Israeli corporate tax policy: A pro-growth system at risk

Eldad Carin / Shutterstock.com

Skyline of downtown Ramta-Gan and Tel-Aviv, featuring the famous Israeli diamond center and the financial district surrounding it on June 28 2011, in Tel Aviv, Israel.

Article Highlights

  • Evidence that high corporate tax rates can impeded workers' wages is mounting, particularly for small, open economies like Israel.

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  • The stock of US foreign direct investment in Israel was over $15 billion in 2011.

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  • In 2012, the OECD average corporate tax rate was 25.4 percent, down from a high of 48.0 percent in 1982.

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Globally, corporate tax rates have been declining for over two decades (except in the United States), and one consequence has been an increase in investment, a boost in workers’ wages, and little or no loss of tax revenue. But a troubling tax policy trend is emerging in Israel, where once-aggressive efforts toward a competitive corporate tax are being reversed. Proposals to raise the headline Israeli corporate tax rate for a second year and, in particular, to raise taxes on highly mobile, export-oriented production represent the wrong approach and will harm economic prosperity. The consequences of this reversal in a small and open economy like Israel’s are potentially dire and could extend to investors in the Israeli economy from the United States and other foreign countries.

Recent corporate tax policy changes and proposals in Israel raise concerns about the country’s continued economic growth. In 2012, Israel canceled a scheduled phase-down of its top corporate income tax rate and instead raised the rate 1 percentage point to 25 percent. Yair Lapid, the finance minister in Israel’s coalition government, is seeking to increase a number of tax rates, including the overall corporate rate and a preferential rate for export-oriented businesses, as part of a deficit-reduction package.[1]

Although reducing the deficit will require Israel to make difficult tax and spending choices, increasing the tax rate on business income, particularly mobile business activities such as export-oriented production, is the wrong approach. Such tax increases will cause diminished economic prosperity and potentially reduce revenue by discouraging foreign direct investment (FDI) into Israel and encouraging Israeli firms to expand their businesses abroad rather than at home.

In this paper, I explore the detrimental effects of a corporate tax rate increase on FDI in Israel and discuss implications for other open economies. To set the stage for this analysis, I begin by highlighting the recent controversy over Israel’s growing deficit and reviewing Israel’s current economic situation, deteriorating fiscal outlook, inward FDI flows, and current corporate tax system. Next, I offer a brief review of the academic literature on the effect of corporate tax rates on domestic investment generally. I then discuss the shortsightedness of a plan to reduce Israel’s budget deficit by restricting business investment, a key to Israel’s economic success and future growth. Last, I highlight the impact that the proposed tax increases in Israel could have on the United States.

Read the full paper.

Notes

1. The proposed budget would also increase individual income tax rates 1.5 percentage points and the value-added tax rate 1 percentage point (to 18 percent), among other changes.

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