Personal Direct Tax Reform Proposal

Introduction

In the course of 1998, a Finance Ministry team under the Minister of Finance at the time, Prof. Yaakov Neeman, drew up a plan for comprehensive reform in personal direct taxation.
Various Finance Ministry officials debated the plan for several months, in consultation with professionals in the private sector. Although the preparatory work progressed to advanced planning stages, the plan was neither implemented nor presented to the government and the Knesset for their approval, because doubts arose about to the ability to marshal sufficient political support for the proposal.
Since the need for reform in direct taxation has not changed, presumably an initiative to revise the tax laws will again be taken in the near future. A future tax reform need not be identical to the one formulated in 1998; instead, one assumes that it will reflect the social and economic perceptions of the decision-makers at that time. Nevertheless, we do not think it superfluous to sketch in writing the main provisions of the proposals that were phrased, and the considerations that were mulled, as the plan was being formulated in 1998. This will make it possible to resume discussions of the issue at some future time with an awareness of the work already performed; it will also shorten the decision-making process and facilitate the framing of a new plan that will tackle the tax system's problems.
Publication of the reform proposal will facilitate the development of public debate on the policy considerations that underlie the plan and on basic issues such as social justice, the desired breadth of the tax base, the appropriate level of the maximum tax rate, the desirability of general filing of tax returns, and the correct degree of punishment for tax offenses. Apart from documenting the topical proposals, this account should relate to additional aspects associated with the planning of such a reform. After all, in planning comprehensive measures in the field of taxation, the tactical facet is sometimes no less important than the particulars of the proposals themselves. Although each of these domains exists independently, the two are intertwined. Overemphasizing one of them at the expense of the other may doom the entire process to defeat.
The first part of this chapter focuses on several aspects of the tax reform. First, it surveys the considerations that underlie the decision to compose the tax-reform plan. Afterwards, it presents the models that were used to analyze the reform proposals and that constituted an important input in giving the reform its contours. Over a period of several months, these models were used to examine dozens of alternatives and to provide decision-makers with information on the effects of various proposals on central-government revenue and the distribution of the tax burden among individuals. Farther on, the main principles of the plan at its beginning and its end are listed, with reference to various constraints that gradually led to revisions in the details of the plan.
Notably, this chapter does not include technical details and a full itemization of each proposed change in the income tax code, since it was assumed that the next reform will not necessarily treat these details identically.
The second part of the chapter focuses on tactical aspects of preparing a tax reform and points to several possible conclusions and lessons from the experience gathered in preparing the 1998 reform. Although the remarks and trends of thought presented in the chapter also reflect personal views and outlooks, they may provide food for thought when it comes time to devise reform plans in the future.

Appendix 1-review of Israel's direct-tax system in 1998.
Appendix 2-definitions in the Household Expenditure Survey, adjustment of the survey data, and income distribution by deciles.
Appendix 3-detailed presentation of the proposal to limit social tax benefits.

^(*) Written by Avi Lavon and Meir Kupota.

Part A: How the 1998 Personal Tax Reform Plan Was Made

A. The Need for Personal Direct-Taxation Reform

1. General

The State of Israel has a well-developed system of direct taxation that provides more than half of central-government tax revenues for the state budget. However, even though the direct-taxation laws have been amended and revised dozens of times over the years, several basic problems that cause widespread public dissatisfaction with the tax system have remained unsolved. The focal point of the problem is that some members of the middle class who pay taxes honestly face a daunting tax burden while much of the population pays relatively little tax. There are several reasons for this: the many exemptions that the Israeli tax system offers¹, the ability of some taxpayers to engage in sophisticated tax planning, and the ability to evade taxes without substantive resistance on the part of the enforcement and punishment system. Consequently, the tax system is sometimes perceived as biased in favor of the well-heeled, resulting in a sense of injustice.
There seems to be a consensus, both in the "street" and among experts, that various modifications can help the tax system to function better and facilitate the formation of appropriate behavioral norms in complying with the tax laws. Lower tax rates would mitigate the incentive to evade taxes and help reduce the extent of underground capital and illegal economic activity. The advantages that may be gained from such action transcend the fiscal and economic domain; they may have a favorable effect on behavioral norms in Israeli society and on the system of rule of law. Lower tax rates than today's would also stimulate growth, prompt structural changes in the business sector, and encourage foreign investors to invest in Israel. Finally, they would encourage workers in high-demand technological occupations to refrain from emigrating to countries that have lower tax burdens, thus helping Israel maintain its comparative edge in the quality of its human resources.

