Dei'ah veDibur - Information & Insight

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5 Iyar 5760 - May 10, 2000 | Mordecai Plaut, director Published Weekly








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Major Finance Reform Proposal

by M. Plaut and Yated Ne'eman Staff

Last Thursday the committee headed by Treasury Director- General Avi Ben-Bassat published its long awaited plans for reform of the tax system and capital markets of Israel. On Sunday the government approved the plan but set up a special Cabinet committee to discuss the package and suggest changes. Finance Minister Shohat, who is a member of the committee, said that he would work to ensure that the changes are minor.

The goal of the reform is to simplify and modernize the extremely complicated tax system of Israel by eliminating virtually all of the special breaks accorded to various groups and to universalize the tax payments so that the market can allocate the country's financial resources efficiently. In Israel's complicated system it was extremely difficult to make rational capital allocation decisions, and often the allocation was distorted by artificial tax considerations.

Under the plan, the maximum marginal tax rate, including health and National Insurance Institute payments, will be reduced from 59.7% to 50%. Wage earners will reach it at an income of NIS 14,001 ($3,500) a month.

Other key proposals made by the committee include:

* A tax on employers' contributions and real gains in continuing-education funds (kranot hishtalmut). These funds are very large but the special status they have enjoyed prevents their resources from being properly invested.

* An estate tax of 10% on gifts distributed while alive or posthumously beyond $1 million;

* A capital gains tax of 36% on profits in the local stock market (hitherto tax free);

* Taxation of foreign assets;

* All savings schemes will be taxed;

* A 25% tax on cumulative profits from sales of apartments after the first NIS 1m. in real profits;

* Elimination of the half-point tax benefit given to all women;

* The elimination of tax breaks given to industry workers, such as Israel Electric Company employees, for afternoon, evening, and night shifts;

* The elimination of tax breaks given to Eilat-based employers;

* A 10% tax on apartment rental income exceeding NIS 3,000 per month;

* Additional tax credit points will be given to mothers of young children under 12 years old;

Pension plans of all types will not be taxed, nor will savings schemes currently in effect.

Another aim of the reform is to redistribute the tax burden from the middle class to the upper class, by taxing various previously untaxed income streams (including capital) while reducing the income tax paid on salaries.

Under the reform, the number of those filing tax returns will rise gradually, from 22% to 29% of all taxpayers in the first year and higher thereafter. Up to now, wage earners in Israel did not have to file a tax return every year. The taxes they pay are deducted from their wages, and most other economic activities they engage in (savings plans and stock purchases) are tax-free.

The Israeli government plans to ask the Knesset Finance Committee to approve transitional regulations to begin the formal implementation of the economic reform. If the tax reform proposal is approved by the government and the committee later this year, the taxes on various savings plans would go into effect retroactively from Monday, 3 Iyar-May 8.

The Histadrut held a one-hour work stoppage on Sunday to convene and discuss the planned reform.

Ben-Bassat explained how the reform became important: "Basically, we had a series of irrational tax exemptions which were legislated thanks to pressure from interest groups."

The tax reform proposal is expected to reach the Knesset for its preliminary reading some time next month. Shohat hopes it will be approved by the end of October, but many observers are skeptical of the chances of many provisions, given the power of the special interests and the weakness of the government.

National Religious Party leader Housing Minister Yitzhak Levy, for example, said that he is opposed to the elimination of the tax break given to all women, and that he wants a threshold for savings to be set before being taxed.

Interior Minister Natan Sharansky (Yisrael Ba'aliya) said he is ardently opposed to the tax on home rentals. Ministers Eli Yishai, Dalia Itzik, and Yuli Tamir have also said they oppose the proposals in their current form.

Pressure groups like the Israel Women's Network and Na'amat, the Manufacturers Association, and the Histadrut are also working to eliminate clauses in the reform of interest to them.

Likud leader Ariel Sharon called the plan "antisocial" and an attempt to "dig deeper into citizens pockets." He said it would hurt more of the population than it would help. He pledged that he would cancel any antisocial measures that are approved if elected prime minister. Sharon said the Likud would fight in particular against taxes on inheritance and savings plans.

The Arab parties are not expected to support the plan.

As of now, only Israelis who never had immigrant rights must report passive income from abroad, which includes interest, dividend payments, certificates of deposit, or home-rental incomes, among others.

Immigrants who keep their overseas income overseas were never required to report or pay taxes on their passive income.

"They now want to change the tax system so that all your income, whether you brought it or not, is taxable at Israeli rates," Yitzhak Heimowitz, chairman of the legal committee of the Association of Americans and Canadians in Israel, told The Jerusalem Post.

Contrary to popular belief, Heimowitz said that capital- gains taxes of 35 percent have always been in effect for immigrants who realized profits on overseas stock markets.

However, very few immigrants living in Israel actually reported this income, as the law did not require them to do so. Immigrants from the U.S. paid only the 25% U.S. tax rate required by American law.

That is the crux of what led former finance minister Yaakov Ne'eman to refer to some American immigrants as "tax evaders" in a highly publicized outburst in November 1998.

The major immigrant organizations realized long ago that, with the liberalization of the shekel in May 1998, the issue of passive income abroad was going to come to a head.

Everyone agreed that, once Israelis were permitted to open accounts abroad, all income from abroad would have to be reported to prevent the US, or any other foreign country, from become a de facto tax haven.

In fact, from an economic perspective, this reform should have accompanied the 1998 shekel liberalization, but Ne'eman and then prime minister Binyamin Netanyahu - who had drawn up a similar comprehensive tax reform plan - never mustered the political backing to present it to the public.

Heimowitz explains why immigrants should not be taxed: "The difference is that the money an Israeli places overseas was earned here, but the savings of an immigrant that was earned abroad is in no way linked to Israel."

This is especially damaging, he says, because immigrants have no recourse; they will have to pay taxes on savings that, in many cases, they were relying on to be tax-free to help finance their immigration.

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