Lapid’s budget: It’s really that bad

In the competition for foreign investment, for Israel to increase its corporate taxes is similar to a boxer who willingly ties one hand behind his back before entering the ring.

By YARDEN GAZIT
May 20, 2013 23:07
4 minute read.
Yair Lapid at cabinet meeting, 20 May 2013.

Yair Lapid at Cabinet Meeting, looking official 370. (photo credit: Marc Israel Sellem/The Jerusalem Post)

 
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Protesters have taken to the streets against Finance Minister Yair Lapid’s budget proposal.

They, together with politicians from opposition parties, claim the proposal does not tax the wealthy enough, and some of them argue that the deficit should be higher in order to avoid budget cuts. But given the economic conditions Lapid inherited, they ought to criticize his proposal for its overly high, and not too low, taxes and deficits.

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A financial rule of thumb for both households and governments is that one should live within one’s means.

That doesn’t mean we should never go into debt. Most people go into debt when they take out a mortgage, and that is not a sign of fiscal irresponsibility.

But it does mean that we should only take out loans if we have good reason to expect that our future income will grow at a sufficient rate to pay them back, and not get ourselves trapped in debt.

So the argument between those who support deficit spending and those who are more fiscally conservative shouldn’t involve ideology. It should reflect people’s different assumptions about future growth. In order to assess which side is right we must examine economic expectations.

What are the current economic conditions? Most economists agree that the global economy in general and European countries, which are Israel’s largest trade partners, in particular will likely remain under duress in the foreseeable future. Israel’s growth rate has been steadily decreasing for the past three years, from five percent in 2010 to 3.1% in 2012. Interest rates for 10- year Israeli government bonds – which reflect investors’ estimate of the risk of default – are higher than rates on government bonds in 22 of the 34 countries in the OECD for the same period.



Immediately after Israel in the bond yields table are Italy and Spain, countries that were forced to rein in their budgets through severe austerity measures in order to avert bankruptcy.

This does not seem like a very promising outlook for economic growth.

Economic conditions therefore advise against going into more debt. Lapid’s plan would reduce the deficit to 3% in 2014. He says that government debt will remain at 74% of GDP, but that will only happen if the economy will also continue to grow by 3 percent.

That seems like an overly optimistic scenario.

Higher taxes have a restraining effect on economic activity. When income, VAT and corporate tax rates increase – as would happen under Lapid’s proposal – households and corporations have less money to spend on goods and services and to invest in growth-creating projects. So if, more realistically, growth is lower than 3% in 2014, debt levels – and interest payments – will increase.

A good government budget ought to encourage economic growth. Even if one supports a large “welfare state,” one should recognize that growth is the only sustainable way to increase quality of life and improve government services for the entire population. You can only redistribute as much wealth as people in society have created.

Lapid claimed that the rise in the corporate tax rate will increase “distributive justice,” and make the wealthy pay more taxes. He is wrong. First, reduced corporate profits will hurt the average retirement saver (and not only tycoons) whose pension contributions are invested in the local stock exchange. Second, many corporations will roll the increased tax onto the consumer through raising prices.

More importantly, increased corporate taxes will hamper growth. Some countries can afford high corporate tax rates because corporations want access to their large domestic markets, their developed infrastructure, or their safe geopolitical conditions. Israel cannot.

According to a recent position paper by the Jerusalem Institute for Market Studies, corporate taxes in Israel after Lapid’s increase will be higher than in nine of 12 other OECD countries with a similar population size. Among the countries with a lower corporate tax rate are Sweden, Switzerland and Ireland.

Furthermore, Israel is among the only countries in the world acting against the global trend of reduced corporate tax rates. In the competition for foreign investment, for Israel to increase its corporate taxes is similar to a boxer who willingly ties one hand behind his back before entering the ring.

The result of reduced growth will be lower incomes, fewer jobs, more unemployment and more cuts in government services. As always, the poor will be the first to suffer the consequences.

Why then do we hear protesters and politicians claiming that the deficit ought to be higher or that the wealthy ought to pay more taxes? One possible answer is that it is easy to see those harmed by cuts in specific government services today. They know who they are, and we know them. It is much more difficult to see those who will become unemployed or suffer from worse cuts in the future because of misguidedly high deficit spending. We don’t know who they are, although they are certainly among us. So there is an organized political base against cuts and for anti-growth taxes, while the political base for growth-generating policies and reforms is disorganized.

The answer is as old as politics.

The author is a Research Fellow at the Jerusalem Institute for Market Studies.

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