The government of Israel spends hundreds of millions of dollars a year in direct and indirect subsidies to industry. Since the 1950s, the government has subsidized investment, subsidized exports through exchange-rate compensation for an overvalued currency, subsidized export marketing programs, provided grants and loans for research and development, assisted firms in financial difficulty through special loans and guarantees, and, through a new law enacted in 1990, extended these programs in the form of state-guaranteed loans to small businesses and high-risk ventures. In the early 1980s, subsidies to the business sector reached a peak of 14.6 percent of gross domestic product. These subsidy programs have three negative consequences. First, they misallocate resources between labor and capital, resulting in overinvestment in capital and the creation of fewer jobs than desired. Second, they drain the state budget, which is in chronic deficit. Third, they substitute state bureaucratic judgment for private sector investment decisions. The result: slowdown in productivity, inflation, crowding out of funds for private investment, high taxes, and bailouts of bankrupt companies. The State Comptroller has documented misuse of tens of millions of dollars in public funds allocated to prominent foreign and Israeli companies. Dr. Paul Rivlin, the author of Policy Studies No. 8, recommends that the government phase out all investment grants over three years, and offer tax benefits only for new investment. In general, the main goal of economic policy should be to reduce the reliance of business on government. Dr. Paul Rivlin is a Policy Analyst with IASPS. He is an economic consultant who has worked in industry and banking in the United Kingdom and Israel.