Geoforum, Vol. 8, pp. 131- 134, 1977. Pergamon Press. Printed in Great Britain.

Government Incentive Systems: The Case of Israel

YACOV KEDEM,* Israel

Summary: This paper proposes a framework for analyzing government incentive systems, prevalent in many countries, as a means of implementing national goals. The incentives are directed mainly to industry, services and individuals and are designed to modify the decision-making process of the firm or the individual. The major incentives used in Israel are discussed and the ahievement of various national aoaIs. such as: increasina industrialization and population dispersal, are viewed according to data available on economic sectors in recent years,

Introduction

The large amounts of national budgets now set aside for subsidies and incentives require further research as to their effectiveness. In many countries, both developing and developed, extensive systems of govern- ment subsidies have been formulated as a means of implementing specific national goals. The Inter- national Monetary Fund (LENT, 1967) reported in a survey of 85 countries that in 1950 only 10 of them gave incentives to foreign investors. By the mid-1960s two-thirds of the countries applied some system of incentives, mainly tax incentives. Studies have been carried out in this area within several developing countries: Puerto-Rico (TAYLOR, 1957) Mexico (MOSK, 1970) and Israel (FINGER, 1971), dealing mainly with investment subsidies and tax incentives.

The questioning of tax incentives as a method of im- plementing federal activities was initiated in the U.S.A. by Surrey (SURREY, 1970) and has aroused interest but the measures of effectiveness of incentive schemes are still undergoing research.

Government Incentive Systems

Government incentives may be viewed as to their direct economic effect on production and employ- ment generation, (BUCK & ATKINS, 1976) or as a means of changing local and foreign investment priority decisions (AHARONI, 1966) or location effects (MULKEY & DILLMAN, 1976).

The conceptual framework proposed here views incentives as part of an overall government incen- tive system, which serves the attainment of national goals. Such a framework is useful in considering the total national system and the sub-systems involved, as shown in Fig. 1.

The main examples of national goals are described though many more could be specified and their ranking debated. The three major sectors the govern-

* Department of Industrial Engineering and Management, Ben-Gurion University of the Negev, Beersheva, Israel.

. ment incentives are directed to are: industry, services (including tourism) and individual citizens. The objective of these incentives is to alter and modify these sectors’ decision making process so as to attain the pre-specified national goals over a time horizon. The long-term effects on the firms and individuals involved are not discussed here, as national goals are analyzed and not local objectives. Two components of the above system are presented in detail as to their application, in the case of Israel: (a)The incentives directed to the three sectors men-

tioned. (b)The achievement of national goals due to the

effects on the decision making process of these sectors.

Incentives to Industry and Services

The main incentives available to industries and services in Israel are specified in the Law for the Encouragement of Capital Investments from 1950, revised periodically (INVESTMENT AUTHORITY, 1974) and recently in September 1976. According to this law, the country has been divided into three priority regions: (a)Zone A - having the highest priority of develop-

ment - mainly the Galilee and Negev areas. (b)Zone B - development towns, already established

but requiring additional encouragement. (c)Zone C - including the main metropolitan centers

of Tel-Aviv, Haifa and the Coastal Plain. The extent of incentives differs in each zone and are summarized in Table 1.

These incentives are given to what is termed as ‘Approved Enterprises’ - a status decided upon by a central government agency, the Investment Center, according to prespecified criteria (INVESTMENT AUTHORITY, 1973). The above Law includes many additional points that are not elaborated on in this context, but the stressed aspects give an indication of the extent and cost of these incentives and their attractiveness to firms and investors. A discussion of the cost and interest factors involved is presented in (AHARONI, 1969) and (LEVY, 1976).

131

132 Geoforum/Volume 8/Number 3/1977

Effects on declslon maklng

process of sub -sectors

1. Locqtlo" preference

Z.Produc+ m,x

Incentlvesto 3.rntens,+y Of capitol and

- labour

NotIona I goals: 4.Ma"power selectlo"

1. Developing remote areas S.Manqgement and efflclency

2. Population dispersal 6.Marketlng

3. Absorb,ng lmmngratlon ?.Growth factors

4. Generating employment

5. Increarlng na+,onal product,on Incentlvesto

I. Location preference

6. Improving balance of payments- services and -

2.Growth factors

7. Encourqging foreign Inv*stors tourism

3.Management qnd efflclency Achievement Ot

8. Executmg public-utlllty and 4.htanpower SelectIon

defense projects notional goals

t

I. Resldentlal Incentives to preference

I

lndlvlduals Z.Deslred quality of

qnd organized

3.Cholce of employment

4.Recreational and cultural

preferences

I 5.Interreglonal mlgratlon

I

L ---- -l ----- L__--_--.--___l

Figure 1

l The dynamics of government incentive systems

Table 1

l Main incentives offered to industry and services in Israel

Max. Government Grant Max. Government Loan Max. Government Aid - Loan + Grant

1. Approved Enterprises (% of Total Investment) (% of Total Investment) (% of Total Investment)

Zone A 30% 40% 70% Zone B 15% 45% 60% Zone C 5% 45% 50%

2. Tax Concessions ~ Total Taxes to be paid are: 40% on undistributed profits and 49% on distributed profits (as opposed to 61% tax rate for all regular firms, not on ‘Approved Enterprise’ status).

