Five families

‘I will not be the one to break the peace we’ve agreed here today’

On the face of it, Israel’s tax burden isn’t outrageous. As you can see in the chart below, our government eats up 31.6% of GDP in taxes (GDP is the value of all the goods and services the country produces). That’s a lot of money, but it’s lower than the tax take in most OECD countries. We’re taxed more than Americans or Australians, but much less than the French or the Danes.

tax as percentage of GDP

So far so good.

There’s a catch, however. That catch is the vast web of hidden taxes that don’t show in the official statistics. It turns out that – like ‘dark matter’ in the universe – the hidden taxes are quite possibly bigger than the ones we can see.

I’m referring, of course, to Israel’s Bolshevik regulation of product markets – the markets for goods and services. For whereas the proper function of government is to protect consumers by ensuring that markets are competitive, in Israel, the government mostly fulfills the opposite function – protecting suppliers by ensuring that markets are not competitive!

Since we live in the Land of Milk and Honey, let’s take those two products as our examples. At $1.56 per liter and $1.27 per 100g, respectively, the consumer prices of milk and honey in Israel are roughly double their prices in other developed countries. They are also regulated markets. Dairy products in Israel are regulated by the Israel Dairy Board and honey by the Israel Honey Board. (I’m not making this up!!)

These bodies are comprised of the producers of milk and honey products, respectively, together with some government functionaries, and they regulate the market in roughly the way the ‘Five Families‘ of New York regulated their industries in the Godfather, which is to say, without too much concern for the public interest. To illustrate how this works, let’s imagine a conversation between a consumer and the regulator. (For best effect, the role of Don Regulatore should be read in a Marlon Brando Italian accent!)…

Consumer: Godfather, I can’t afford milk in this country. I need to import cheap milk from abroad

Don Regulatore: You can’t. It’s illegal.

Consumer: Well, can I buy directly from a farmer and at least cut out some middle-men?

Don Regulatore: You can’t. It’s illegal.

Consumer: OK, can I buy bulk quantities and negotiate a better price?

Don Regulatore: You can’t. It’s illegal.

Consumer: Godfather, you leave me no choice. I’m buying a cow and making my own milk!

Don Regulatore: You can’t. It’s illegal.

Milk and honey are just two of dozens of examples of regulated markets, where the market is fixed to protect producers, not consumers. I could have chosen banking, bread, cars, cement, eggs, meat, olive oil, real estate, spare parts, or many others. These regulations act like taxes – sucking money from the public and transferring it to special interests – but they are worse than taxes for they are invisible, unmeasured and thus immune to public scrutiny.

Sometimes the regulation is blatant like in the milk example – price-fixing, production quotas, and penalties for those who violate the sacred code by – gevalt! – reducing prices or ‘over producing’. At this point, you’re probably thinking, ‘Isn’t that the definition of a cartel? Don’t people go to jail for that?’ and the answer would be, yes, unless you’re lucky enough to be in the food industry in Israel, in which case the government actually runs your cartel for you!

Mostly the regulation is more subtle – restrictions on who is allowed to enter a market, bureaucratic obstacles to new competitors, high tariffs on imports, restrictions on who is allowed to import, redundant and costly ‘safety’ certification processes, packaging and labeling requirements that differ from international standards, redundant and costly kashrut supervision requirements, inefficient ports, etc., etc. It’s basically about putting enough red tape around potential competitors that they give up before they start.

So how big is the invisible tax burden? How does compare to the visible one?

In truth, it’s impossible to measure precisely but the best proxy, in my opinion, comes from looking at Israel’s per capita productivity. Why? Because variations in labor productivity between countries are driven primarily by differences in institutions and government policy, see Hall and Jones (1998). Where institutions are uncorrupt and policy promotes open, competitive markets, then individuals and firms will better themselves by producing better or cheaper than the competition. Where institutions and corrupt and policy promotes rent-seeking, however, potentially productive individuals and firms will better themselves economically by methods other than production – lobbying, bribing, litigating, and blocking competition.

Or in other words, rather than figuring out how to make the most competitive honey in the world, they will lobby the government to block competition in the honey market.

In the chart below, I’ve plotted over 150 countries to show the correlation between economic freedom and GDP per capita, using data from the Heritage Foundation Index of Economic Freedom. (I stripped out a few countries, e.g., Qatar, Saudi Arabia, Iran, UAE, Venezuela, where oil and gas production exaggerates economic performance.) The correlation between economic freedom and GDP per capita is striking.

Israel’s current position is shown in red – we score 68.4 (out of 100) on economic freedom, which is a little above the middle of the pack. Our GDP per capita of $32,300 puts us roughly 25th in the world, towards the bottom end of the OECD countries.

GDP per capita and economic freedom labelled

The red arrow is an approximation for what would happen to the Israeli economy if the government increased our economic freedom from 68.4 to 80, which is where we find countries like Australia, New Zealand, Canada and Switzerland. Our GDP per capita would probably move to around $50,000, but let’s be more conservative and call it $45,000. We can therefore roughly estimate the hidden tax of bad regulation as the gap between our current GDP per capita and the figure we could achieve if the government stopped dragging us down: $45,000 – $32,300 = $12,700. Bad regulation costs Israel’s economy $12,700 per person per year!

Let’s compare that to the cost of visible taxes. We already said these are 32.6% of GDP, which works out to 0.326 x $32,300 = $10,530 per person per year. Thus, Israelis are probably paying more in hidden taxes than in visible ones!

It was Louis XIV’s Finance Minister, Jean Baptiste Colbert, who famously stated, ‘The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.’ I can only imagine he would be impressed by the tens of billions of shekels Israel’s regulators have funneled from the public to special interests with barely a squeak of protest.