Shalom and the Balance Trap

Israel’s new minister of finance, Silvan Shalom, told Globes that he fears a crisis in high-tech industry. In order for high-tech, Israel’s once vibrant sector, to grow, Shalom said that he is preparing tax concessions for high-tech. In his words, “I have ordered reform and structural changes in this vital sector.”

Shalom is about to learn what every other finance minister of Israel learns when he orders reform: nothing much ever happens, especially when it comes to cutting taxes.

Shalom himself will be to blame for this failure. He has allowed himself to become ensnared in the Israeli macroeconomic trap, that of getting the balances right. Getting the balances right, in this case keeping the budget deficit within pre-specified limits, is Israeli academic and Bank of Israel doctrine. This doctrine holds that cutting taxes would increase the budget deficit, which would cause harmful economic consequences. Falling into the trap derailed former Prime Minister Netanyahu’s meager reform efforts. It will destroy Shalom’s attempt at even limited tax cuts and every other reform effort.

Shalom is on record as saying that “Income tax is undoubtedly high and should be lowered. However, the decline in revenue from taxes [due to the economic slowdown] prevents (us from) carrying out immediate reform.” In this statement, Shalom has knelt at the shrine of macroeconomic balance. The limited, as yet unspecified, tax reduction in high-tech he is talking about is intended to mollify the macroeconomists. But he will soon discover that they can never been satisfied whenever any tax cut for Israelis is proposed.

There is never a good time in Israel to cut taxes. There is always a good time in Israel to increase government spending. This is Israeli fiscal reality. Until this pattern is reversed, that is, it is always a good time to cut taxes and never a bad time to cut spending, every finance minister will find himself enmeshed in the same macroeconomic trap.

No wonder Israeli professors specialize in macroeconomics. If they specialized in microeconomics, they would find themselves in the uncomfortable position of having to advocate tax cuts, deregulation, reducing the scope and size of government—in short, support freedom and free markets.

Mr. Shalom, it is up to you to lead, not follow. You have an opportunity, which will quickly disappear, to change the direction of the Israeli economy: smaller government, lower taxes, higher growth. You need to propose bold tax cuts precisely because the economy is stagnant.