2. The Substance and Implementation of the Changes-Various Approaches

As stated above, there is a broad consensus about the desirability and the need to modify Israel's direct-tax system. The experts, too, have various attitudes and views on how urgent it is to improve the situation, the tactics to adopt in making the changes, and the most appropriate minutiae of the changes.
For example, the former Minister of Finance, Prof. Yaakov Neeman, represented the view that favors urgent change by means of a comprehensive reform adopted en bloc. His approach stemmed from concern that the existing situation, if it continues, may harm the tax system; from tactical reasons; and from consideration of the interrelations between the segments of the plan. (The tax reductions were to be funded from extra revenue generated by the elimination of exemptions.)
Others think the situation is not as bleak. They argue that, although action to improve things should be taken, it can be done gradually, without a comprehensive reform implemented hastily and "in one go."

3. Academic Research as an Aid in Choosing among the Approaches

It is difficult to choose one approach over another on the basis of economic data, since economic research does not always provide clear and unequivocal answers to the questions at issue. Below we provide examples of the problems and difficulties that research faces in regard to taxation. The examples show how hard it is to take a firm stance on both the urgency and the contents of the reform:
The desired criteria of a good tax system: In certain fields, there is no consensus about the indicators that one should use to judge an existing tax system. For example, economic theory does not tell us, unequivocally, how progressive a tax system should be and how large tax disparities among different types of income ought to be.
Implications of expected changes: Economic theory does not always give clear information about the results one may expect from changes made in the tax system. When we ask whether, and to what degree, tax rates affect the labor supply, for example, economic theory provides two clashing answers. Empirical research indicates that labor supply responds favorably to lower tax rates, but the intensity of the effect is disputed.²
A lack of solid research information: In regard to several tax-system phenomena that are considered problematic, solid information on the situation in Israel and other countries is lacking. For example, no studies shed clear light on the extent of tax evasion and underground capital in Israel. To what extent will today's tax evader, at high tax rates, begin to pay honest taxes if the rates are lowered? There is no clear answer. There are no clear data and consensus about the extent of tax reduction that is needed to create a real change in the public's behavior concerning tax evasion. There are also disagreements about whether tax evasion in Israel is on the rise-causing increasing harm to the tax system-or whether the phenomenon exists at a constant level.
Disagreements about analysis of the data: Even when there are data about a given phenomenon, experts do not always agree about its causes. For example, forecasts of tax collections often overestimate or underestimate the tax actually collected, but the experts do not always agree about why. Therefore, it is difficult to cite a shortfall in tax collection as evidence that the situation of Israel's tax system is worsening.
Effects of personal preferences: At times, the attitude toward a given tax-system phenomenon is derived from the beholder's outlooks and preferences. An example is the issue of the ceiling wage on which National Insurance contributions and health tax are paid. This ceiling creates a "hump," in which middle-income earners pay the highest rate of direct tax and others with especially high incomes pay a lower marginal rate.³
However, there is no consensus among experts about the need to do away with this "hump," and, if so, how to accomplish this.⁴ Some argue that Israel's situation in this context is not unusual by international standards. Furthermore, from the standpoint of the progressivity of the tax system, it has been claimed that the situation is not especially problematic, since progressivity is defined as a steady upturn in average tax rates, and Israel's tax rates meet this condition. None of these explanations changes the feeling among some Israelis that the system shows blatant preference for the well-to-do and for capital. Not only is a large share of their income totally tax-exempt, and not only is their capital not subjected to capital-gains tax, but even their direct-tax rate (of which National Insurance attributions are part) is lower than the rate for middle-income taxpayers.
Difficulties in performing international comparisons: It is especially problematic to draw conclusions by comparing Israel's situation with that of other countries on the basis of a few indicators. For example, many Israelis feel that the tax rates and tax burden in Israel are high by international standards.⁵ In contrast, it is occasionally argued that this feeling is unjustified, since Israel's direct-tax burden, in percent of GDP, is one of the lowest in the West and that Israel's marginal tax rates (at least in terms of the highest marginal rate) are not exceptionally high in comparison with Western countries.
