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Lowering Value Added Tax will increase the spending power of the lower income and narrow socioeconomic gaps, Finance Minister Yuval Steinitz told the Knesset plenum, which yesterday approved a 0.5% cut in VAT, effective from tomorrow, January 1, from 16.5% to 16%.

The move will further bolster economic growth, and combined with a 0.25% increase in the Bank of Israel interest rate, will help rein in economic pressures, Steinitz said.

He raised VAT by 1% at the height of the economic crisis last July, from 15.5% to 16.5%. The increase, which was to have remained in force until the end of 2010, was supposed to bolster state tax revenue by NIS 2.4 billion in 2009 and NIS 4.8 billion in 2010. But, as the economy continues to improve, the treasury decided on the cut, which was coordinated with Prime Minister Benjamin Netanyahu and will short state revenue by NIS 2.4 billion in 2010.

"Dark forecasts and concerns for the American, European and Israeli economies pervaded the world last summer," Steinitz told the plenum. "For Israel, these dire forecasts included both unemployment rates and the national deficit (expected to total NIS 80 billion over two years). The situation has improved somewhat since Netanyahu's government was inaugurated," Steinitz said, "but we remain in a state of uncertainty, so we will maintain a 0.5% rate increase."

The Finance Ministry issued a statement yesterday that cancelling half of the VAT increase that came into force just last July, effective immediately, rather than at the end of 2010, was made possible by an improving economy.

Raising VAT is considered regressive because it hits the weakest socioeconomic strata the hardest. Netanyahu's government went ahead anyway, despite strong recommendations to alter income tax and taxes on companies instead.

Haim Shani, director general of the Finance Ministry, said that the lowering of VAT now was part of a long-term strategy to reduce it. The ministry forecasts that economic growth in 2010 will be higher than the official estimate of 2.5%.

There's no doubt this is the right move, and a crucial and important one, for the general public," said MK Moshe Gafni (United Torah Judaism), who chairs the Knesset Finance Committee. "Indirect taxation on the Israeli public is very high compared to the rest of the world, and it hobbles the residents.

Meretz chairman Haim Oron, on the other hand, complained that the government's taxation policy offers only minor relief to the weak and dramatically helps the wealthy, leaving national coffers and the state's true long-term needs in a state of neglect. Oron also criticized Netanyahu and Steinitz's decision to lower personal marginal income tax rates and company taxes.

MK Meir Sheetrit (Kadima) said that lowering VAT by 0.5% after recently raising the rate by 1% is proof that Netanyahu's government is zigzagging - without a policy - while hurting the poor and extending benefits to the rich. Sheetrit supports a drastic cut in VAT to help the poor and the middle class in place of the cut being made.

A senior source in the Tax Authority described the decision to lower VAT as scandalous, and said that the authority had not been a partner to the decision-making process. Companies do not have enough time to prepare for the rate cut, said the source.

Many economists in the private sector doubted that the change in VAT would trickle down to consumers.

VAT will not be reduced on public transportation fares in January because its 0.5 percent reduction, a surprise move yesterday, came after the tickets had already been printed.

Fares are set to increase tomorrow by an average of 4.4%, as part of the twice a year adjustment according to changes in the consumer price index.

The finance and transportation ministries agreed to adjust fares to the new VAT rate starting February 1st, when the excess charge will be reimbursed retroactively in the ticket prices.

Under the new fare rates, a city bus ride in the Dan region will cost NIS 5.80 instead of the current NIS 5.50, and in Jerusalem and Haifa, the fare will be NIS 6.20 instead of the current NIS 5.90. City bus fares in Be'er Sheva will increase to NIS 4 from NIS 3.80.

The Transportation Ministry says public transportation costs have increased 40% in the past six years, while fares have risen by just 11%. As a result, the ministry says, the state has been forced to increase subsidies dramatically.