Israel Lowered the Value-added Tax, but Consumers May Have Little to Celebrate

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Moshe Kahlon at Tel Aviv University, September 18, 2014.Credit: Ofer Vaknin

Israel’s value-added tax dropped by one percentage point Wednesday night to 17%, but for consumers there may be little to celebrate and the party could end as abruptly as it began.

Finance Minister Moshe Kahlon announced the VAT reduction about a month ago, citing figures showing that the government was so awash in revenues there was no reason not to give businesses and consumers some tax relief. Kahlon also said corporate income tax will fall to 25 % from 26.5% and a week later announced a round of cuts on the alcohol tax.

The reduction will cost the state about 5 billion shekels in revenues a year, and just 1.25 billionshekels in 2015, since it only went into effect in the fourth quarter. But the government saw tax collections rise 7.4% in the first eight months of the year to 184 billion shekels ($46.9 billion); in August alone the surplus was 2.6 billion shekels.

But the fiscal picture could change quickly, especially as the economy appears to be slowing.

When he was asked by Prime Minister Benjamin Netanyahu during deliberations on lowering VAT and other taxes what would happen if tax collection suddenly stopped growing so quickly, Kahlon answered the same way he did when asked the same question at the news conference announcing the reduction, “Then we’ll go back and raise VAT.”

Since it first introduced the tax 39 years ago, the Israeli government has repeatedly adjusted the rate. It started in 1976, when Yehoshua Rabinovitz was finance minister, at a modest 8%. Over the years it mostly rose, but there were many times when it was lowered as well. The 18% rate that Israelis have been paying since June 2013 is the highest VAT has ever been, but it was hiked to that level two times before — in January 1991 and in June 2002.

The reason why VAT is such a popular tax to raise or lower is that it requires nothing more than the approval of the Knesset Finance Committee.

VAT was raised from 16% to 17% in September 2012, when Yuval Steinitz was finance minister. Back then, the government was overspending and officials were looking for a quick fix, but Steinitz vowed that he would lower the rate back to 16% as soon as the situation improved.

In fact nine months later, Yair Lapid, his successor, facing even deeper concerns about the budget deficit, raised VAT to 18% over the objections of many treasury officials. Lapid promised to lower the rate again when the situation improved, but it was Kahlon nearly 18 months later who could take the credit.

In fact, Kahlon acted contrary to the opinion of many treasury officials. Kahlon wasn’t just interested in offering voters a gift: He is concerned that the surplus fund the government collects will end up being spent on extra defense appropriation or claimed by other ministries for pet projects.

Avigdor Yitzhaki, Kahlon’s housing czar, reportedly believes that lower VAT will give Israel’s slowing economy a small shot in the arm. Gross domestic product edged up at just a 0.1% rate in the second quarter, but Kahlon has yet to unveil any plans for restoring growth.

Of course, that is based on the assumption that lowering the VAT rate actually leads to lower prices.

Experience has shown that only part of the savings will go into consumers’ pockets. Government services, such as the fee for renewing a driver’s license and car registration, will drop as will controlled prices, like electricity and water. But in the private sector, many businesses will simply keep the savings for themselves. As a rule, the smaller the business the more likely it is to hold onto the savings.

“Based on experience and what happens in the market, I’d say in practice the impact will be nil,” said Tamir Ben Shahar of the market research firm Czamanski Ben Shahar. “I really don’t think any business is going to be burning the midnight oil to adjust prices downward.”

If the treasury’s projections hold true and the economy grows 2.9% next year, tax collections with be far in excess of the 280.7 billion shekels Finance Ministry planners expected (that is, before the reductions in VAT and corporate income tax). For now, Kahlon is saying that instead of more tax cuts, any windfall will go toward reducing the national debt.

With reporting by Adi Dovrat-Meseritz

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