However, those who subject the tax burden to a comparative examination must bear in mind that some Western countries include, in computing their tax burden, social-security contributions that correspond to pension contributions in Israel, which are not included in the tax burden. Furthermore, the tax burden is an average sum that pertains to the population at large. Since half of working Israelis do not reach the tax threshold, this figure may portray a low burden for the population at large while certain groups of taxpayers shoulder a very high direct-tax burden by international standards.
Similarly, an examination of tax rates should also take account of the income to which the rates apply. For example, Israel's highest income-tax rate applies to a rather low income, three times the per-capita GDP, whereas in other countries-such as the United States-the highest tax rate (47 percent in the case of the U.S.) applies only to income that is nine times greater than per-capita GDP or even higher. Consequently, while Israel's marginal tax rate is not high by international standards, the average tax rate for certain groups of taxpayers (those who derive most of their income from labor and who earn between NIS 10,000 and NIS 20,000 per month) exceeds conventional Western levels.
Difficulty in drawing conclusions on the basis of international comparisons: This difficulty in the field of taxation is aptly illustrated by the issue of the income-tax threshold. Israel's threshold, as a percent of the national average wage or per-capita GDP, is considered high by world standards;⁶ it exempts about half of the country's taxpayers from all income-tax liability.
However, it is hard to draw practical conclusions from an isolated figure such as the tax threshold, since the tax burden is affected not only by the threshold but also by credits and deductions, the level of the tax rates, and the density of the tax brackets. A low tax threshold is not necessarily evidence of an onerous tax burden. For example, in a tax system with no credits, no deductions, and a beginning tax rate of 0.1 percent, the poor would pay tax from their first sheqel but the burden would be negligible. Israel's income-tax threshold may be relatively high, but its taxpayers are liable to other taxes-such as National Insurance contributions, health tax, and indirect taxes-at a level that surpasses that in other countries. Furthermore, other countries may have a set of transfer payments that offsets the taxes that they impose on low-income earners.
For example, if Israel's high tax threshold counterbalances some of the indirect-tax burden on low-income population groups, then lowering the threshold to the level of some Western countries may result in pressure to lower other taxes or raise transfer payments in order to avoid a worsening of income distribution.⁷
It should also be borne in mind that lowering the threshold would have undesired results such as greater inequality in income distribution. Therefore, this move would have to be accompanied by complementary measures that might prove controversial.
Difficulty in weighting the variables: An international comparison of tax systems must refer to the full range of variables of which the system is composed. It must address itself not only to tax rates but also to the spread between the tax brackets; the extent of credits, deductions, and exemptions; the method used to deduct expenses; the time at which tax is paid; the method of depreciation; and the other taxes (such as indirect and capital-gains taxes) to which the taxpayer is liable. The examination must include the level of transfer payments, the extent of services provided by the state in return for taxes paid, the average income level, the cost of living, and other parameters.
Ultimately, when one wishes to determine the need for changes in a tax system by "grading" the system on the basis of international comparisons, one must weight the parameters. This weighting will vary among groups of taxpayers and, at times, at the level of the individual taxpayer.
However, since there may be different views about how much weight each variable deserves, it is very difficult to compare different tax systems and, perforce, to state flatly, on the basis of an international comparison, that a given tax system requires immediate reform.

4. Conclusion

Many Israelis agree today that the personal direct-taxation system needs changes. However, there is no consensus about how urgent the changes are-whether they should be implemented at once, as part of a comprehensive reform, or whether they can be introduced gradually over a lengthy period of time. The public is also of many minds about the desired changes themselves, and economic research does not always supply clear and adequate answers. Consequently, the differing approaches are based not only on research data but also on personal feelings and viewpoints.
It is therefore our conclusion that the public agrees widely that there was good reason to fashion a proposal to tackle the most conspicuous problems of the Israeli tax system, foremost the onerous tax burden on the middle classes. However, this public consensus did not necessarily extend to the contents of the changes proposed and the tactics chosen. Thus, it is important to stress that while the principles of the plan, spelled out below, may serve as background material for a future reform, there is no reason to assume that the changes to be made in the future will necessarily be identical to those bruited in 1998. Any future plan will correspond to the economic and social preferences and outlooks of the decision-makers who will formulate it.

