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Prime Minister Benjamin Netanyahu folded. After a long day of consultations and indecision he reversed his resolution from more than a month ago to impose value-added tax on fruits and vegetables.

The prime minister's latest move was strongly opposed by his top advisers.

The reversal of the decision to levy VAT on fruits and vegetables, as well as on tourism services, is expected to create a NIS 2.3 billion hole in the budget each year. To finance the shortfall, Netanyahu has decided to partially revoke the promised cut in corporate tax rates.

The 1% corporate tax cut to 25% that had been scheduled to come into effect within days has been canceled. However, the additional cut of 1% that had been planned for January 2010 remains on schedule. Netanyahu also decided that the reduction in the maximum rate of income tax for individuals, also scheduled to come into effect on January 1, 2010, will be by 1% rather than 2% as originally planned.

Officials in the Prime Minister's Office and in the Finance Ministry said yesterday's decision on the VAT was not the result of fears about a lack of Knesset support for the measure. "A central part of my job is to be attentive to public sentiment," Netanyahu explained. "I have concluded that this is not the right time to levy the VAT, and this is my decision." But Shas and Labor figures emphasized yesterday that they did not support the tax and that Netanyahu had no choice but to back down.

Finance Minister Yuval Steinitz learned of Netanyahu's decision just moments before it was announced to the Knesset. Nevertheless, Steinitz said yesterday that he "respects the prime minister's decision and will act accordingly."

The exemption from VAT that fruits and vegetables have enjoyed is a historical distortion, Steinitz stated: it was right to cancel it.

"The prime minister and I have been arguing the matter for weeks, but unfortunately I was unable to convince him," the finance minister said.

Netanyahu's decision was made public shortly after Steinitz met with three Shas parliamentarians, who reiterated their opposition to the VAT on pfresh roduce. The meeting included a phone conversation with Shas chairman and interior minister Eli Yishai, who said he would fight the issue to the end.

Yishai said he would be willing to resign from government and bring about early elections if necessary, adding that he was following the directives of the party's spiritual leader, Rabbi Ovadia Yosef.

Shas members welcomed Netanyahu's last-minute decision and while about it, took credit for the prime minister's about-face.

"Obviously, a government that seeks to take care of its citizens cannot permit this measure. As a result of Shas's opposition, the prime minister's people and the Finance Ministry changed their position," a Shas spokesman said.

"There has been no VAT on fruits and vegetables for 30 years, so there won't be for another 10 years either," quipped one top official in the Prime Minister's Office yesterday. Minority Affairs Minister Avishay Braverman said that the maximum income tax should remain unchanged at 46%, and the money that becomes available should be spent on important social projects.

Finance Committee chairman Moshe Gafni expressed satisfaction with the decision.

"In Israel's difficult economic situation, no new burdens should be placed on the economically disadvantaged," he said. "The plan to levy VAT on fruits and vegetables was a mistake to begin with.

Gafni has meanwhile canceled the vote on the Economic Arrangements Law that had been scheduled for this morning, during the meeting of his committee. The Economic Arrangements Law is a hodgepodge of unrelated legislative items that have some vague connection with economics. It is always passed in conjunction with the Budget Law.