House of cards

The war against real estate investors has altogether failed to deflate the real estate bubble.

BENJAMIN NETANYAHU and finance minister Moshe Kahlon. (photo credit: REUTERS/BAZ RATNER)
BENJAMIN NETANYAHU and finance minister Moshe Kahlon.
(photo credit: REUTERS/BAZ RATNER)
Economic constructs have often been compared to houses of cards. Carelessly pull out one of the cards and the entire edifice is liable to crash down.
Here in Israel, where our particular house of cards may look resilient, we must be extra cautious because many of its extensions have been historically added on in a slapdash fashion, have survived but are particularly susceptible to tinkering. Exempting apartment owners from having to pay tax on small rental incomes is a case in point.
Back in the early 1990s it dawned on policy-makers that there is a sizable reservoir of empty apartments throughout the country, purchased as a hedge against inflation but not rented out for reluctance to tangle with the taxman. To facilitate the absorption of waves of aliya from the former USSR it was decided to exempt rental income below a given adjustable taxation threshold.
The payoff to officialdom’s hands-off strategy was immediate. Numerous flats became available for rent.
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Yesteryear’s successful ad hoc arrangement is still in force and remains every bit as beneficial as it was a quarter of a century ago. It continues to make many thousands of housing units accessible to tenants that otherwise might not be.
The taxation threshold nowadays is just below NIS 5,000 a month per single apartment. Owners of multiple units are not eligible for this exemption as they are clearly in business and are not private individuals with one extra real estate holding.
Onto this scene enters neophyte finance minister- designate Moshe Kahlon, exuding populist fervor and hyping his intention to erase inequality by taxing all rental income, “from the first shekel,” by as much as 25 percent (consistent with the norm for capital gains tax).
Is this just? Probably not. In populist parlance it is enticing to paint any apartment owner a grasping landlord, a member of a privileged and exploitative elite, who must be forced to share his/her wealth in the interests of common folks. But, especially in the Israeli context, this is more often than not far from the truth.
For decades the tradition among veteran Israelis was to purchase a second flat for the children. Many rental properties also belong to mom-and-pop investors who dreaded putting their hard-earned savings in the bank, especially during the turbulent 1980s, when inflation skyrocketed out of control. In some cases such properties are now rented out to pay for accommodation in old-age residences.
Young families who own only a single apartment sometimes need to rent it out because they are forced to relocate temporarily for job purposes and they in turn rent elsewhere. Some couples rent out their first smaller flat and upgrade to accommodate growing families by themselves renting somewhat larger lodgings.
There are more categories similar to the above and none can justifiably be lumped in with real estate professionals or speculators. The draconian move of imposing a regressive tax would mean the loss of a full quarter of unspectacular incomes.
Proprietors using rental income to pay mortgages would be hit because their revenue would no longer offset their expenditure. If the rental income is used to pay rent elsewhere, the blow would be doubled because, where feasible, the costs of the rent tax will be passed on to the tenant. It would probably be the nonexempt professional investors who would be first to hike rents.
The war against real estate investors has altogether failed to deflate the real estate bubble. There are many tax exemptions that should preoccupy the new finance minister before the low-rent exemption. Removing it will only transfer income from the middle classes to the taxman and make a bad situation lots worse for the have-nots.
Kahlon’s populism is likely to foremost hurt the ordinary citizens whom he professes to champion. If eventually rents go up or if fewer properties are rented out, housing costs in general would rise. It invariably happens that when governments tinker with market forces, prices spiral.
A combination of populism, hubris and inexperience can prove disastrous and set off unforeseen consequences that damage all aspects of the economy.