Reports being leaked by the Ministry of Finance to the public about foregoing taxes on trapped profits are infuriating, insulting, and harmful. Such a concession is neither effective nor constitutional. It will not help the Israeli economy or its growth, but will harm them.
The Law for the Encouragement of Capital Investment was first enacted in 1950, and was intended to help a poor country attract foreign investors. The law was essential and it contributed to amazing achievements for the young country. But what was right then is not suitable now.
Developing countries with low human capital costs have been harnessed to the global tax race. Ireland led the race, despite warnings by top economists against a race to the bottom and the destruction of the welfare state. The Bank of Israel's Research Department has also published reservations about subsidizing financial capital.
The Ministry of Finance's response in 2002 was the opposite and it proposed two plans to attract potential investors: the Irish plan - a companies tax rate on a preferred enterprise of just 11.5% and a dividend tax rate of 15%; and an alternative plan with far-reaching tax breaks - a zero tax rate so long as a company did not distribute dividends, and if it did distribute dividends, a companies tax rate of 25% and a dividend tax of 15% on Israelis and 4% on foreign residents. Many companies opted for this option.
Against the law, the constitution, and ethics
A law designed to encourage capital investment in a developed country is both inefficient and harmful to economic development. The Bank of Israel's Research Department details the serious damage that such a law harms Israel's industry, the periphery, and jobs.
The articles of incorporation of Intel Corporation (Nasdaq: INTC) lay down high ethical principles. It is doubtful if its executives would dare to retreat from an agreement signed with a sovereign state that is based on law. That is not the case in Israel, where everything is permissible, even if is not fair, is against the law and the constitution, and even if is unethical.
The concession that Minister of Finance Yuval Steinitz allowed himself to consider indicates that he and his advisors do not understand what a tax is, what its function is in a democratic society, what constitutional principles are, and what is public property.
A tax is not a penalty. It is not arbitrary. It is the price we pay, voluntarily and consensually, for our wish to live in a social society. It is a mechanism for the distribution of profits created from common ownership of economic enterprises: the public (through the government) invests in infrastructures, social capital, and human capital; firms and employees invest in financial capital, assets, and labor. When the enterprise succeeds, the parties share the profits. Intel, Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA), Check Point Software Technologies Ltd. (Nasdaq: CHKP), and other companies know this too. They invest in Israel because of the quality of its outstanding social and human capital, not because of tax breaks.
Every reasonable person knows how to share with his partners their common profits. A reasonable man does not want to be a freeloader or a free rider and he does not want to evade his responsibilities and ethical commitments.
One of the fundamental demands of every legal system is certainty, not arbitrariness. Retroactively changing the tax system harms this requirement and creates chaos, which gives the establishment's men unacceptable power. At their whim, they collect taxes and at their whim they forgive them invites constant pressure on the government and strengthens the capital-power connection. There is a reason for the unequivocal ban on the granting of tax breaks that are not anchored in law.
Changing the tax rate on trapped profits should be carried out, if at all, through primary legislation. But such legislation harms constitutional rights. Changing the tax rate on trapped profits is a retroactive action; it is engaged with past tax years. Companies that chose the alternative tax plan owe the public from the day that they made a profit. The public (the government) has property rights to the debt. Forgiving this debt therefore harms the public's property rights.
Obviously, not every taxpayer in Israel cannot have the same treatment from the tax authorities. Every taxpayer who owes taxes to the government will pay them in full, or be declared bankrupt. The awarding of subsidies, grants, and tax breaks to a specific taxpayer harms the constitutional right to freedom of occupation. They harm free competition and push other firms out of the way.
Steinitz is playing dice with the economy
The argument, based on unsubstantiated speculation, that this is "government policy", is insufficient. Threats by companies, if any were ever made at all, about breach of contract and unfairness, do not justify harming constitutional rights. Fair companies do not violate agreements, both because of their ethical code and for fear of harming their reputations.
A responsible, sagacious, and efficient government would not imagine changing tax rules and granting additional exemptions to companies that had agreed to a clear tax plan. Capitulation to demands sends the wrong educational message to the general public and to other investors: it is possible to violate contracts, even if they are grounded in law; the tax code discriminates between groups; the rule of law isn't; and the government can be pressured. All of this will damage the public's confidence and its willingness to pay taxes, and will drive away potential investors who seek stability, certainty, and a culture of keeping contracts.
Intel's CEO once listed the reasons for investing in Israel: human capital ("Only in Israel do I have an engineer who makes me $350,000 a year" (in the 1990s)); social capital; and the country's educational and research systems.
The current government's concept of fair taxes on Intel, Teva, Check Point, and other companies will cause them to forego Israel's advantages, and testifies to the government's weakness, and its astonishing lack of confidence in the country's workers and scientists, and in the strength of Israel's community in general.
Albert Einstein said that God does not play dice with the universe. Steinitz is playing dice, thereby violating the known rules of the game: he decides who will win after throwing the dice.
Foregoing legal taxes on trapped profits will not achieve the goal that the government set. It harms the rule of law in Israel; it will erode constitutional rights of equality, property, and freedom of occupation; it will harm international and investor confidence in Israel's human capital, its rule of law, educational and research system, and the worth of investing in the country; it will increase the deficit, the tax burden on the country's residents, or reduce public services; it will greatly harm social solidarity; and it will increase the brain drain.
The author is a researcher and teacher of tax law and policy, fiscal legislation, and the constitutional principles of the national economy at the University of Haifa. He is the author of "Introduction to tax law" (in Hebrew).
Published by Globes [online], Israel business news - www.globes-online.com - on July 9, 2012
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