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The Wage Response to a Reduction in Income Tax Rates: The Israeli Tax Reform

  • Roni Frish ORCID logo EMAIL logo , Noam Zussman and Sophia Igdalov
Published/Copyright: February 1, 2020

Abstract

This study examines the effect of an income tax reform on wages. An Israeli reform implemented in 2003–2009 reduced individuals’ marginal income tax rate by 7–17 percentage points. We utilized the differential and non-monotonic marginal tax rate reduction, and used Israel Tax Authority panel data of wage earners, merged with Labor Force Surveys. We found that in the business sector, the elasticity of reported gross wages relative to the net-of-tax rate is about 0.1. The wage earners in the lowest wage quintile were not affected by the tax reform, those in the second and third quintiles did not respond to the tax cut, but elasticity increased with wage, reaching about 0.4 in the upper decile. We did not find statistically significant differences in elasticity by gender, ethnicity, or education.

Appendix

A
Table 7:

Outline of reduction in income tax rates according to the recommendations published by the committee for tax reform in 2002.

Brackets (in monthly NIS in 2002 prices) The proportion of the average monthly wage in the economy in 2002 (percentages) Income tax rates (percentages)
The change in income tax rates (percentage points)
2002 2003 2005 2008 2008 Compared with 2002
0–1,970 0–28 10 10 10 10 0
1,971–3,950 28–56 20 19 19 17 −3
3,951–4,900 56–70 30 26 26 26 −4
4,901–10,400 70–148 30 28 27 26 −4
10,401–10,590 148–151 45 28 27 26 −19
10,591–18,840 151–268 45 45 41 34 −11
18,841–30,000 268–427 50 50 47 37 −13
30,001–34,820 427–496 50 50 47 39 −11
Over 34,820 Over 496 50 50 50 49 −1
  1. Source: Income Tax Reform: Recommendations of the Committee for Tax Reform, Table 4; Central Bureau of Statistics; and analyses by the authors.

Table 8:

Characteristics of the study population by gender, 1998–2010.

Average
Standard deviation
All Men Women All Men Women
Men1 (rate, percentages) 61.0 48.8
Age (years) 42.1 42.9 40.8 8.2 8.6 7.3
Jews1 (rate, percentages) 88.6 86.5 91.9 31.7 34.2 27.2
Well-educated1,2 (rate, percentages) 29.9 29.7 30.1 45.8 45.7 45.9
Married3 (rate, percentages) 79.6 83.6 73.1 40.3 37.0 44.3
Number of children4 (under 18) 1.55 1.56 1.52 1.49 1.53 1.44
Employment rate (percentages) 77.9 80.2 74.3 41.5 39.8 43.7
Yearly wages5 (NIS, 2010 prices) 135,810 162,577 91,010 208,785 249,323 96,455
Distribution of economic branches6 (percentages) Agriculture 2.2 2.3 2.0
Low-tech industries 10.9 14.3 7.3
High-tech industries 4.0 5.7 2.2
Electricity and water 0.8 1.3 0.3
Construction 5.4 8.9 1.6
Wholesale and retail trade 12.9 14.5 11.2
Accommodation and food services 2.7 2.9 2.4
Transportation, storage, and mail 4.5 6.3 2.6
Communications 1.0 1.2 0.8
Banking, insurance, and other financial institutions 3.6 2.8 4.5
Computer services and R&D 4.3 5.6 2.9
Real estate and miscellaneous business services 13.2 14.9 11.5
“Private” community and social services and miscellaneous personal services 1.9 1.8 2.6
Foreign organizations and state agencies 0.0 0.0 0.0
Public sector 32.6 17.5 48.1
Distribution of residential district (percentages) Jerusalem 6.5
North 16.9
Haifa 12.8
Center 27.2
Tel Aviv 19.6
South 13.6
Judea and Samaria 3.4
  1. Source: Israel Tax Authority – employee-employer files; Central Bureau of Statistics – Labor Force Surveys and Population Registry; and analyses by the authors.