3. Interest Rates on Loans - Zone A - 12%, Zone B - 14%, Zone C - 15% (as opposed to 25% - 35% interest rates on unsubsidized bank loans).

4. Export Subsidies - Additional grants will be given to firms who export their produce, according to the added-value of the products).

5. Accelerated Depreciation -- During the five year ‘Approved Enterprise’ period, firms are allowed to depreciate equipment over a period of two years.

Incentives to Individuals raising the attracting and retaining powers of these

regions. Since housing costs are a major expenditure The incentives offered to individuals as part of the in Israel and serve as a deterrent in residential government incentive system are directed mainly to those living in or moving to development areas.

changes, the Ministry of Housing offers large subsi-

These incentives are part of the general attempts at dized mortgage opportunities for purchasing apart- ments in development towns or subsidized rental

Geoforum/Volume 8/Number 3/1977 133

Table 2

l Total investment, government loans and grants in ‘approved enterprises’, 1966674, in Israel (in millions of Israeli pounds)

Year 1966 1967 1968 1969 1970 1971 1972 1973 1974

SXl”I T.l.* G.L.+G** T.I. C.L.+G T.I. G.L.+G T.I. G.L.+G T.I. G.L.+G T.I. G.L.+G T.I. C.L.+G T.I. C.L.+G T.I. C.L.+G

Industry 255.7 73.6 676.1 322.3 512.4 247.4 503.0 234.4 1063.8 463.9 1095.0 523.7 1410.0 469.5 1509.6 625.8 2944.1 1266.6 Hotels 98.1 23.8 90.5 44.4 153.0 73.8 253.0 145.0 278.6 148.1 325.9 182.6 707.4 305.8 294.4 147.7 214.6 108.1 Shipping 26.7 20.2 138.7 18.3 92.9 - 143.9 0.2 221.5 0.2 730.2 35.2 343.0 - 261.2 4.4 195.3 12.6 Building 8.6 0.8

0.l : 11.9 4.6 24.2 6.7 67.6 12.2 74.9 12.9 120.1 26.6 270.3 43.3 480.3 121.1

Agriculture 6.7 0.7 1.7 0.8 2.4 0.9 4.8 1.9 3.9 1.6 5.4 2.4 38.4 21.1 Other Sectors 86 9 3.9 52.1 5.2 154.4 11.4 149.0 7.5 135.3 13.2 379.8 35.6 406.0 35.3 846.0 51.4 411.8 42.8

Total 476.0 122.3 975.5 390.2 931.3 337.9 1074.8 394.3 1769.2 638.5 2610.6 791.9 2990.4 838.8 3186.9 875.0 4284.5 1572.3

* T.I. = Total Investment in ‘Approved Enterprises’. ** G.L.+G = Government loan + Grant in ‘Approved Enterprises’

Based on Investment Center Report (1975), p.12.

schemes. Additional incentives are: tax concessions for people living and working in preferred regions, financial assistance in transfer from central cities, ‘standing loans’ (loans that become grants after living in a development area for over five years) and transportation assistance. The incentive systems are directed especially to professional experts needed in industry, education and health services and to indi- viduals dealing with social and community centers.

The main problems of Israel’s new development towns today are social, cultural and ethnic problems (KIRSCHENBAUM & COMAY, 1973), rather than economic problems. These apparently are the essen- tial factors in retaining population in these towns over a long period of time, more than the availability of economic and housing incentives.

The Achievement of National Goals

In the case of Israel, the national goal of increasing national production and improvement of the balance of payments are on a very high priority level. The distribution of the total investment in the main

economic sectors in Israel for the period of 1966-74 is summarized in Table 2, based on data in (INVEST- MENT CENTRE, 1975). The table shows only investments in ‘Approved Plans’.

Since industry is the main tool for inducing increase in national production and export, most of the investments and government funds for the described period have been directed to this sector. The growth rate of government funds in the total investment sum (37% in 1974 and up to 42% in 1975) is an indicator of the role the government plays in inducing econo- mic activity in Israel. Government incentives often serve as a catalyst in attaining the national goals concerned with the growth of the economy.

