3 things they're not telling you about cutting corporate taxation

Kahlon, Netanyahu  photo: Flash 90

The supposed benefits do not stand up to close inspection.

1. Cutting the corporate tax rate in Israel is irrelevant to high-tech companies and exporters.

The background to the "adjustment" of the corporate tax rate in Israel to the US rate is the reduction of corporate tax in the US from 35% to 20%. Minister of Finance Moshe Kahlon has already notified his US counterpart, Secretary of the Treasury Steven Mnuchin, that such a dramatic cut in the US corporate tax rate will require Israel to adjust the local corporate tax rate (which was slated to drop to 23% in any case). The main concern is that the reduced rate in the US will cause Israeli companies to move their activity there in order to pay tax there. In addition, foreign companies interested in activity in Israel are liable to reroute to the Far West.

The question that we should be asking is, for whom is moving to the US relevant? The answer is high-tech companies and companies whose business is export-oriented. This is where the surprise comes in: the corporate tax cut currently on the agenda has nothing to do with either of these categories. High-tech companies were put on a reduced tax track last year, whereby they pay 12% tax (6% for large companies), and their owners pay a reduced 4% tax on dividends withdrawn from their companies. Export-oriented companies are entitled to pay reduced tax in the framework of the Law for the Encouragement of Capital Investments - 7.5% in outlying areas and 16% in the central region. As in the case of high-tech companies, shareholders in these companies also benefit from a reduced 20% tax rate on dividends (compared with 30% for shareholders in ordinary companies).

There is only one group for which moving to the US is an option, and which is likely to benefit from reduced corporate tax in Israel - self-employed people and owners of what is referred to in the law as "close-held corporations."

2. A corporate tax cut will not affect the desire of wealthy people to emigrate.

To continue the preceding point, the question will arise whether the tax cut will affect residence considerations of self-employed people and owners of close-held corporations, and if so, how this can be measured. The question may sound theoretical, but in fact it was examined recently by a team of researchers headed by one of the Israel's leading economists - Prof. Michel Strawczynski, who has since been appointed manager of the Bank of Israel Research Department.

The conclusion reached by Strawczynski's team was surprising: tax cuts do reduce the desire to emigrate from Israel, but not uniformly. People with high incomes are affected by tax cuts far less than people with low incomes. Every shekel in reduced tax reduces the desire to emigrate 10 times as much for low income earners as the same cut for high income earners. There are probably far better and cheaper ways of preventing high-tech people from emigrating to the US than cutting corporate taxation.

3. It will require a tax cut for people with high incomes.

What few people realize is that cutting the corporate taxation rate will force the state to simultaneously cut income tax for the people with the highest incomes. The reason is very simple: the need to prevent tax planning. For example, take a wage earner with a very high monthly income, of NIS 100,000. He currently pays a maximum marginal income tax rate of 47%. In other words, for every shekel he gets in excess of NIS 41,410, the state takes NIS 0.47. If that wage earner decides to found a personal service company that receives his salary instead of him, he will pay tax in two stages: 24% tax on the "salary" that will be paid to the company, and an additional 30% tax that he will pay on the money as soon as he withdraws it from the company for his private use. In the end, he will pay practically the same tax rate on his income on both tracks: 47% on the income tax track and 46.8% on the two-stage personal service corporation track (corporate tax and dividends tax).

This equality in results is no accident; it is a deliberate policy for preventing distortions in the tax system and eliminating the incentive for establishing personal service corporations in order to pay less tax. For precisely this reason, the state had to reduce the maximum income tax rate from 48% to 47% last year in response to the cut in corporate tax from 25% to 24%. While everyone is talking about cutting corporate tax, no one is talking about the cut in income tax that will follow. For example, the Ministry of Finance, which announced that every 1% cut in corporate tax will reduce state tax revenues by NIS 900 million, "forgot" to mention the cost of the additional income tax cut that will immediately follow it, which is equivalent to hundreds of millions of shekels - money that will remain in the pockets of people with the highest incomes in Israel.

Published by Globes [online], Israel Business News - www.globes-online.com - on December 4, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

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Kahlon, Netanyahu  photo: Flash 90
Kahlon, Netanyahu photo: Flash 90
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