Too many cooks spoil the tax broth

The tax system has a pivotal role in the functioning of any economy. The first job of a well-designed tax system is to provide revenue for the services provided by the government effectively and fairly. Taxes also have a powerful influence on citizens’ behavior – for example, encouraging work or idleness, thrift, or irresponsible spending. They can redistribute income more fairly and also affect the macro-economy. Collecting more taxes in boom times and leaving more money in citizens’ hands in downturns helps to stabilize the economy. It follows that the proper functioning of the entire economy depends on a stable and well-designed system of taxes.

Yarom Ariav, the recent Director General of the Israeli Finance Ministry, concludes that the country’s current structure of tax administration constitutes a troubling obstacle to maintaining a consistent and stable tax system. In the Taub Center’s new State of the Nation Report, Ariav points to a recent series of problematic policy reversals reflecting Israel’s inability to implement such a tax regime: While direct taxes have been reduced, indirect taxes have been increased; the value added tax rate is constantly being changed; the gasoline tax was raised and almost immediately the increase was cancelled; a plan to end the VAT exemption on fruits and vegetables was suddenly revoked; there have been frequent changes in the taxation of real estate with no real policy in evidence; tax exemptions for foreign investors were followed by an announced intention to reverse the exemption; and so on.

Ariav explains that the problem originates with the ill-advised merger of two quite distinct taxation functions: policy and collection. Before 2004, there were two distinct collection bodies in the Ministry of Finance: the Income Tax Department and the Duties and VAT Department. Above these collection departments was an administrative unit, the State Income Administration. While the subordinate bodies implemented the tax policies, the supervising administrative unit devoted itself to strategic considerations such as  the design and harmonization of tax policies. In 2004, the two  departments were merged into the Tax Authority.

There may have been a certain rationale for merging the two collection departments, but practically speaking this has not yielded any meaningful savings thus far. At the same time, the merger was perceived as making the State Income Administration superfluous.  While the Income Administration ceased being the locus for organized strategic thinking about tax policy, no other body within the Finance Ministry filled the strategic policy making void that was created. The result is that now there are a plethora of different officials within the ministry working in virtual isolation from one another — and often at cross purposes — to craft Israel’s taxation policy. The Tax Authority is charged with collecting taxes, not designing them; the Budget Department is focused on overseeing expenditure, not income; and so on.

Ariav calls for the immediate restoration of the former status and function of the State Income Administration, stating that both logic and history make this the right office for examining and coordinating tax policy from a system-wide perspective, thus providing Israel with a tax regime that will promote growth, stability and fairness.