This proposal does not contemplate any changes in VAT. It has shown itself to be reasonably easy to collect and enforce, without creating an unreasonable bookkeeping burden. The exact rate, today 16 percent, is not sacred, but neither is it excessive by European standards. The present format of the monthly VAT statement is simple and can easily be expanded to accommodate the business income tax and the withheld personal tax.

The system we propose is completely integrated. Business tax, personal tax (including NII), and VAT operate together, are withheld together, and paid together. Whatever is taxed as personal income is not taxed as business income, and vice versa. The two are mutually exclusive, but together they cover the total added value. Furthermore, if personal and business tax rates are fixed at an equal rate, as we suggest, a conceptual simplification occurs that makes the whole tax system elegant and simple, resolving questions of capital transfer as well, as shown in the next section.

A fresh perspective is now in order. The difference between income and expenses (those covered by VAT invoices only) is taxed at 25 percent and the remaining 75 percent becomes available to the business for whatever purpose it wishes without any further tax liabilities on that money. These purposes may include net salaries to workers and managers, fringe benefits, interest on loans that the business has taken, loans to employees, withdrawals by owners, dividends to stockholders, payment for rented premises (unless covered by VAT invoices), trips to professional meetings, or retention of earnings for future investment or for working capital; in fact, any purpose whatsoever. This is not to imply that these payments are free of tax, but simply that the tax has already been paid, and that these are net payments.

By making the personal and business rates equal and constant we have eliminated the trade off between personal and business income and thus made irrelevant, for tax purposes, all issues of income division between various groups involved: between the business and its employees, the business and its owners or shareholders, the employees and shareholders, etc. The business income tax and the personal income tax are not only integrated, they are combined into a single, simple Income Tax.

As noted in Appendix III, this single, combined income tax is imposed on a tax base which is essentially equal to the gross domestic product, an ideal situation.

The simplicity of this combined income tax is also reflected in the fact that this system has only one parameter, the tax rate, which we propose to set at 25 percent. This should make this system relatively immune to the pressures of interest groups, who exploit the complications present in existing tax systems. The VAT system, which also has only one parameter (in Israel), has stood up well in this regard.

Consistency with the approach to taxation outlined above, requires that investment in a business should be viewed as the opposite of distribution of salary or dividends. In other words, an individual putting money into a business would enjoy a tax benefit and the business would suffer a tax debit. The effect on the Treasury would be proportional only to the difference between the personal and business tax rates. Similarly, when the individual takes his investment out, he suffers a tax debit and the business gains a tax credit. Investment would thus be treated just as any other transfer between an individual and a business. But since withholding operates, these credits/debits are effected within the business. If the personal and business tax rates are equal, there is no net effect on the tax liability of the business or on the government.

The investment or withdrawal of capital is then simply a movement of funds from one place to another with no tax consequences. There is no tax on this kind of capital gain, although gains on the sale of capital assets by way of business are taxed. We try to justify this in Appendix VI. Since there are no tax consequences, neither is there any problem of inflation. The government can now get out of the investment business altogether. Instead of trying to bribe people to invest in Israel by subsidizing their investments, the government should have an "Investment Policy" that simply tries to make Israel a good place to do business in. The present emphasis on encouraging investment as such is misdirected.

A recent study by Dan Galai of the possibility of turning Israel into an international financial center shows clearly that the essential ingredients for such a center are available in Israel; what is lacking is an attractive tax framework and regulatory environment. 9 Once these are provided, the modest investment required will be found without special inducements. The tax system proposed here would put the emphasis on doing business, where it should be, rather than on investment per se.

In general, the trend should be toward reducing the total tax burden as a fraction of the GNP, and hence tax rates should move downwards. This subject is well covered by Rabushka and Hanke. 10 No economy can prosper and grow when the total tax burden is in the vicinity of 50 percent.

Assuming that the rationalization of tax rates that we propose leads to a good part of the "black economy" turning white, and that economic growth resumes, it will be possible to reduce the total tax burden by adjusting the tax rates downward. Our preference is for reducing income taxes and eliminating nuisance taxes and leaving VAT as it is for reasons given in the following paragraphs.

Assuming the requirement for a given amount of tax revenues, we still have the freedom to apportion it among various sources - personal income tax, business income tax, VAT, and others - as we like. It might be desirable to shift the burden from income taxes to VAT, ultimately perhaps entirely. Some of the advantages of a gradual shift of the tax burden from income taxes to VAT would be:

1. A natural, built-in export incentive and a modest protection for local manufacturers would result from a shift to VAT. The cost component due to income taxes would go down, bringing down the price of locally manufactured goods before VAT, whereas a similar imported product would carry in its price a component caused by the average income tax paid in its country of origin. Since VAT on the local product and on the imported product are equal, the local one would thus enjoy a certain advantage. A local product destined for export would be free of VAT, as it is today, and also benefit from the reduced income tax burden, again giving it an advantage over foreign goods. This advantage is essentially proportional to the added value (salaries, dividends, etc.), as it should be.

2. The moderate protection thus afforded local manufacturers should make it possible to eventually eliminate remaining customs duties.

3. This would effectively turn Israel into something like a free trade zone. Manufacturers and suppliers of services would be free of direct taxes. Those employed in these industries would, of course, have to pay VAT on their own consumption. But there would be a clear benefit to setting up manufacturing and service industries in Israel and exporting the products.