Israel's Deficit Plunges as Tax Take Rises, Spending Growth Slows

Positive fiscal trends could stave off tax hikes next year, say treasury officials.

The Finance Ministry reported some unexpected good news on the budget on Wednesday, saying this year’s deficit could end up being far lower than originally forecast and enable the government to avoid another round of tax hikes and spending cuts.

The treasury said higher-than-expected tax revenues over the last few months and lower-than-planned spending had reduced the 12-month-trailing budget deficit to just 3.79% of gross domestic product at the end of July.

The figure marks a steady decline in the deficit from a peak of 4.55% of GDP at the start of the year.

The ministry estimated that if current trends continue, the overspending for the year will probably be between 3.5% and 4% of GDP, much lower than the 4.65%, or NIS 45.6 billion, in the budget approved by the Knesset last month.

The treasury’s announcement has ramifications for next year as well, making it likely that the government will meet the 2014 budget deficit target of 3% of GDP and perhaps obviating the need to raise additional taxes in 2013 and 2014.

The latest budget figures could also have political ramifications for Finance Minister Yair Lapid, who was forced to postpone campaign promises to help the middle class and instead impose an austerity budget after he took office in March.

The bond market greeted the news by bidding up prices for government debt. Ten-year shekel bonds, which are not linked to the consumer price index, rose 0.18% on the Tel Aviv Stock Exchange on Wednesday, cutting their yield to 3.74%. Inflation-indexed bonds for the same period rose 0.16%, trimming their yield to 1.65%.

The treasury said tax revenues jumped 12.7% in July to NIS 23.2 billion from NIS 20.2 billion a year ago after factoring in inflation. The Tax Authority collected NIS 140 billion in revenue in the first seven months of the year, up from NIS 129.6 billion in the same period in 2012, a 6.6% increase after inflation.

One-time factors

But treasury officials warned that the rising tax revenue in recent months isn’t likely to continue through the rest of 2013 and into next year because it is largely due to one-time factors.

In any case, government spending has increased at a slower rate than planned when the budget was crafted earlier this year. Government spending since the beginning of the year has reached NIS 135.4 billion, a 5.2% increase over the same period last year, but still below the 8.8% increase foreseen in the 2013 budget.

Meanwhile, in a separate report on Wednesday, the State Revenue Administration said VAT revenues rose 1.2% after inflation to NIS 82 billion in 2012. That marked a second year of sharply slowing revenue growth after a 2.2% increase in 2011 and a 7.4% rise in 2010.

The report noted that the steepest increases in VAT proceeds came from imports both in 2011 and 2010 - the latest years for which there are figures - when they rose 14.5% and 11.6%, respectively, in inflation-adjusted terms. The sharpest rise in domestic VAT revenues in 2011 was generated by health services, which increased 11% in real terms and 30% between 2008 and 2011.

Exceptions on VAT cost the government NIS 3.3 billion in 2011, of which NIS 2 billion was attributable to fresh fruits and vegetables, NIS 700 million to purchases by tourists and NIS 600 million to sales in Eilat.

The report noted that the actual VAT rate imposed in Israel is higher than the average in the European Union despite the lower nominal rate. VAT in Israel is imposed in full on nearly all products and services, whereas in Europe many consumer products such as food, drugs and apparel enjoy reduced tax rates.

Israel first imposed VAT in 1976 at a rate of 8%, and as of June 1 it’s 18%. The State Revenue Administration said, contradicting conventional wisdom, that the tax isn’t extremely regressive, but rather almost neutral regarding income levels.

With reporting by Eran Azran

Emil Salman