17.10.2006
 
Bank of Israel supports an "Earned Income Tax Credit" Program
 
Experience in countries that have implemented Earned Income Tax Credit programs shows that they help significantly in reducing the number of poor among working families, and in reducing the level of poverty for those that remain poor; research on the Israeli economy indicates that introducing a similar plan in Israel would be expected to significantly reduce the number of poor among working families.
This paper sets forth the principal proposals for implementing such a program, to be introduced in 2008, that would reduce the incidence of poverty considerably while maintaining the fiscal goals as set by the government.
Against the background of data on relatively high poverty among households where the major breadwinner is a low-wage earner, the Bank of Israel supports the implementation of a plan to increase income of these workers through government finance (known as "Earned Income Tax Credit"). Experience in countries that have implemented Earned Income Tax Credit (EITC) programs shows that they help significantly in reducing the number of poor among working families, and in reducing the level of poverty for those that remain poor. Research on the Israeli economy indicates that introducing a similar plan in Israel would be expected to significantly reduce the number of poor among working families. Moreover the expected effect of EITC on employment is positive, albeit slight, while alternative plans to reduce poverty, such as income guarantee, have negative effects on employment.
To introduce such a plan in Israel in 2008, a decision must be made shortly so that the preparatory work can be completed. The following principals are proposed in order that the program will considerably reduce poverty among wage earners while maintaining the fiscal goals set by the government:
  The program should concentrate on families with children, with at least one wage earner.
  The program should include, at least initially, an annual grant based on wages of the previous year.
  When there is more than one wage earner in the family, the family benefit should be based on the higher of the salaries earned by the two parents, though the higher salary must still be low enough to be eligible for the grant (see Table below). This limitation is required to prevent payment of benefits to low-wage earners from medium- or high-income families (which are most of the low-wage earners).
  Calculating the benefit based on the wages of the higher earner of the parents would also avoid reducing the other parent's incentive to work.
  In implementing the program, it is important that the benefit is paid directly from the government to the wage earner and not through the employer; experience elsewhere has shown that in this way, the benefit increases the wage-earner's income and does not lead to a reduction in his wage by the employer. The cost of the required mechanism for the program is estimated to be tens of millions of shekels a year, which includes the costs of assistance centers and advertising. Implementing the program will not require a general obligation to file tax returns in the economy.
  In order to boost the credibility of the program and to save on operating costs, it is recommended that the employers' annual report to the tax authority that includes the ID numbers of those workers for whom the tax transfer will be made, should be submitted early. Implementing such a reporting requirement is not a complex task.
  The benefit should be paid only to those earning above a certain threshold in order to ensure that the eligible workers work significant hours. There is no need to track the number of hours worked in practice as there are very few families on low incomes whose major wage-earner works few hours on high hourly wages.
  In order to reduce the incentive for fraud, instead of paying a full, set grant to each eligible recipient, it is recommended that the grant increases on a sliding scale from a certain threshold. The recommended grant decreases gradually after a certain set salary, in order to avoid an effective high marginal tax.
  Due to cost-benefit considerations on the simplicity of implementation versus the savings in payments, there is no need to stipulate that eligibility for the grant is dependent on other income from capital, as there are very few families with children whose income from labor is low, but whose income from property is considerable.
On the basis of these principles, the Bank of Israel proposes that from 2008 a plan be implemented that awards grants to working families whose highest wage-earner earns at least NIS 1,000 a month (equivalent to a third of a full-time job on minimum wage) along the following lines:
 
Number of children Initial percentage of wage to be paid as grant Income that entitles recipient to maximum benefit Maximum benefit Income at which no benefit is due
1 or 2 20 3,500 500 5,000
3+ 30 4,000 900 7,000
 
Such a program could reduce by a sixth the number of poor families with working household members, at a cost to the state budget of NIS 1.2 billion a year (of which 70 percent would be budget expenditure and the remainder from the reduction in income tax revenues). In addition, the program will reduce significantly the poverty gap among working families that will remain poor after the implementation of the program. It should be noted that 85 percent of the funds allocated to the proposed plan will reach the families of workers in the lowest four deciles by income; this is far more than alternative plans with similar costs.
As an alternative to implementing the program in full, a pilot program could be run in a selected part of the country. For example, implementing the plan in the north (in the Zfat, Kinneret and Golan districts and in the Acco district north of the Acco-Karmiel highway) with a population of 530,000 would cost NIS 135 million a year and would be expected to reduce the number of poor working families by some 18 percent. The total number of poor individuals in the area would be expected to drop by 6 percent. Based on this pilot plan, which would include monitoring both the implementation of the program and the effects on the population, it would be possible to introduce the program to the entire country.