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News Analysis: Tax increase could pay for Israel's social reform

(Xinhua)

08:44, August 30, 2011

JERUSALEM, Aug. 29 (Xinhua) -- A tax increase for the top earners in Israel could be one way for the government to fund social reforms, according to a proposal put forward by the Finance Ministry, local Ha'aretz daily reported.

The government is currently facing a growing number of protest movements targeting its economic policies, which the protesters argue favor the very rich at the expense of the middle class.

While the Israeli economy on the national level has experience a steady growth over the last couple of years, there is a growing sense among large segments of the population that the wealth generated has ended up in the bank accounts of a small number of the very rich who also control large parts of the economy.

The frustrations exploded into tent camps and protests around the country over the last six weeks.

Three weeks ago an estimated 250,000 Israelis took to the streets in cities across the country to protest the increasing difficulty for young people to find affordable housing. Other protests have focused on the high cost of child care, and foodstuffs, especially dairy products.

Among the Finance Ministry's recommendation are a 5-percent increase on capital gains taxes, dividends and interest payments. Tax rates on these transactions are currently between 15 percent to 25 percent.

The ministry also wants to cancel a 1-percent decrease in the corporate tax level from 24 percent to 23 percent scheduled for January 2012, a decrease that is supposed to continue yearly until 2018.

Although the tax increase is important to fund the social reforms, local analysts have different opinions concerning its outcome, with some arguing that the measure may hinder economic growth.

FINANCING SOCIAL REFORMS

Dr. Miki Malul of the Ben-Gurion University of the Negev told Xinhua that raising the corporate tax level is a good initiative, as taxes on firms are relatively low and the social reforms need financing.

The general rule, according to Malul, should be that if the government wants to introduce costly reforms "it shouldn't increase the deficit. So if the government wants to increase its spending, it must increase the income tax."

"Corporate taxes should be increased because most of it is coming from local companies that aren't tradeable, but are active in a monopolistic market," Malul said.

He added that in the past, Israel has used its low taxes to attract foreign companies to establish themselves in the country. He believes this policy needs to be continued, and with special incentives and tax reductions since the companies provide employment.

Malul argued that the government needs to address the difference between tax on capital gains and taxes on income as " today there is a huge distortion in Israel, where the tax on labor is high while the tax on investment gains relatively low."

"It puts a heavy burden on work and a relatively low burden on capital, and in that case you will allocate more effort to the capital and less effort to work," Malul said.

"WAIT AND SEE"

Prof. Haim Levy of the Academic Center for Law and Business in Ramat Gan said that if the government decides to raise dividend payments for a company's shareholders, then it needs to be done very carefully and in several stages.

He suggested that after an initial 1-percent increase the government gauge the market reaction, and implement a second increase only if the economy continues to grow.

Income from dividends is one of the main sources of revenue and preferred means of income for many of Israel's top executives as the current dividend tax is lower than the income tax.

Levy argued that if the government raises the tax by 1 percent or 2 percent, nothing will happen to the economy. However, 5 percent or more could become a signal for investors not to invest too heavily in the local stock market.

An increased dividend tax may also lead the bigger investors to look to stock markets abroad, where the return on their capital will be greater, causing them to abandon the Tel Aviv Stock Exchange.

INVESTMENTS DIVERTED?

While the intentions of the new tax structure would be to target the very rich, Levy argued that the effect would also be felt by many smaller investors.

"If I'm a small investor on the stock market, then I'm afraid that the corporation will pay more taxes and on top of that there will be a tax on dividends, which means less to me," Levy said.

He added that some investors might decide that they are better off investing in the Israeli government bonds, or even American tax-free bonds, instead of the local stock market. This could lead to a situation where firms would not be able to issue new stocks to take in more capital needed to continue growth.

Levy also said that one shouldn't put all the super-rich in the same class, as among them there is a lot of entrepreneurship which has led to some of the world leading companies, such as computer security firm Checkpoint and generic pharmaceutical giant Teva.

The issues that need to be addressed, according to Levy, are intricate. They include cross-ownership of banks and insurance companies, and production and services companies by business leaders, with some of them exploiting their financial intuition to buy stock in their other companies, hence creating even more unearned income.

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