¹ Many types of income - such aas those accured outside of Israel or earned from rental of a dwelling, interest, capital gains on the stock exchange, and sains from the sale of a dwelling - are totally tax - exempt or liable to tax at low rates. Adittionally, quite a few benefits for various entities have made their way into the tax laws over the years.

² See, for example, Chapter XVII of this Report.

³ National Insurance contributions and health tax paid up to the monthly gross income of NIS 22,714 (1998 average). Consequently, the marginal tax rate actually decreases at the highest income levels, from 60 percent (63 percent when the employer's share in National Insurance contributions is included) to 50 percent.

⁴ The "lump" can be eliminated by abolishing the National Insurance ceiling, raising the tax rate on high incomes or reducing the rates that apply to middle incomes

⁵ The direct-tax rate climbs to 40 percent (not including the employer's share of National Insurance contributions) at a monthly gross income of only NIS 3,500 (60 percent of the national average wage) and 55 percent at NIS 9,500 (150 percent of the national average wage).

⁶ See the State Revenue Administration Report for 1997, No. 47, Chapter XVI.

⁷ Transfer payments have the effect of reducing poverty; direct taxes are used to narrow income disparities among the population at large. According to data from the National Insurance Institute, direct taxes in 1997 increased the incidence of poverty by 20 percent while transfer payments reduced the number of households under the poverty line by 60 percent. In 1995, even though the income-tax threshold was no lower than it is today, reduced rates of National Insurance contributions and health tax were introduced for income up to half the national average wage in order to improve income distribution and reduce the incidence of poverty.

B. Personal Tax Reforms in Israel and Abroad

In the 1960s and 1970s, Western countries raised their tax rates considerably to finance the expenditures of the welfare state. It is true that tax rates were lowered from time to time, in order to stimulate demand at times of economic slump, but not until growth rates slowed in the second half of the 1970s did the spotlight turn to the supply side. It was argued then that one could encourage labor and investments by reducing tax rates and that the accelerated growth resulting from this would avert harm to state tax revenues.
The supply-side approach assumes, as its point of departure, that the collection of taxes casts a pointless cost on the economy-a direct financial cost to the tax authorities and citizens, as well as indirect costs in terms of lost welfare as a result of change in the behavior of workers, investors, and consumers. In a nutshell, one may say that this "excess burden" is a rising function of the marginal tax rates. Moreover, this function has a positive second derivative-a small increase in the marginal rate leads to a greater increase in the excess burden, and vice versa, a decrease in the marginal rate leverages a meaningful increment in welfare.
The supply side approach promised that lower tax rates would induce additional growth and consequently higher tax revenue. As doubt was cast on the existence of this virtuous circle, an alternative model was offered where lowering tax rates would be finances by broadening the tax base. This model was the heart of economists and politicians.
The American income-tax reform of 1981 was inspired by the supply-side approach. Although growth rates increased in the years following the reform, the contribution of the reform to this increase is not clear and, in any case, the intensity of the growth was too small to offset the revenue lost by the lowering of rates. In the final reckoning, tax collections declined.
The supply-side approach was refined in the second half of the 1980s. In the American federal income-tax reform in 1986, tax rates were lowered in every bracket -especially in the highest bracket-and various tax benefits were pared. Quite a few countries followed the Americans' lead-at varying degrees of intensity-and many others declared their intention to do so.
Israel was not oblivious to this trend. In the ten years following the Ben-Shahar reform (1975), there were hardly any changes of substance in personal income tax. In 1986, Israel, too, began to discuss a reform of this kind, and tax rates were lowered a year later. In 1988, a public commission chaired by Prof. Eytan Sheshinski recommended an additional decrease coupled with the elimination of tax benefits. These recommendations were not implemented, but tax rates were lowered in 1990. About one-third of the funding for this tax cut was provided by a reduction of tax benefits; the rest was generated by increases in the rates of indirect taxes. Between 1991 and 1993, income-tax rates were hiked to cover the expenses of immigrant absorption, but they were lowered again in 1994-1995, with no downscaling of tax benefits.
The need to carry out a tax reform has been expressed several times since 1995, but no such reform has been carried out. In fact effective tax rates were raised in 1997 to reduce the budget deficit. Despite the frequent changes in tax rates, the share of personal income tax in GDP decreased negligibly, from 11.4 percent in 1986 to 11.2 percent in 1998. In contrast, the trend in National Insurance contributions and health tax (until 1994: health-fund membership dues) was the opposite-their share in GDP climbed from 3.7 percent in 1986 to 4 percent in 1998. (These figures do not include the employer's share, which decreased during that time by about 2 percent of GDP.) All told, the share of personal direct taxation in GDP did not change-15.1 percent 1986 and 15.2 percent in 1998, with a dip to 12.9 percent in 1991 and an uptrend in 1992-1998.
This does not necessarily justify the conclusion that, in the final reckoning, the tax system underwent no changes of substance during that period. Although the average tax rate remained stable, changes may have occurred in the distribution of tax among taxpayer groups. It is also possible that the tax policy affected growth to an extent that is hard to estimate.
Summing up, we should note that during the period reviewed, there was much talk about the need to downscale tax benefits in order to free up sources to pay for the reduction of tax rates, but little was accomplished. The international and Israeli experience shows how difficult it is to eliminate tax benefits and keep them eliminated. Pressure groups that stand to lose from such measures are strong enough to cushion the loss and recoup the lost benefits in various ways. In contrast, the public at large, harmed by the bestowal of benefits to specific sectors, rarely has a lobby or any other means of applying pressure, and its voice is not heard.

