Benjamin Netanyahu looked at the calendar and at the macro-economic data, and decided the time had come to get a suitable ticket ready for a future Likud leadership battle. Netanyahu very much wants to reach any primary elections in his party with a record of economic growth, while his rival, Prime Minister Ariel Sharon, is enmeshed in the withdrawal from Gaza.
However, the data Netanyahu sees indicate a certain weakness, with export growth fading. According to his economic lights, another round of cuts in both direct and indirect taxation can not only conjure up a following wind, even if only a temporary one, for private consumption, it will also look good on the resume he presents to the Likud voter.
Therefore, before we talk about the pros and cons of the tax cuts plan itself, we should all remember that the chances of it being implemented in 2006 depend, to a great extent, on the good will of the prime minister, on the backing he gives it, and on the finance minister's political ability to pass that plan and next year's budget before the elections. If such support is not guaranteed in advance, the plan will molder in some Finance Ministry drawer.
As far as the substance of the plan is concerned, from the details so far leaked to the press it seems to be made up of elements which any government could adopt. In the coming years, any Israeli finance minister will have to cope with falling corporate tax rates in many countries. Estonia and Slovakia set the ball rolling, and there is no industrialized country that is not considering the matter. The idea of reducing VAT and income tax while raising capital gains taxes to levels similar to those recommended by the Ben Bassat committee also sounds reasonable, if the required financing is there in the long term.
The problem with Netanyahu's plan is not the trees but the forest. The IMF warned him a few months ago not to try cutting taxes until he is certain that he can continue narrowing the fiscal deficit. Netanyahu is convinced that cutting taxes will contribute to GDP growth, and hence to higher state revenues, so that an unplanned rise in the deficit can be avoided.
The trouble is that growth in Israel is first and foremost a function of external conditions, and if global growth declines in the next couple of years, the tax cuts will have to be financed from somewhere else. Given Netanyahu's approach, the somewhere else will be welfare and social spending, not to mention infrastructure.
What's more, a plan like Netanyahu's will lead to a widening of income gaps through a substantial rise in private companies' after-tax profits and a fall in the top rate of income tax, only partly offset by higher capital gains tax.
For the plan to be reasonable from an economic and social point of view, it must be accompanied by other measures, such as bigger welfare and education budgets, and the introduction of compulsory pensions and negative income tax. Without such complementary policies, the plan does no more than create extra rents for those with means.
If the finance ministry is left without fiscal sources, those complementary measures will remain a pious wish. In such circumstances, Netanyahu will bequeath a very tough assignment to his successor. But maybe that doesn't matter too much to the current finance minister, since, as I said, he's already thinking about the next stop.
Published by Globes [online], Israel business news - www.globes.co.il - on May 17, 2005