxes for the rich. However, the report – which focuses on 2011 – is now outdated.

As a result of this summer’s socioeconomic protests, our government established the Trajtenberg Committee which made a number of significant recommendations that have since been passed by the Knesset. For instance, the corporate tax, which has gradually fallen over the past decade from 36% to just 24%, was raised a percentage point to 25% in accordance with the committee’s recommendations, resulting in an additional NIS 700 million in state revenues. However, the government should resist populist pressure to make addition tax hikes, which would push the corporate tax rate here higher than the 2011 average for OECD countries of 25.5%. Caving in to such pressures might convince local businesses to relocate abroad – not unheard of in this era of globalization – resulting in a much larger loss of tax revenues.

The Knesset also passed Trajtenberg Committee recommendations to lower income taxes for the middle class (those with an income from NIS 8,000-14,000 a month) while raising the income tax for those who earn more than NIS 41,000 a month.

Still, indirect taxes remain the most problematic aspect of our tax system. VAT, customs, excise taxes and other indirect taxes provide about half of our tax revenues, compared to just a third on average among OECD countries. Indirect taxes are inherently unfair and regressive since the poor and rich pay the same 16% VAT for basic necessities such as food and clothing.

One of the reasons we rely so much on indirect taxation is because VAT and other types of indirect taxes are relatively easy to collect. In contrast, when it comes to income tax and other direct forms of taxations, there is a notoriously high level of tax evasion.

According to a 2007 World Bank report, Israel’s real economic activity is 23% more than what is reported. This lively black market provides tax-free incomes for thousands of Israelis.

This might explain why the average Israeli household spends more than it earns. Last summer the Central Bureau of Statistics reported that in 2010 the average net income per family was NIS 12,020 a month, while the average expenditure per family was NIS 13,496 a month. It could be that a large percentage of Israeli families maintain steadily growing overdrafts in their banking accounts or run up enormous debt. But it could also be that many of us receive additional income that we choose not to report. On one hand this is good news, since it would imply that Israelis are better off than they let on. But it is also bad news because the state is being robbed of important tax revenues.

Instead of instituting additional tax hikes on the income of the rich or on capital gains and corporate revenues, more effort should be devoted to tax collection and broadening the tax base. Large black markets continue to flourish – particularly in the Arab and haredi sectors – and they need to be eradicated.

Raising taxes on business activity, on capital gains or on the highest salaries might sound fair, but such moves are counterproductive as they tend to lead to a fall in economic growth, relocation of businesses and more aggressive tax sheltering or evasion.

What the government should be doing is using more aggressive methods to enforce the law by tracking down and punishing tax evaders.

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