  2. (1) Based on the Labor Force Surveys. The other explanatory variables rely on the employee-employer files and the Population Registry.

  3. (2) The most recent school or academic institution.

  4. (3) The proportion calculated among taxpayers whose family status is known.

  5. (4) Employees during at least 1 month of the year (this definition is equivalent to a positive wage during the year).

  6. (5) Those who had a positive wage during the year.

  7. (6) The following is the division into economic branches in the business sector (according to the uniform classification of the economic branches, 1993): agriculture (0); low-tech industries (10–29, 36–39); high-tech industries (30–35); electricity and water (40–41); construction (45–46); wholesale and retail trade (50–53); accommodation and food services (55–56); transportation, storage, and mail (60–65); communications (66); banking, insurance, and other financial institutions (67–68); computer and R&D services (72–73); real estate and other business services (70, 71, 74, 75, 76); “private” community and social services and other personal services (94–97); foreign organizations and entities (99). The public sector: public administration (77–79), education (80); health services (85), welfare and nursing services (86), “public” community and social services (90–93).

Table 9:

Elasticity of gross annual wages relative to the net-of-tax rate by sector1 (positive gross annual wages in the earlier and later years).

All2 Business sector Public sector3
Non-weighted With virtual income 0.016 0.039** −0.030*
(0.012) (0.015) (0.017)
Without virtual income −0.011 0.004 −0.040**
(0.011) (0.014) (0.016)
Weighted4 0.066*** 0.072*** −0.009
(0.013) (0.016) (0.018)
  1. Source: Israel Tax Authority – employee-employer files; Central Bureau of Statistics – Labor Force Surveys and Population Registry; and analyses by the authors.

  2. *, **, *** Significant at a level of 10 %, 5 %, and 1 %, respectively. The standard deviations (clustered by taxpayer) are displayed in parentheses. All of the estimations include the explanatory variables appearing in Table 1.

  3. (1) The dummy variables for the deciles are based on the wage deciles of wage earners in the business and public sectors together.

    The results for the business sector are very similar to the results in Table 1 (the positive wage columns), but are not identical to them, because the deciles there are based only on the business sector.

  4. (2) The estimations include a dummy variable for the public sector.

  5. (3) The main branches included in the public sector (according to the uniform classification of the economic branches, 1993): public administration (77–79); education (80); health services (85); welfare and nursing services (86); and “public” community and social services (90–93).

  6. (4) Weighted according to the wage in the earlier year.

Figure 8: 
            National insurance institute fees plus health tax rates,1 1998–20102 (percentages).
            
              Source: Israel Tax Authority, Central Bureau of Statistics, and analyses by the authors.
            (1) The rates applying to wage earners whose ages vary between 18 and retirement age.
            (2) Between July 2002 and June 2003, the ceiling on income subject to National Insurance Institute fees was canceled, and the figure reflects this. In August 2008, the ceiling was raised to 10 times the average wage.
Figure 8:

National insurance institute fees plus health tax rates,1 1998–20102 (percentages).

Source: Israel Tax Authority, Central Bureau of Statistics, and analyses by the authors.

(1) The rates applying to wage earners whose ages vary between 18 and retirement age.

(2) Between July 2002 and June 2003, the ceiling on income subject to National Insurance Institute fees was canceled, and the figure reflects this. In August 2008, the ceiling was raised to 10 times the average wage.

Figure 9: 
            The share of selected quintiles in reported gross annual wages,1 1998–2010 (percentages).
            
              Source: Israel Tax Authority – employee-employer files; and analyses by the authors.
            (1) From all jobs held by the taxpayer. Taxpayers belonging to the study population (including taxpayers in the top three thousandths).
Figure 9:

The share of selected quintiles in reported gross annual wages,1 1998–2010 (percentages).

Source: Israel Tax Authority – employee-employer files; and analyses by the authors.

(1) From all jobs held by the taxpayer. Taxpayers belonging to the study population (including taxpayers in the top three thousandths).

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Published Online: 2020-02-01

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