There is an ideological battle of sorts being waged behind the scenes regarding Israel’s fiscal policy. On one side are the more neo-liberal, pro-capitalist Prime Minister Binyamin Netanyahu, Finance Minister Yair Lapid and many others in the Treasury. On the other side are newly appointed Bank of Israel Governor Karnit Flug and other economists at the central bank, who are increasingly concerned with income inequality and advocate “inclusive growth” policies aimed at lowering gaps between rich and poor. The clash between these two competing economic world views – which is one of the reasons Netanyahu was wary of appointing Flug – came to a head this week over Lapid’s decision – fully backed by Netanyahu – to do away with a planned income tax hike.In recent days, the Treasury “discovered” a hefty NIS 3.5 billion surplus for the 2014 budget – a discovery that raised many eyebrows, since just six months ago there was talk of a NIS 18b. shortfall. Could it be that Netanyahu’s and Lapid’s desire to avoid an unpopular tax hike, which had been slated to go into effect in January and would have pushed the highest tax bracket beyond 50% to 52%, was the impetus behind the Treasury’s sudden “discovery”? Netanyahu and Lapid decided that instead of going ahead with a rise in income taxes and using the extra NIS 3.5b. to improve healthcare and social services, they would instead cut fiscal expenditures. This decision is in line with the neo-liberal position that both income taxes and the fiscal budget should be as low as possible.In contrast, Flug and others at the Bank of Israel thought the government should have gone ahead with the tax hike anyway and that the NIS 3.5b. surplus should be used to improve healthcare and social services. As Flug noted during a speech last week at a financial markets conference organized by the Calcalist newspaper, the country’s real challenge in the medium-to-long term is to fight income inequality and the tremendous gap between the rich and the poor by striving for “inclusive growth” – a term used by economists such as Nobel Prize laureates Joseph Stiglitz and Amartya Sen, who are critical of neo-liberal economic policies. Israel ranks 28th out of 33 OECD countries when it comes to income inequality (the difference between the income of the top 20 percent compared to the bottom 20%). And it is clear to Stiglitz, Sen, Flug and others that unless governments intervene to fight socioeconomic inequalities, these inequalities will persist. Market forces won’t solve them.However, the question is whether the solution is to raise income taxes and spend more on social services.That definitely seems to be part of the problem. Israel spent just two-thirds of the OECD average for social services in 2011. And while Israel has one of the highest poverty rates among OECD countries, the income tax burden is about the same. In other words, we tax the rich less and we spend less on social services, even though proportionally speaking, we have many more citizens living below the poverty line.Moving beyond our unsatisfactory welfare state’s ability to cushion the poor, however, we should also be looking for solutions to the underlying cause of income inequality – an inadequate education. Israel has consistently ranked low in international scholastic assessments scores such as the PISA , though there has been some improvement in recent years. More worrying, however, is the tremendous gap between those who succeed on the PISA and other tests, and those who don’t. Between 1999 and 2011, Israel had a larger gap between weak and strong students than almost any other OECD country, including France, the US, Britain, New Zealand and Spain.And improving our educational system does not necessarily mean just funneling more money into our schools. We also have to think about ways of improving the quality of our teachers, recognize the importance of investing in both talented and challenged students and place a stronger emphasis on basic learning skills.While we cannot ignore income inequality – which Netanyahu and Lapid seem to be doing – we must also think seriously about how best to implement Flug’s vision of “inclusive growth.” Ideological differences aside, reducing the gaps between rich and poor should be the goal of anyone who cares about the future of the State of Israel.