C. Formulating the 1998 Personal Tax Reform

1. General

When Prof. Yaakov Neeman took up the Finance portfolio, he decided to initiate comprehensive changes in personal direct taxation. Although the Finance Ministry labored for several months to formulate the reform, it was not presented to the government and the Knesset for approval. This section of the chapter surveys the main provisions of the plan that was produced and refers to changes made at various stages of its preparation.

2. Main Provisions of the Plan in Its Final Form

The plan produced by the Finance Ministry rested on several basic provisions:

1.	Reduction of personal direct tax rates (income tax, National Insurance contributions, and health tax) by NIS 13.5 billion (3.6 percent of GDP), bringing down the highest rate of direct tax from 60 percent to 40 percent and limiting the maximum average direct-tax rate to 35 percent.
2.	Elimination or downsizing of tax benefits, in the long term, at NIS 5 billion (1.3 percent of GDP), mainly in the capital market and savings field. Since the Protection of Investments of the Public Law prohibits a worsening of the terms of some savings, a gradual decrease in tax benefits was stipulated. Thus, the elimination of benefits was expected to augment tax collections by only NIS 2 billion in the first year.
3.	Introduction of general filing of tax returns, as a condition for broadening the tax base and as a way to enhance tax collection.
4.	Tougher enforcement of tax laws by means of stiff fines and simplification of legal processes.

The reform included additional changes. We shall note two of them:

Changeover from a territorial tax method, in which some income derived from abroad is exempt, to a personal tax method, in which residents' income from abroad is taxable in Israel (subject to a credit for tax paid abroad).

Unification of the direct-tax base, including income tax, National Insurance contributions, and health tax (except for certain minimum sums that special population groups remit to the National Insurance Institute).⁸ The significance of this unification is that all income to which regular income-tax rates apply will also be liable to National Insurance contributions and health tax. Hence, in cases where a limited tax rate will be chosen (on investment income, for example), there will be no further liability for National Insurance contributions, of course.

