Shekel money bills.
(photo credit: REUTERS)
Israel ranks 54th out of 190 countries in the 2018 Ease of Doing Business (EDB) index published by the World Bank Group. However, if one looks at the “ease of paying taxes,” a sub-index of the EDB, Israel ranks 96th, far behind most developed economies.
These rankings show that Israel needs to improve its taxation system to better compete internationally and create a friendlier business environment for local firms. Today, Israeli entrepreneurs face two main obstacles when complying with tax law: a relatively high rate of corporate taxes, and a very complicated and costly bureaucratic process.
The rate of corporate income tax in Israel is currently 25% and will be lowered to 23% over the next two years. This tax reform is a positive development for the economy, but a further reduction of the corporate tax rate will be needed if Israel wants to attract foreign investments and compete on the international markets.
Countries in the OECD with similar size economies have already adopted tax rates below 20%, such as Switzerland (8.5%), Ireland (12.5%) and Hungary (9%).
Israel understands that lowering the corporate tax rate enhances business density and entrepreneurship entry rates, as seen in the hi-tech industry. The hi-tech sector, the pride of the Israeli economy, is subject to a much lower corporate tax rate, ranging from 6-12%, less than half the tax rate applied to the rest of the economy.
The policy of a low corporate tax rate has proven very beneficial to the hi-tech sector, which has enjoyed a 6% rate of economic growth annually for the past 10 years. The other sectors of the economy that were taxed at 26.5% over the same period hardly reached a growth rate of 2%. Reducing the corporate tax rate for all businesses would enhance the growth rate for all sectors of the economy.
According to a 2010 article in The American Economic Journal, higher tax rates are associated with fewer formal businesses and lower private investment. A 10 percentage point increase in the effective corporate income tax rate is associated with a reduction in the ratio of investment to GDP of up to 2 percentage points and a decrease in the business entry rate of about 1 percentage point.
The relatively high rate of corporate tax is not the only hurdle that entrepreneurs face in Israel. Paying taxes is one of the most time consuming and costly process among OECD members. Business owners need an average of 235 hours a year to comply with taxes compared to 82 in Ireland or 84 in Norway.
On average, corporations in Israel have to comply with 33 tax payments a year, one of the highest among developed economies. For example, Georgia, Norway, Ukraine, Singapore and Mexico all require fewer than seven payments a year.
Many countries such as India, Lithuania and New Zealand have introduced or enhanced systems for filing and paying taxes online to ease corporate income tax compliance.
By encouraging businesses to use online platforms to file and pay VAT and social security contributions, Israel’s total number of tax-related payments could decrease from 33 to11 (the OECD high income regional average). All else being equal, Israel’s ranking on the ease of paying taxes would improve from 96 to 58 and Israel’s overall ranking on the EDB index would increase from 54 to 46.
Reducing the number of payments would also reduce the time spent paying taxes. Assuming that, after adopting a simplified online filing platform, Israel’s companies would spend 82 hours instead of the current 235 hours, Israel’s ranking on the ease-of-paying-taxes index would improve from 96 to 25 and the overall ranking would be 41. Already, Ireland, Norway and Estonia have been able to drastically reduce the number of hours needed to file taxes after implementing tax reforms in the past few years.
Simplifying the process of paying taxes would have the strongest effect on small and medium enterprises (SME). SMEs are very sensitive to the ease of doing business and cannot always develop and survive in a complicated and costly tax environment.
If Israel were to adopt a lower corporate tax rate and simplify the bureaucratic process of paying taxes, more entrepreneurs would enter the market and existing companies would enjoy a much more business-friendly environment with increased productivity, greater competition and economic growth for the whole economy.
A move to lower the corporate tax rate in Israel is a policy decision that would have a beneficial impact on economic growth, but it would be even more effective if the bureaucratic process of paying taxes were also simplified.The writer is director and co-founder of the Jerusalem Institute for Market Studies. www.jims-israel.org
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