The following changes are proposed in the personal tax structure:

1. All the present tax rates would be unified into a single, flat rate, probably about 25 percent.

2. This single rate would include 8 percent NII.

3. This tax, including NII, would be collected on all personal income, with almost no exceptions, with full withholding.

4. Income from an unincorporated business would be taxed in the business within the framework of the business income tax, unless it is withdrawn by the owners for personal use and then taxed as personal income. Personal income tax on such a withdrawal would be withheld in the business.

According to the Bank of Israel the average personal tax burden, including NII, has been 25-30 percent in recent years. 7 In Appendix III we present some arguments to show that a rate of 23.5 percent would suffice, and that a rate of 25 percent would enable us to eliminate some nuisance taxes. We believe that a flat rate at this level would be no less progressive, in practice, than the present system with its high marginal rates. It is worth pointing out again that the crucial factor in the psychology of tax avoidance and evasion is the marginal rate and not the average rate.

NII, as a result, will no longer be the regressive tax that it is today. Our proposal would make the NII tax part of the personal income tax, and by applying it to all personal income, significantly widen its base. An examination of the data on tax receipts for the year 1988 suggests that the tax base might double. This would enable the rate to be reduced by about half from the present 15 percent, while incidentally reducing somewhat the cost of labor in Israel. It should be noted that these questions are currently the subject of debate in the United States.

The following data from the United States Internal Revenue Service, published recently by John Mueller, show the effects of the recent tax changes in the United States, when the marginal rate for the very highest incomes was reduced from 50 percent to 28 percent. Incomes are in dollars per year.

Table II

Although the increase in personal exemptions that was one component of the changes, along with the inflation and general prosperity of the 1980s, contributed to the effects shown in the table, still the increase in the tax burden carried by the high incomes is impressive. One should bear in mind that the effects shown in the table are due to changes in the tax rates alone, since the social security taxes in the United States (about 15 percent up to a maximum income of $42,000 in 1986) were not affected by this reform. Given that we propose to change the present regressive nature of NII as well, there would be an additional shift in the tax burden towards higher incomes.

A flat rate of 25 percent on all income would make Israel competitive with the rest of the world, especially the United States, and should effectively eliminate the transfer of assets abroad to escape taxation. Another point to remember with regard to the subject of tax evasion is that "white" money is generally more valuable than "black" money. White money can be used for any purpose, whereas black money can only be used in ways that are not traceable, mainly consumption. Furthermore, black money, if not used, remains idle, while white money can draw at least the minimal interest available in the banks. At today's Eurodollar rates (about 8 percent) the income tax rate proposed here (25 percent) would be repaid by interest within three years. There is practically no financial reason to evade taxes at this level.

A single flat rate has several additional advantages. It eliminates the requirement for periodic adjustments in tax brackets, in order to keep pace with inflation. It renders irrelevant the question of how to divide income among family members in order to minimize taxes. It also removes the inequity that exists in the taxation of the woman whose income is derived from her husband's business. By treating all income equally, it also treats all income brackets equally. Since different income brackets have different income sources, the present system, by favoring some sources over others, incorporates serious discriminatory effects, usually in favor of the wealthy.

Employee benefits, if paid on a current basis, should be treated as salary and taxed, as they are, by and large, today. All the small tax exempt benefits and small loopholes should be eliminated. Deferred benefits, such as the presently tax exempt Hishtalmut, are more problematic, since the question of whether the employer has funded them becomes an issue as well. 8 Ideally, deferred benefits should be taxed as personal income, and simultaneously recognized as a business expense, when the benefits are actually handed over. Then the question of funding becomes an issue that concerns only the two parties. Loans extended by a business to an individual, whether employee, manager, owner, or whatever, should be seen as a transfer of capital back and forth; as explained in Section VIII, the tax significance is proportional only to the difference between the personal and business tax rates. If the tax rates are identical there are no tax consequences.

It should be stated explicitly that no provision exists in our proposal for personal exemptions, and that there is no threshold which would throw low income families out of the income tax net. All personal income is taxed from zero at 25 percent. This point is serious enough to require some discussion and even a slight digression into the expenditure side of the budget. The present system has a threshold that arises from an income tax credit (not an exemption) to which every taxpayer is entitled. In 1989 this credit amounted to about $900 with an additional credit of about $400 if the taxpayer's wife had no income of her own. Using the present lowest tax rate of 20 percent, this means that the first $4500 (or $6500 including a non-working wife) is income tax free. On the other hand, NII does tax this income at 15 percent from zero. If compensation for the lack of personal exemptions in our proposed system is thought necessary, we would much prefer to implement it through the expenditure side, by paying every person a per capita allowance of $150 per year.

This could easily be done through the already existing NII system of child allowances. The procedure of allowance per capita should prove to be more progressive than the existing system of tax credit per taxpayer, since those who are at the bottom of the salary scale may not have enough income to use up the full tax credit. Also the poor, with their large families, probably have more dependents per taxpayer. The cost of such an allowance could be covered by increasing our proposed tax rate by one or two percentage points.

The fact that our system does not include tax allowances, exemptions or credits and that the tax rate is flat, means that the amount of tax collectible on any wage is dependent only on its amount and not on the circumstances (whether married, with or without children) of the wage earner. And what is true for wages pertains to fringe benefits, dividends and any other transfers to individuals as well. Furthermore, the withholding is exact. There is no overwithholding or underwithholding to be made up through an individual tax return that is filed at the end of the year.

Therefore, our proposed system does not include a separate tax return for the individual taxpayer. We assume that all personal income is received from organized sources of one sort or another. Wages (including fringes, pensions, etc.) are paid by businesses, non-profit organizations and the government itself. All of these withhold 25 percent. Profits and withdrawals from an unincorporated business are taxed and withheld in the business, exactly as for an incorporated business. Dividends and other distributions are treated as wages. Someone who carries on a part time business from his home will have to register as a business and file the monthly return that every business files.

His part time business will be taxed as any other business. It will be the job of the tax authorities, as it is their job today, to ensure that all businesses, even small ones, are known to them and that taxes are collected. One can think of sources of income that slip through the net, such as income from work done overseas. But we feel that the benefits in simplicity and reduction of bureaucratic hassle far outweigh the loss in tax collection from those sources that escape the net. In our proposed system, an individual tax return would be superfluous, supplying to the government information that it already has about taxes that have already been paid.

Nevertheless, if it is thought necessary to include an individual reporting requirement, it would presumably have to serve either or both of the following functions:

• To capture categories of income that do not fall naturally within the framework of our system, such as the foreign income already mentioned.

• To provide the tax authorities with information on the total income, including tax exempt income, of each individual, for purposes of enforcement. To this end, we have designed a simple individual tax form, shown in Appendix V.