The reform was expected to be rather expensive in its first year, but increased revenue was foreseen in subsequent years, from three sources: maturation of the reduction in tax benefits, enhanced collections as a result of general filing of tax returns and tougher enforcement of tax laws, and GDP growth prompted by the lower tax rates. Only the increase stemming from the first of these sources was factored into the cost of the reform.
To bridge the gap between the cost in the first years of the reform and the extra revenue expected later on, a "transition surtax" at 15 percent of all direct-tax payments was proposed. This surtax was expected to bring in NIS 6 billion, reducing the first-year deficit to NIS 5 billion-or even less, considering the possibility that the reform would enhance collection and boost GDP.

3. Simulation Models for Changes in Tax Laws

When tax rates were changed in the past (at least in 1987-1997), decision-makers contented themselves with two figures-the effects of the reform on central-government revenues and on taxpayers with selected characteristics. The tax model of the State Revenue Administration answered the first question; the answer to the second question was based on an analysis of representative taxpayers: usually a male employee who earns NIS 2,000-NIS 30,000 per month (gross) and has a non-working wife and two children. Although these characteristics are representative of only 5 percent of households, the analysis gave us a good indication of the effect of the limited reforms carried out during that time.prepared in 1998. The decision-makers wanted to gauge the impact of the reform on central-government income and, no less, on income distribution countrywide. These two questions were debated in the context of a static model that assumed no change in gross revenues and the distribution of revenues among households as a result of the reform. Thus, the model did not take account of behavioral change. This premise was accepted even though behavioral change was not only expected but also considered one of the desired outcomes of the reform. In other words, it was hoped that the reduction of tax rates on labor would stimulate labor supply and reduce tax evasion. Since it was impossible to quantify these effects at any acceptable level of probability, and for reasons of caution, a static model was chosen.
Ultimately, the reform was examined with the help of four different tools:

a.	The State Revenue Administration tax model-This model is based on annual income-tax returns filed by the self-employed and by employers for their wage-earning employees. The file includes relevant variables for the computation of the income-tax liability of every individual who had any taxable income during the year. The Economic Research and State Revenue Administration uses the model to produce collection forecasts and to simulate the results of changes in tax rates. The model has two main limitations: (1) it provides no information about exempt income, i.e., most capital gains and transfer payments; (2) the examination unit is the individual taxpayer and not the household (although a family model, in which each unit includes married spouses and children up to age 18, could have been adopted). Due to the first limitation, the model cannot estimate the increment of collections derived from a complex reform that combines a reduction of rates with a broadening of the tax base. This combination of limitations renders the model incapable of providing information about the effect of policy changes on income distribution and the incidence of poverty, since it is standard practice to calculate these indicators on the basis of total household income. (To be more precise, the classifying variable is disposable income per standard adult.)
b.	Household Expenditure Survey-In view of the limitations of the State Revenue Administration tax model, it was decided to estimate the effects of the tax reform by means of the Central Bureau of Statistics' Household Expenditure Survey, with needed adjustments. In fact, an alternative tax model was devised, including a database and simulation programs for the existing tax laws and those to replace them in the course of the reform. Two kinds of adjustments were made: (1) the survey data were updated to reflect increases in prices, wages, and population between 1992/93, when the survey data were gathered, and 1998; and (2) the data were calibrated against actual data on tax revenues and collections in 1998. Appendix 2 presents several definitions from the Household Expenditure Survey, describes how the survey data were adjusted, gives a breakdown of household income, and distributes this income into deciles.
c.	Individualized examination of the effect of the reform on civil servants-Malam Information Services, Ltd., prepares the payslips of tens of thousands of civil servants. This creates a handy tool that includes up-to-date data on a rather large population group, in contrast to the data in the State Revenue Administration model, which are obtained at a lag of approximately three years. However, since the Malam data, like the tax model, provide no information on exempt income, the examination of payslips was meant to describe the situation of employees at their place of work only.
d.	Computation model based on various representative taxpayers-This used to be the main tool in examining the effect of changes in tax laws on individuals' net income. In fact, as stated, it focused attention on a rather small population. When the model based on the Household Expenditure Survey was developed, this model was relegated to secondary status. However, it was then enriched with a menu that allowed analysts to select values for about thirty variables that affect tax liability or eligibility for transfer payments, and thus, to assemble a larger selection of cross-sections. The list of variables follows:⁹ Socio-demographic variables: Sex-women qualify for an extra half credit-point and additional credit points for their children. Age-larger provident-fund benefits for persons aged 55 or older and those eligible for old-age pension. Family situation-credit-point eligibility for non-working spouses and single-parent families, for children commensurate with their number, for spouse's labor, and for year of immigration-credit points for recent immigrants; totally blind/disabled-income is exempt up to a ceiling; percent of credit for inhabitants of development areas; employment status-self-employed have a different status in contributions to National Insurance and pension funds. Types of income: the breakdown is by the tax rate that applies to the income. The income variables were divided into two groups: types of income that do not change as one's work income changes-shift wages, transfer payments, pensions, and gambling income-and those that presumably increase, at a certain function, as work income increases-dividends, interest, rent, and capital gains. The function chosen is the percent of work income that rises to a certain threshold, i.e., persons with work income under this threshold have no income of this type.¹⁰ Miscellaneous: Donations-which entitle the donor to a tax credit; the proportion of wage that constitutes a basis for employer's contributions; and the realization rate of provident-fund benefits by the self-employed.

