The Israeli tax system has not been lacking in proposals for its improvement. Appendix I provides a brief historical sketch of the system's development and a summary of two recent outside proposals for reform. The most recent outside proposal was submitted in 1988 by the Commission of Experts on Personal Income Tax, also known as the Sheshinski Commission. This proposal sought to introduce improvements while maintaining the existing system. Nevertheless, the basic deficiencies of the system remain. Our proposal takes, at least partly, a more basic starting position: What system would we design if we were starting from the beginning? Even so, it is heavily weighted by what exists.

We propose a tax system having as its direct tax source a single, global income tax that would replace the present company (business) income tax, personal income tax, and National Insurance Institute (NII) levies. This single tax would have a single flat rate and would be imposed on a tax base which comes very close to being the gross national product. All income, personal and business, would be taxed once, and only once. We propose a rate of 25 percent for this combined, single tax. This would raise the same amount of revenue that is presently raised by all direct taxes, including NII, and make our proposal neutral from the point of view of total tax burden.

Indirect taxes, especially value added tax (VAT), 1 would be left unchanged.

The single, comprehensive income tax we propose is simple and clean. Its calculation is similar to that for VAT. We propose that its collection be integrated with the collection of VAT on a monthly basis. Its characteristics make the collection of this tax on business income and on personal income (withholding) on a monthly basis exact and complete. There is, in principle, no need for end of year tax returns for companies or individuals.

The basic simplicity of our tax with its single parameter (the tax rate) would make it much more immune than other systems to the pressures of special interests that exploit the multiplicity of rates, brackets, exemptions, exclusions, allowances, etc., that are usually present.

We want to emphasize that one of the major benefits of our proposed system would be a large reduction in bureaucratic hassle and in the abrasive contact that typifies the relationship of the tax authorities and the taxpaying public.

This paper is divided into several sections:

1. Introduction
2. The Present System - Some Details
3. The Present System - Some Problems Sections II and III, together with Appendix I, provide an overview of the present system and some of its problems. The discussion is necessarily brief and no claim is made as to completeness, either in the details of the system or in the list of problems.
4. Our Plan - Business Income Tax
5. Our Plan - Personal Income Tax Sections IV and V describe the changes that are needed in the present direct tax system (including NII) in order to achieve the system we propose. We try to justify these changes on other grounds as well and also describe some of the benefits that flow from these changes.
6. Value Added Tax This section is short since no changes are contemplated.
7. Integration of the System and Final Results Here we show how the business and personal income taxes we have derived are integrated and then combined into the single income tax we desire.
8. Investment Taxation and Policy Here we describe how investment and capital gains fit into our proposed system.
9. Future Changes We make some remarks on possible trade-offs between our new income tax and the presently existing indirect tax system (VAT, in particular).
10. Conclusion

Sources

Under the present system, revenues are derived from the following sources:

1. Income tax on personal income of all kinds is assessed progressively at rates of 20-48 percent. There is a tax threshold that arises from personal tax credits which depends somewhat on circumstances. Typically, it might come to about $6,000 per year for a couple. A variety of possible deductions and credits exist. Income from unincorporated businesses is taxed in this category.

2. Income tax on incorporated businesses is fixed at the rate of 43.5 percent on earnings. The calculation of profit is conventional, with the exception of adjustments for inflation, which are discussed below. A variety of benefits and subsidies exist for those meeting specific requirements.

3. NII (National Insurance Institute - the Israeli equivalent of Social Security) taxes are collected on salaries (but not on fringe benefits) and on self-employment income earned. The total employer and employee contribution amounts to about 15 percent, and is collected up to a ceiling of about $40,000 per year.

4. Value Added Tax (VAT) is collected at a rate of 16 percent on all locally made products. VAT is not collected on exports or on financial services, but is collected on imports.

5. Purchase tax is collected on locally produced and imported consumer goods such as cars, appliances, etc.

6. Customs taxes are collected on imports, but are steadily diminishing in importance because of Israel's adherence to various free trade agreements and a general trend towards liberalization.

7. A large number of small (sometimes nuisance) taxes are imposed, which contribute perhaps 10 percent of total tax receipts. These are described in Appendix II.

Table I