Netanyahu's Economic Reforms and the Laffer Curve

Israeli Prime Minister Benjamin Netanyahu might be best known for his hawkish foreign policy, his confrontational, even alienating demeanor, and his determination to resist Iran and radical Islamist forces at all costs. But what he'd really like to be known for are his economic reforms. At least that was the point he continually made while accepting the American Enterprise Institute's Irving Kristol Award on November 9. Speaking to a largely sympathetic, right-of-center crowd, Netanyahu earned applause when he argued that the Laffer curve worked, and that his 2003 tax cuts had transformed Israel into a market economy and an engine of growth.

In 2003 Israel was suffering from its worst economic recession since its founding. The second intifada was primarily blamed for the downturn, but Netanyahu, who took over the Finance Ministry under Prime Minister Ariel Sharon, also blamed a bloated public sector and stifling regulations. Using a story about training as a parachute soldier (an anecdote he repeated at the AEI dinner), Netanyahu explained that the public sector had become a fat man resting on a thin man's back. If Israel were to be successful, it would have to reverse the roles. The private sector would need to become the fat man, something that would be possible only with tax cuts and a trimming of public spending. Netanyahu's Finance Ministry even put out information packets explaining the Laffer curve to Israelis.

Netanyahu didn't just engage in rhetoric. He pushed through controversial reforms that some have blamed for creating serious income inequality. The top individual tax rate was cut from 64 percent to 44 percent, while corporate taxes were slashed from 36 percent to 18 percent. Government spending was capped for three years. Pension ages went up for both men and women. He also liberalized currency exchange laws. The results were a success on the macroeconomic level. Unemployment dropped, as did the debt-to-GDP ratio (from 102 percent to 80 percent). And taxes went from 35.6 percent of GDP in 2000 to 30.5 percent in 2015. Netanyahu credits these reforms for making Israel's high-tech boom of the last few years possible.

Does this prove that the Laffer curve was a success? Some economists have long conceded that in smaller economies, it might be possible to generate higher revenues by lowering taxes. It certainly is easier to make tax cuts pay for themselves when dealing with a nation of 8 million like Israel than a nation of 300 million like the United States. And in Israel, tax receipts did rise after Netanyahu's tax cuts. In fact, they were sharply higher in 2007 than in 2003, before falling for several years because of the global recession.

A cursory examination of Israel's financial situation shows that Netanyahu might have succeeded where President Reagan failed. His tax cuts did pay for themselves. And he has transformed Israel into more of a market economy (although the rise of tycoons led to sharp protests in 2011 and a slight tax increase to pay for more public spending). In fact, the prime minister recently announced plans for more cuts to taxes, this time to the VAT and corporate levies.

So AEI, an organization devoted mostly to conservative economic policy goals, seems justified in giving its award to Netanyahu. After all, he might have shown that the right-of-center economic policies that have stalled in the United States might actually work for other countries.