⁸ In 1995, a large step was taken toward standartization of the bases; completing this process is a prerequisite for unification of the collection of these taxes.
⁹ See Table XVIII-1 for an example of a cross-section
¹⁰ For example, in the example shown in Table XVIII-1, an employee has interest income that is equal to 10 percent of his gross income that exceeds NIS 10,000 per month.

Table XVIII-1
Example of Taxpayer Characteristics in 1998

	Characteristics	Cross-section	Remarks
a.	Socio-demographic variables
	Sex	0	Woman "1", man "0"
	Age	45	Yes "1", no "0"
	Married/unmarried	1	Yes "1", no "0"
	Number of children up to age 18	4
	Working spose	1	Yes "1", no "0"
	Number of extra credit points for newly arrived immigrants	0	1,2,3
	Totally blind/disabled	0	Yes "1", no "0"
	Percent of tax benefit for special localities (development area, nothern border)
	Employment status	1	Employee "1" Self-employed "0"
b.	Income (NIS per month)
	Shift wage	0
	Benefits from Defence Ministry and other ministries	0
	Old-age pension	0
	Child allowance	1,225
	Lottery and gambling income	0
	Pension	0
c.	Other income
	(As percent of work income exceeding NIS 10,000)	0.0
	Ordinary divident	0.0
	Divident from Approved Enterprise	0.0
	Divident from foreign securities	10.0
	Capital and betterment gains	0.0
	Income from rental of dwelling	10.0
	Real short-term interest	0.0
	Interest on foreign-currency deposits	0.0
	Real long-term interest (more than ten years)
d.	Miscellaneous
	Total charitable donations (NIS per month)	0
	Pension wage (percent)	80
	Realization of contributions to provident funds by self-employed (percent)	80

Source:Economic Research and State Revenue Administration

For any given representative one can compute the effect of the reform at different levels of work income. Each of the four tools described above sheds a different kind of light on the reform and improves our ability to evaluate the results of the proposed reform.

4. Characteristics of the Reform in Its Initial Version

When work on the reform began, several constraints were adopted, in view of which the reform plan would be formulated:

a.	Maximum marginal tax rate-The Minister of Finance decided that the marginal tax rate, including income tax, health tax, and the employee's share of National Insurance contributions, would not exceed 35 percent.
b.	Revenue-neutrality-It was decided at the outset that the reform would pay its own way, i.e., that the cost of reducing the tax rates would not exceed the extra revenue generated by the downscaling of tax benefits.
c.	No detriment to disadvantaged population groups and the progressivity of the tax system-In view of its importance, this stipulation was fine-tuned in the course of discussions of the reform, and it included four rules:

................*	Disposable income shall not be reduced in any of the lowest deciles. This stipulation applied at the decile level but not at the level of individual households within the decile.
................*	The incidence of poverty-the percent of households under the poverty line-shall not increase. The poverty line was defined as 50 percent of median disposable income per standard adult.
................*	The Gini Index of disposable-income distribution shall not rise.
................*	The ratio of disposable income between the uppermost quintile and the lowest quintile shall not widen.