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VAT is rising by 1% tomorrow, from 15.5% to 16.5%, through the end of 2010. On January 1, 2011, value-added tax reverts back to 15.5%.

In approving the measure, the Knesset also decided to increase the salary tax for financial institutions that do not pay VAT from 15.5% to 16.5%.

The VAT increase is expected to yield the state NIS 2.4 billion in 2009 and NIS 4.8 billion in 2010.

This is considered a regressive measure, since it disproportionately affects people with lower incomes. Prime Minister Benjamin Netanyahu and Finance Minister Yuval Steinitz resisted pressure to cancel the increase and instead to cancel the reductions in income tax and corporate taxes planned for 2010, which will benefit the very wealthiest members of society.

Meanwhile, Tax Authority deputy director general Boaz Sofer estimates that while the imposition of VAT on fruits and vegetables will reduce farmers' profits only slightly, by NIS 12.5 million to NIS 16.6 million annually, consumers will pay the brunt of the new measure. Marketers and retailers will also absorb some of the extra cost. According to Sofer's calculations, consumers will pay between 7.75% and 11.6% more for fruits and vegetables once they are forced to pay VAT on them. Farmers are expected to receive between 1.4% and 2.7% less for their produce, on which they currently earn a net profit of just 10%.

Sofer contends that international studies show the public is not particularly sensitive to price increases for fruits and vegetables, and that for example, a 10% price hike causes only a 2.17% drop in consumption. It thus follows that an increase of 7.75% to 11.6% in fruit and vegetable prices will lead to a drop in consumption of 1.7% to 2.5%. That will reduce farmers' net profits by NIS 3.9 million to NIS 5.8 million.

It also seems that the state miscalculated the amount of money it will see from imposing VAT on produce. The Finance Ministry says the state will earn an additional NIS 1.8 billion from the measure, but it's forgetting the fact that NIS 600 million of that amount will be paid by governmental bodies such as the Defense Ministry. These organizations may be paying VAT on paper for their fruits and vegetables, but they'll be getting the money back from the state through budget allocations. The upshot is that the real revenue from the unpopular measure will be more like NIS 1.2 billion a year, not NIS 1.8 billion.

As if that were not enough, in order to gain the approval of Shas for charging VAT on fruits and veggies, as well as the rest of the state budget and the Economic Arrangements Bill, Finance Minister Yuval Steinitz is drawing up a list of goodies to hand out.

He will propose allocations of tens of millions of shekels to shore up failing local governments. In addition, Steinitz will offer to provide NIS 300 million in compensation to low-income earners, to waive VAT on fruits and vegetables purchased by soup kitchens, and to aid these organizations financially.