In mid-May, the Israel government approved in principle the Ben-Bassat recommendations on tax reform. The primary goal of the reform is to eliminate the inherent discrimination on work as opposed to capital, which causes distortions in the allocation of capital and funds. Israel's present tax rates on work rise rapidly, reaching a level of 55 percent on gross monthly income above NIS 10,000 (about $2,500). In contrast, revenue earned through capital is tax-exempt. Furthermore, the state grants generous subsidies to capital investments. The lack of taxes on capital has served to widen social gaps between rich and poor, since only the wealthy earn significant income from capital.
The central premise of the Ben-Bassat committee is that high marginal tax rates harm economic efficiency by creating a disincentive for people to work hard or take risks to earn more. According to this reasoning, the committee's primary objective was to cut Israel's high marginal tax rates, thus increasing the disposable income of salaried employees. To compensate for the state's loss of tax revenue, the commission recommended eliminating tax exemptions totaling NIS 6 billion, notably in the capital market. Capital gains will now be taxed at a rate of 25 percent.
One immediate reaction to the official publication of the report was a frantic rush by the public to open long-term savings plans and evade the coming 25-percent capital gains tax. Bank officials indicated that in the day prior to the release of the committee's recommendations, approximately NIS 2.5 billion was moved from short-term savings accounts and other short-term investment plans to long-term savings accounts.
The reform's long-term impact on foreign investment may be even more acute. The committee recommends a fixed tax rate on distributed corporate profits of 36.25 percent, compared to the present tax rate of between 23.5-32 percent. It also suggests annulling all benefits to foreign investors and matching their conditions with those of local investors. Many experts suggest the recommendations will drive foreign investments from Israel, and are liable to cause an almost immediate halt in the establishment of plants in Priority Region "A". According to Yoav Nissan Cohen, CEO of Tower Semiconductor, "the Ben-Bassat committee recommendations significantly affect the attractiveness of foreign and local investments in Israel, which in any case is not great. We may have to reconsider the decision to set up the new plant in Israel."
Several months following publication of the Ben-Bassat recommendations, a number of political developments, such as a coalition crisis and threats by the Histadrut (Israel’s powerful labor union) have made it increasingly unlikely that the tax reform will actually be implemented.
Prior to the release of the Ben-Bassat recommendations, Israel’s economy exhibited signs of growth, due largely to a buoyant international economy and the tourist influx resulting from the Pope’s visit in March. The recovery in many sectors of the economy that began in the second half of 1999 continued in the first quarter of the year, with business sector product increasing by approximately 6.7 percent over the fourth quarter of 1999. According to recent projections, expansion is expected to persist throughout the year, and per capita income should rise for the first time in several years.
© 2000 Mena Report (www.menareport.com)