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Wednesday, January 26, 2011

The Dependency Curse

A version of this article was published at http://www.israelnationalnews.com/Articles/Article.aspx/9962


Last week, Netanyahu adopted the recommendations of the Sheshinski Commission, charged with determining the appropriate rate of taxation on oil and gas extraction profits. The commission was empaneled based on the recent discovery of large offshore gas fields, Tamar and Leviathan. At the beginning of this week, the recommendations were brought to the cabinet for a vote, and passed. The only ministers to oppose were from Yisrael Beytenu.

The commission decided to raise the extraction taxes to rates comparable to those found in Western resource-rich countries, to a rate ranging from 52% to 60%, nearly doubling the current levels. They applied the tax to all future and current extraction sites, so that the large profits expected from the Tamar and Leviathan fields would essentially be divided between the invested companies and the State.

As soon as these major finds were revealed to the public there was strong pressure on the government to raise tax rates so that "the country's resources" could be shared by the entire country. The socialist elite were the first to jump on the "spread-the-wealth wagon" but a lot of people who should know better were also pulled up along the way. First and foremost of these is our Prime Minister, Binyamin Netanyahu, who was forced by public pressure to form the Sheshinski commission and is now standing firmly behind its conclusions.

Obviously, the oil and gas companies were livid about the idea that tax law would be changed specifically to garnish their profits after they had spent considerable time gaining exclusive rights to mine the ocean floor and even commissioning a geographical study to ensure that the Leviathan Gas Field was squarely in Israeli territorial waters, so as not to encroach on the rights of Cyprus.

However, the media and generally socialist-leaning public had no sympathy for Delek Group Chairman, Yitzchak Tshuva, or the other "tycoons."

Only National Infrastructures Minister Uzi Landau (Yisrael Beytenu) stood up for the right of companies to adhere to the tax rate they expected when they invested millions of shekels in their exploratory venture.

Another Yisrael Beytenu MK, Anastassia Michaeli, pointed out that it was not just "greedy tycoons" who held a stake in the large gas finds. The companies who had secured the extraction rights and prepared the fields for extraction were publicly held companies. Shares in these companies were held by private investors, as well as popular mutual and pension funds. The stock price dropped accordingly hurting the bottom line of many average citizens, as well.

As soon as the public campaign to raise taxes on these companies gained steam, so did ideas of what to do with the huge tax windfall. The opposition to the tax created even greater animosity towards the tycoons. MK Yachimovich (Labor) decried the greed of the tycoons for preferring lining their own pockets instead of improving the nation's health, education and welfare systems. Popular radio personalities asked: "How much wealth do they need?"
The irony of course, was that the ones ascribing greed to businessmen who work hard to generate profits, were themselves the very personifications of the green-eyed monster, lusting over money they did nothing to earn. No pot has ever so brazenly called the kettle black.

It seems that only Yisrael Beytenu has seen how damaging this tax-and-grab policy can be, or, at the very least, the only party willing to explain the issues without being swept into populist positions.

The companies involved in discovering and developing the gas fields entered into an expensive and somewhat risky project. The project was financed based on a reward-to-risk ratio by investors who assumed that the current tax rate would remain. A tax hike offsets this balance. While it is true that a democratic government has the right to change tax policy at whim, it is simply a bad business practice to change the terms of even an assumed deal. Legality aside, opportunistic tax hikes look very bad, especially to foreign investors, hurting the entire Israeli economy.

Furthermore, the Israeli extraction industry is relatively new. Adding new taxes makes the industry less lucrative and will discourage competition in the industry, which leads to a monopoly or a small cadre of companies acting in monopolistic fashion.

As mentioned above, these new taxes will not only take money from "tycoons" (who should be protected by rule of law as much as a beggar), but from average working Israelis who invested in oil and gas through the stock market or through pension funds.

The economic reasons for opposing this tax hike are compelling, but there is an even more important reason that the Knesset must work hard to prevent the tax from being raised.

The psychological effects of tax dependency may be the most damaging to Israel in the long run. The effects are being felt prematurely, as different government bodies have already started to snipe over who should benefit from the gas revenues. Each Ministry is now trying to explain how it is financially incapable of development without these gas revenues. The mere thought of extra disposable cash has discouraged ministers from reforming their sectors or increasing efficiency. Why bother belt tightening when we can "suckle from the bounty of the seas?"

The other aspect is that government is by nature inflationary. Wants are infinite but resources are finite. When the gas runs out, how will the country deal with a sharp drop-off in its tax-revenue? Will a society based on tax dependency be prepared for austerity measures, or will the urge to tax only grow? Here, we need only look to modern Europe as an example. For years, the European hunger for taxes was insatiable, and now every European country is forced to make severe public sector cuts – depressing the mood of an already depressed economic situation.

But what about those countries that are riding the resource-profit high? First, Israel's finds are significant, but are no match for those of Abu Dhabi or Qatar. However, these countries are also not models to be emulated. While these are small states with dictatorial rulers, one can see that excess wealth can lead to weird and not-necessarily-sustainable growth. Flashy items like World Cup Stadiums and Towers of Babylon may not be on the Israeli agenda, but there is always an urge to make a splash when you have what to spend.

PM Netanyahu suggests the tax revenues be dedicated solely to education – very practical – until there is a push to turn every classroom in the country into a "smart classroom." Besides the questions of whether "smart classrooms" actually produce smart students, it is only natural for someone spending someone else's money to go beyond necessity into luxury.

The worst effect will be felt by the population as a whole, which, after years of painstaking free-market gains in Israel, will be brought back to the attitude that one can make a living on somebody else's work. The psychological effects of this are immense. Rather than contributing to social cohesion, the attitude will enforce an obsession with jealousy, "wealth gaps" and allocations. The rabbinic dictum of "Who is rich? One who is happy with his portion" will lose all meaning. The psychological attitude of tax dependency, along with the resultant drop in foreign investment, discourages the resourcefulness and entrepreneurial spirit that has been the pride and lifeline of Israel for the last two decades. Israel cannot afford to let its entrepreneurial engine relax!

Proponents of the tax hike must look past the short term benefits and be very wary of the long term damage to the nation and people of Israel. Let our country develop naturally, with resourceful companies generating new sources of employment for workers and profit for investors. Stand up to the populist greed and jealousy. The economic effects of a tax-hike can be reversed. If the tax is repealed, investor trust in Israel will return and competition will enter the market, since markets adjust to new realities very quickly. However, the psychological effects of a tax dependent society may last decades. The Knesset must stem the government's attempt to "reel in the Leviathan on a fishing-rod" and convince the public to resist the urge to live off its ample ingenuity and skill.

1 comment:

  1. "When the gas runs out, how will the country deal with a sharp drop-off in its tax-revenue?"

    Good for you asking the 'what's next?' question, and embarrassing— implicitly—nearly all MK's who didn't and those who shied away from speaking up. Thinking at the margins is what rational people do. It's a shame that Shas's Yishai wants to spend the money on welfare which will basically be poured down the drain.

    What will happen when the money runs out? There will probably be as much populist/socialist rhetoric and maligning of entrepreneurs as we have now. Unless, of course, Yisrael Beitenu continued promotion of fiscally sound and fundamentally fair policies penetrates the greater political dialogue.

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