Yair Lapid at Cabinet Meeting, looking official 370.
(photo credit: Marc Israel Sellem/The Jerusalem Post)
Protesters have taken to the streets against Finance Minister Yair Lapid’s
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.
A financial rule of
thumb for both households and governments is that one should live within one’s
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
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.
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
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.
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
That seems like an overly optimistic scenario.
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
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.
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.
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.
author is a Research Fellow at the Jerusalem Institute for Market Studies.
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