10/6/17 Israel and Americas Shared Economic Challenge

Israel and the United States share the same fundamental economic problem, i.e., increasing income inequality between the wealthy and most of the rest of the population. Despite having vastly different economies, the cause to the growing gap between rich and the rest in both countries is very similar, being caused by the same two factors. During the past decades, both countries have dropped the tax responsibilities of the wealthy and the economies of both Israel and the US have been greatly aided by the boom in high-tech. Vast fortunes have been created in America over the past twenty years all in high-tech — with the five of the six most valuable companies in the US being high-tech firms. In the past several years, the biggest fortunes in Israel have been made by the “exit” sales of Israeli high-tech firms to the world’s tech giants. 

In the US Congress, discussions are currently taking place on one of the largest tax reduction proposals ever, while in Israel, an ongoing dispute rages over how much to raise the government stipend allocated for handicapped citizens, funded from Israel’s equivalent to Social Security. Today, the allocation for handicapped citizens stands at under $700 a month, with the Treasury claiming there is no money for an across the board increase, and paying for such an increase by raising taxes would be considered blasphemous.

In the United States, the marginal tax on income above $400,000 ($3.2 million today) was 91% in 1961. Under a Tax Reform Bill proposed by President John F. Kennedy that number dropped to 77% in 1964 and 70% in 1966, with the top tax bracket starting with those earning $200,000. Under President Ronald Regan, the top tax bracket dropped to $90,000 ($194,000 today) by 1987, with a marginal rate of 38.5%. By the time President George W. Bush lowered taxes again, the highest marginal bracket stood at $311,000 ($424,000 today), and his administration lowered the highest marginal rate to 35%. President Barack Obama raised the highest marginal rate back to 39.6% on income over $450,000 in 2013. 

In Israel, the income tax rates on the highest earners went from a high of 60% to 50% today. However, at the same time, Israel’s Social Security taxes have decreased drastically. Israeli Social Security taxes had been as high as 21%, with no maximum. Today, Israel’s Social Security tax drop off to 9.8% at higher incomes. Furthermore, Corporate taxes dropped the most, from 60% to 25% (and often lower when companies qualify for special incentives) and taxes on corporate dividends are 25%, as is Capital Gains Tax. There is no Inheritance Tax. 

It should be noted that in 1976 Israel introduced a Value Added Tax, which is considered a regressive tax. Today, Israel’s V.A.T. is 17%. V.A.T. is even added to food products. Over the last two decades, Israel went from being a country with very low-income inequality, to a country maintaining nearly the highest income inequality in the developed world — with the US being the only country in the developed world ahead of Israel. In both the US and Israel the inequities are being driven by rapid increases in the pay of the highly compensated. 

While almost all economists agree that at least part of the growth in the gap between rich and the rest of the population has been caused by the lowering of taxation on the wealthy, most economists have under-appreciated the impact of technology. Technology has had two main impacts. First, technology has created a disconnect between the balance that existed between labor and capital. Capital has always needed labor. As a result, it was always necessary to pay wages that balanced the gains of capital. However, with the rising powers of computer robots, and even more so now, with the rise of A.I. and machine learning, workers can be replaced by computers. Consequently, the balance between capital and labor has now tilted overwhelmingly toward capital. 

In both Israel and the United States, there seem to be two economies — the high-tech economy and the economy of everybody else. The high-tech world, dominated by hugely successful companies, such as: Apple, Facebook, and Google pay high salaries; salaries that are significantly higher than the median salary in the US. The same thing has happened in Israel, where a talented computer programmer, who just graduated high school, can receive two and half times the salary of a starting teacher for a temporary job. Approx 10% of Israel’s workforce participates in the high-tech world, which turbo-charges the economy of Tel Aviv, (where many of the high-tech companies are located), while leaving large parts of the country's economy behind.

Finally, and maybe most importantly, are the implications of technology for the future. W. Brian Arthur writing in the McKinsley Quarterly, in an article titled, “Where is technology taking the economy?” claims we have entered into what he calls the “Third Morphing” of the computer revolution; a morphing that has been brought about by the of development machine-learning, artificial intelligence, which has led to a situation where intelligence no longer resides in man but in machines. In short, many jobs currently carried out by humans will likely be filled by computers replacements, thus further concentrating wealth. 

Some optimists believe the current jobs that will disappear will be replaced by new unanticipated jobs. Others, including myself, believe that once these jobs go there will be no new jobs to replace them. When self-driving cars and trucks replace the #1 job in the US (i.e., drivers), there will be nothing to replace those old positions. And if we give people and corporations new lower tax rates, the lower taxes will not be used to create jobs, but either to invest in new equipment, thereby eliminating more jobs or just to enrich stockholders, who will be able to hold on to even more of their new wealth. 

Israel’s problems are structurally less severe than those of the United States. With its 8 million people, Israel can be a major worldwide R&D center and with proper planning, a higher percent of its workers can be part of the technology economy. In contrast, the same cannot be said for the United States. The popularity of both President Donald J. Trump and Senator Bernie Sanders in the last election are just the first signs of the disruption and discontent that changes in the economy have created in the United States. A tax decrease is exactly the wrong prescription for what ails America.

The high-tech revolution has brought about a new inflection point. The world’s economy now produces more than enough to satisfy the needs of all of its citizens. However, as the march of technology continues, the gap between the “haves” and “have nots” will continue to grow. The only solution will be additional government expenditures — whether for guaranteed income or other programs to make sure that all citizens benefit. Of course, this discussion has not taken place, either the US or in Israel.