In a new paper that was published on the Bank of Israel website, “Tax Rates on Labor Income in Israel, an International Perspective: 2006-2007″ by Adi Brender, several interesting developments were noted:

• In the past three years, the average tax rate on wages in Israel has fallen for most income levels, while in developed countries it has risen on average.
• However, for the 2% of Israeli workers at the highest levels of income, the tax rate in Israel is higher than in two-thirds of the countries surveyed.
• In the tax code, Israel offers tax benefits for parents, which are most significant at low levels of income. However, about 75% of Israeli families with children do not fully utilize the tax benefits because the tax credits are normally only given to the mother.
• The report cited economists at the research department of the Bank of Israel who suggested that the characteristics of the tax system – high tax threshold and a relatively steep rise in the marginal tax rates – encourage entry into the workforce, though they reduce the incentive to increase the level of employment and the investment of effort to improve wages, principally for those with medium and high incomes, above 10,000 shekels a month. Workers at these income levels have also benefited fewer from reductions in tax rates in recent years.

The detailed reports tries to summarize the impact of some of the recent changes in the tax structure. While it is normally helpful to lower the tax burden on the population, it is interesting to note that for lower income families, there is a limited benefit for child credits because of the quirk in the law that only gives the credit to the mothers. And, on the other end of the financial spectrum, there is a real disincentive for talented workers to push ahead because of the confiscatory tax that they face as soon as they are earning more than the equivalent of a few thousand dollars per month.

Of course, the onerous tax burden does not just discourage people from working, but when it comes to spending, everything costs 15.5% more because of the VAT. This disproportionately affects the poor because the costs of basic goods and services are relatively higher for them compared to their wealthy counterparts.

The recent improvement in the tax regime has helped, but even though Israel may be ahead of some of its European counterparts, it is critical for the relatively small country to vigorously reform and reduce taxation.

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