POWER + POPULISM = PLUNGING LOCAL STOCK MARKET?

Israelis are beginning to reap the fruits of this past summer’s protests; the problem is that the fruit may be rotten. While some in the middle class may have received some tax relief thanks to the recently passed legislation based on Trajtenberg committee recommendations entitled “The Bill to Change the Tax Burden,” those that actually create jobs received a slap in the face. Not only were corporate tax rates increased (when they were supposed to continue to be decreased by 1% every year for the next 6 years), but both capital-gains taxes and taxes on dividends were raised as well.

Now those that love to vilify corporate greed and “piggish capitalism” ( and it’s really cronyism, not capitalism, that’s the problem in Israel) are now doing cartwheels in the streets, as “the rich guys got what they deserved.” The problem is that the real engine of any economy, namely small-and mid-sized businesses, just received another tax increase and that increased burden will probably end up costing many jobs. In addition, transferring wealth from the wealthy to the less wealthy has never worked to help the lot of those less fortunate.

What needs to be done for the lower and middle class is not just to cut taxes – which is important – but to incentivize them to invest their money in a business, real estate or stock market. This is the way to grow one’s net worth. By increasing the tax on investment, you are stifling the opportunity for economic prosperity for the “have-nots.”

What happened to Bibi?

The real shocker in this is that Prime Minister Binyamin Netanyahu threw his support behind the plan. Everyone is aware of Bibi’s economic philosophy, which is based on the Reagan/Thatcher model, so why the sudden change? It was Netanyahu’s plan of cutting taxes across the board on income, corporations and capital gains that saved the economy from disaster a decade ago, and laid the groundwork for the robust economic expansion that is the envy of the world. Now, in the face of a global economic crisis and a slowing Israeli economy, he is cutting the lifeline of the economy?

The cynics among us would say that he did this to: A) quell any further protests that could wreak even more economic havoc, and B) gain popular support and further his reelection hopes. Whatever the reason, it could have damaging economic consequences.

Lower Revenues

While supporters of the capital-gains tax increase say that this will increase revenues to the government that it can then spend on a host of social issues, the data shows that revenues will drop. In a ground-breaking paper published by the Adam Smith Institute titled “The Effect of Capital Gains Tax Rises on Revenues,” over 50 years of data was collected and it showed that increases in capital gains tax rates actually lowered the revenues that governments took in. The paper is a must-read for those interested in the issue (too bad the Finance Ministry missed it!). Here are some data points relating to the US economy that are worth mentioning:

“In 1968, real capital-gains tax receipts were $34 billion at a 25 percent tax rate. Over the next eight years, the tax rate was raised four times, to a high of 35%. But with the tax rate almost 10 percentage points higher in 1972 than in 1968, real capitalgains tax revenues were only $27 billion – 21% below the 1968 level.

“In 1996, the year before the capital-gains tax rate was cut from 28% to 20%, net capital gains on assets sold were roughly $335 billion. A year later, capital gains had leapt to $459 billion. (The tax cut was retroactive to May 1997). In 1996, the [US] Treasury collected roughly $85 billion in capital gains revenues. In 1997, those tax payments jumped to $100 billion.”

There are many more examples of this.

Impact on TASE

Stock market movement as a result of increases/decreases in capital-gains rates can go both ways. The current issue for the Tel Aviv Stock Exchange (TASE), which has dropped significantly this year, is that investors haven’t really been in the mood to buy local stocks. Now add to the equation these new measures – and more to come – that could hurt growth, and you have a recipe for continued local stock-market weakness. The irony is that this actually is going to hurt the very people that you are trying to help.

Thanks to caving in to populism and political survival, it looks like the lower and middle class will continue to spin their wheels and run in place, and not enjoy any upward economic mobility anytime soon.

The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.

Aaron Katsman is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. a registered broker dealer, Member FINRA, SIPC, MSRB, SIFMA. For more information, call (02) 624-0995, visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.