Your taxes: Social justice and tax policy

It's said the rich and poor alike pay similar taxes on spending, and the rich don’t pay enough tax on income and capital gains. How true is that?

Money 311 (photo credit: Bloomberg)
Money 311
(photo credit: Bloomberg)
We have witnessed the Arab Spring, and we now seem to have a mild Israeli Summer – demonstrators encamped in a number of cities to protest about the living costs, wealthy tycoons and…taxes.
The Israeli tax system is said to be regressive. In other words, the rich and poor alike pay similar taxes on spending, and the rich don’t pay enough tax on income and capital gains. How true is that?
Israeli government policy
In 2003 Israel embarked on a program to reduce the direct tax rates, on income and capital gains, by tightening enforcement and reducing some of the tax breaks. Consequently, the top rate of income tax has decreased from 50 percent to 45%. The regular rate of company tax has decreased from 36% to 24%. Even VAT decreased from 18% in 2002 to 16% by 2010.
The overall tax burden
Israel joined the Organization of Economic Cooperation and Development (OECD) in 2010, and it is customary for a country to benchmark itself against other OECD members. According to the OECD, total Israeli tax revenue as a percentage of gross domestic product (GDP) was 31.4% in 2009, compared with 31.1% in Canada, 34.3% in the UK, 37% in France but only 24% in the US (no wonder the US reached its debt ceiling).
The OECD average in recent years has cruised at around 34%. So it seems the overall tax burden in Israel is better than the international average but not as good (or as bad) as the US.
Where do those taxes come from?
According to the OECD, Israel gets its taxes from:
• income and profits – about 11% of GDP (OECD average 12.5%);
• social security – about 5% of GDP (OECD average 9%);
• property – about 3% of GDP (OECD average 5.4%);
• goods and services – i.e., VAT and import taxes, about 12.5% of GDP (OECD average 10.8%).
So the goods and services tax is higher than the OECD average, and other taxes are a bit lower. But the current Israeli VAT rate of 16% compares well with the OECD average of about 18%. Presumably Israeli import taxes don’t compare so well.
What does the government do with all that money?
Israeli government expenditure totaled NIS 303 million in 2010, according to Israeli government statistics. Of this 18% went on salaries, 18% went on goods and services, 9% on interest, 22% on grants and subsidies, 25% on social benefits and 8% on other expenses.

What do we spend our money on?
According to government statistics, private-housing expenditure rose from NIS 93 billion in 2009 to NIS 99b. in 2010. The increase was entirely due to increased spending on home ownership, which accounts for about two-thirds of the total. The other one-third goes on rent, city taxes and so forth.
Likewise, private fuel consumption rose from NIS 32b. in 2009 to NIS 37b. in 2010. The increase was entirely due to increased spending on transportation and heating fuel, which accounts for about 60% of the total.
Food, beverages and alcohol consumption rose from NIS 82b. to NIS 88b., spread among many different subcategories.
The rate of inflation in 2010, according to the consumer price index, was only 2.7%.
Should the government change course?
We will leave the politics to the politicians. Fiscally, it seems that the regular Israeli VAT rate of 16% isn’t so bad by international standards. However, unlike Israel, some other countries have a reduced VAT rate for foodstuffs; for example, 6% in Belgium and the Netherlands, 7% in Germany, 5.5% in France, 0% in the UK.
Detailed rules and limitations apply in most cases. For example, in the UK, food and drink is, in general, zero-rated, but many items are liable to 20% VAT, including alcoholic drinks, confectionery, potato chips and savory snacks, food for catering or hot takeout, ice cream, soft drinks and mineral water.
Should the top rate of personal income tax in Israel be raised beyond 45%? If you add National Insurance Institute payments, personal tax rates already approach 57% in practice. This drives successful Israeli business people toward using companies to restrict the tax burden on distributed profits (company and dividend taxes) to 43%.
In the UK, the recent increase in the top rate of income tax from 40% to 50% was expected to encourage immigration to Europe and even aliya to Israel. But recent press reports indicate that few have emigrated from the UK so far, mainly due to the inconvenience factor.
The Israeli government has unwittingly contributed to this in a small way by granting olim (from the UK and elsewhere) a 10-year Israeli tax exemption for foreign source income and gains, but not income from work done in Israel.
What do we predict?
If the social-justice demonstrations continue in Israel, don’t be surprised if proposals emerge for a VAT reduction on food, financed by a hike in income taxation... and if the demonstrations fizzle out, expect nothing. But our crystal ball may not be infallible. What do you think?
As always, consult experienced professional advisers in each country at an early stage in specific cases.
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Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.