Politicians are greedy, and want to have control on everything. Including economy and research. And AFAIK, even more so in Israel, because of the military background of prominent state officials.
Respectfully, it's clear you don't really know anything about Israeli exact science academia and high-tech industry, both of which rely very little on government money; most of their funding comes from international competitive research funds and international investors, respectively.
If anything, Israel's army is a driving force for innovation.
Bottom line: your thesis about Israel is nice. It's just unrelated to reality.
I'm sure it has nothing to do with the billions of dollars that pour in to Israel each year as welfare from the U.S.
You are right. The 3$ billions per year Israel receives from the U.S. is ~1% of Israel's yearly budget. Importantly, most of the U.S. aid comes in the form of military equipment (that is, the actual funds flow directly to the pockets of U.S. military industry). It has nothing to do with start-ups and CS departments.
For a military state such as Israel, it is impressive that every now and then they come up with innovations; not very many, but they do come up with them.
I suggest you take a look at, e.g, http://en.wikipedia.org/wiki/Start-up_Nation. Here's one paragraph (the source is backed by reference):
"How is it that Israel -- a country of 7.1 million people, only sixty years old, surrounded by enemies, in a constant state of war since its founding, with no natural resources -- produces more start-up companies than large, peaceful, and stable nations like Japan, China, India, Korea, Canada, and the United Kingdom? The Economist notes that Israel now has more high-tech start-ups and a larger venture capital industry per capita than any other country in the world."
Or, e.g., browse the list that ranks the top-100 computer science departments in the world and observe where and how many times the Israeli flag appears in the list. (FYI, Israel has only 6 universities.)
"I never let my schooling get in the way of my education." -- Mark Twain