Additional goals important in Israel and influenced by the government incentive system are population dispersal and industrialization of high priority re- gions. The data presented in Table 3, based on GRADUS & KRAKOVER, 1975) shows a clear strengthening of preferred peripheral and central subdistricts (mainly Development Zones A and B), while the major metropolitan areas (Tel-Aviv, Haifa,

Table 3

l Location quotients for manufacturing employment in relation to total manpower in Israel, 1965-71

Subdistrict L.Q. 1965 L.Q. 1971 Per cent Change Central Subdistricts:

Tel-Aviv Haifa Petach Tikva Ramla Hadera Rechovot Hasharon

1.22 1.03 -15.57 1.21 1.11 - 8.26 1.26 1.23 - 2.38 1.38 2.63 +90.58 0.82 1.00 +21.95 0.66 0.74 +12.12 0.67 0.66 - 1.49

Peripheral Subdistricts:

Jerusalem Ashkelon Beer-Sheva Y izreel Akko Zefat Kinneret

0.70 0.55 -21.43 1.12 1.37 +22.32 0.85 0.96 +12.94 0.65 0.89 +36.92 0.58 0.77 +32.92 0.64 0.88 t37.50 0.53 0.54 + 1.89

Source:1Gradus & Krakover (1975) p.10

134 Geoforum/Volume 8/Number 3/1977

Jerusalem) have undergone a decrease in the L.Q. Quotient* for the period of 1965-71.

The districts are classified according to being highly industrialized (L.Q. 1 .lO) or at a low state of indus- trialization (L.Q. 0.85), with intermediate values of L.Q. representing average industrialization. Certain peripheral low industrialized subdistricts in 1965 have improved in this point until 1971, e.g. BeerSheva, Zefat, Izreel and Hadera. Consequently, Tel-Aviv is gradually transforming from a highly industrialized region (1965) to an average state of industrialization (1971) and these trends are continuing up to the present.

Conclusions

Only partial aspects of government incentive systems have been discussed and their effect upon the deci- sion making process of firms and individuals and the attainment of national goals in the case of Israel.

As many countries have adopted incentive systems as a means of developing certain areas or strengthening economic structures and activities, the total effects should be considered and not just local results. Government incentive systems require public funds and therefore their effectiveness should be evaluated periodically. Through such evaluations, every national system can focus on the appropriate incentives neces- sary to attain the goals at the pre-specified priority levels, as dictated by the government policy-making bodies.

The incentive systems, based on past experience, should be modified so as to induce the desired

* L.Q.+;

Ei ~ Manufacturing employment of the subdistrict E - Total manufacturing employment in the country Mi ~ Total manpower of the subdistrict M - Total manpower available in the country.

activities, according to national economic forecasts. It should be noted that government incentive systems of all sorts increase the governments’ interest and often intervention in decision making of tirms and investors and require that they be guided by public welfare criteria. This is not always accepted by those who receive the incentives and incorporate them as an essential part of their financial structure.

References

AHARONI Y. (1966) The Foreign Investment Decision Process, Division of research, graduate school of business administration, Harvard University, Boston.

AHARONI Y. (1969) A Note on Governments’ Tax Incen- tives to Investors, Leon Recanati Graduate School of Business Administration, Tel-Aviv University, Working Paper 75169.

BUCK T. W. & ATKINS M. H. (1976) Capital subsidies and unemployed labour, a regional production function approach, Reg. Studies 10,2 15-222.

FINGER N. (1971) The Impact of Government Subsidies on Industrial Management. Praeger, N.Y.

GRADUS Y. & KRAKOVER S. (1975) TheEffectofGovern- ment Policy on the Spatial Structure of Manufacturing in Israel, Research Report No. 1, Department of Geo- graphy, Ben-Gurion University of the Negev, Beersheva.

INVESTMENT AUTHORITY (1973) IsraelInvestors’Manual, Jerusalem.

INVESTMENT AUTHORITY (1974) Law for the Encourage- ment of Capital Investments, Jerusalem.

INVESTMENT CENTER (1975) 25 Years-Investment Center, Report, Ministry of Industry and Commerce, Jerusalem.

KIRSCHENBAUM A. & COMAY Y. (1973) Dynamics of population attraction to new towns: the case of Israel, Socio-Economic Planning Scjences 7, 687-696.

LENT G. E. (1967) Tax incentives for investment in develop- ing countries, International Monetary Fund Staff Papers 14. 249.

LEVI H. & SARNAT M. (1976) Investment incentives and resource allocation, The Economic Quarterly, Israel 23, 304-315.

MOSK S. A. (1970) Industrial Revolution in Mexico. Univer- sity of California Press, p. 196.

MULKEY D. & DILLMAN B. L. (1976) Location effects of state and local industrial development subsidies, Growth and Change 7.

SURREY S. (1970) Tax incentives as a device for implement- ing government policy. Harvard Law Review 83, 705.

TAYLOR M. C. (1957) Industrial Tax Exemptions in Puerto- Rico. Madison, p. 132.