NOTES

      1. Value Added Tax (VAT), as its name implies, is a tax on the value added to a product or service at every stage, until the final consumer pays the tax on the full retail price. Added value includes, for example, wages and fringe benefits, pre-tax profits, financial costs, and certain other costs, but does not include purchased inputs such as raw materials and certain purchased services. In practice it is calculated indirectly through invoicing, by subtracting invoices received for purchased inputs from invoices written to cover sales. All sales of goods and services which are included in the VAT framework must be covered by VAT invoices which state explicitly the VAT included. Every business periodically transfers to the Treasury the difference between the VAT it has collected from its customers and the VAT it has paid to its suppliers. This difference is the tax on the value it has added to the goods it sells.
      2. This is an anomaly that requires explanation. Let us assume a business with a gross profit in the current year of $200,000, a net worth at the end of the previous year of $1 million, and a rate of inflation in the current year of 10 percent. The net worth of the company is depreciated by inflation and by the end of the current year has lost 10 percent ($100,000) of its real value. The Steinberg Law compensates the company for this by having this amount deducted from gross income, so that the company's taxable income becomes $100,000. But suppose that because of a succession of bad years the company had a negative net worth of $1 million. In this case the "compensation" becomes an addition of $100,000 to the company's gross income. This occurs even if the company is inactive in the current year. In other words, net worth is treated as a cash asset whose inflationary depreciation needs to be compensated, and negative net worth is seen as a debt whose inflationary depreciation is really a profit which should be taxed.

        Of course, the inflationary adjustment of net worth is only one part of the total picture, which also includes, for example, inflationary adjustment of tax loss carry forwards (due to the losses which caused the negative net worth in the first place). All the adjustments taken together should neutralize the effects of inflation. But the effect is also to destroy any direct, visible connection between sales and expenses, and income taxes.

      3. Robert E. Hall and Alvin Rabushka, The Flat Tax (Stanford: Hoover Press, 1985), p. 29.
      4. Alvin Rabushka and Steve Hanke, eds., Toward Growth: A Blueprint for Economic Rebirth in Israel (Jerusalem: Institute for Advanced Strategic and Political Studies, December 1988), pp. 21-55.
      5. Hall and Rabushka, The Flat Tax, p. 31.
      6. There is no VAT on financial services, which makes the taxing of banks and other financial institutions difficult, since our scheme uses the VAT framework to determine sales and expenses for the business income tax. It may be necessary to calculate the added value of financial institutions directly, rather than indirectly, as is usually done (see Note 1). Alternatively, the problem could be finessed altogether by imposing an ad hoc surtax on the total wage bill, or on total turnover, or on assets or net capital. This is no trivial matter, since the method used may affect, for example, the ability of banks to share with the government the large bad debt writeoffs that they have from time to time.
      7. Bank of Israel, Annual Report for 1988 (Jerusalem: Bank of Israel, 1989), p. 127.
      8. Hishtalmut is a tax exempt benefit, recognized as an expense to the employer, which is paid to many employees, especially those with academic training, for the purpose of enhancing their professional skills. The payment can range up to $4,000 or more per year and may be used for courses, travel to professional meetings, and so on. It is usually used for trips abroad that are justified by some very minimal professional activity overseas. Hishtalmut is generally recognized to be a way of increasing net income without incurring tax liability.
      9. Dan Galai, "Israel as an International Financial Center," Policy Studies 1, Division for Economic Policy Research (Jerusalem: Institute for Advanced Strategic and Political Studies, November 1989).
      10. Rabushka and Hanke, Toward Growth: A Blueprint for Economic Rebirth in Israel, pp. 21-55.

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