Lapid’s zero-VAT Plan: A Pyrrhic Victory in the Making

The finance minister’s stubborn insistence on moving forward with his dubious housing plan is bad politics, not good economics. He will pay the price.

Tomer Apelbaum

“We didn’t have money to buy an apartment. Both of us work hard and pay taxes. They call this the middle class? We have two children and a third on the way. My husband, Avi, serves in the reserves and he fought in Gaza during Operation Protective Edge. This is our country. We were born here. We fight for it and for our children despite all the difficulties. The hardest thing is housing. Our parents can’t help us much to buy a home. We didn’t know what to do. But thanks to Yair Lapid, we’ve bought a new apartment. He canceled the VAT on homes, and that is what enabled us to do it. Without him we wouldn’t have our own home.”

This is an ad taken from the Yesh Atid party’s election campaign sometime in 2016 — or at least the kind the party hopes it can publish.

It’s not just Israel and Hamas angling to portray themselves as victorious in the Gaza conflict. Finance Minister Yair Lapid and his Yesh Atid party are fighting for their own kind of victory, unconnected to the war in Gaza. That victory, should it come, will be for Prime Minister Benjamin Netanyahu and Defense Minister Moshe Ya’alon. It is not connected to the reform of the Israel Broadcasting Authority, which belongs to Communications Minister Gilad Erdan. It is also not connected to the ports reform. If something good does happen there, the laurels will go to Transportation Minister Yisrael Katz.

The arch of triumph that Lapid is constructing is built from a single hoped-for achievement: exempting many first-time home buyers from the value-added tax on homes bought from contractors, so long as the price doesn’t exceed 1.6 million shekels ($460,000). From the beginning, zero-VAT looked like an act of desperation. Instead of releasing the bureaucratic bottlenecks that prevent the government from selling enough land and slowly lowering home prices, Lapid opted for a plan that would lower them overnight.

He’s invested all his energy in this undertaking, but victory has proven as elusive as the one Israel hoped to achieve in Gaza.

Last week the haredi parties taught Lapid a basic lesson in parliamentary tricks and once again blocked the approval of the law. He failed to predict the strength of the opposition to his idea within both the coalition and the opposition. In the opposition he has his known enemies: Since he joined the government, he’s been in conflict with the haredim over sharing the burden of army service. In the coalition are the rebellious Likud Knesset members, who have no interest in giving Lapid any sort of political victory.

No signs of retreat

But Lapid, who last week was preoccupied with the economic issues arising from the war in Gaza, the first among them being the need to find billions of shekels to pay for it, is showing no signs of a retreat on zero-VAT. Even though international credit-rating firm Standard & Poor’s joined the long list of zero-VAT skeptics, Lapid keeps repeating his mantra: Zero-VAT is meant not for economists but for young couples who want to buy homes and can’t because of the high prices.

Lapid’s stubbornness is astonishing. He knows very well that his proposal is super-problematic. He has even said on several occasions that even he “objects in principle” to differential VAT rates. Nonetheless, he is willing to start a war with the Bank of Israel, the economists in his own ministry, and even with Netanyahu, who despises the idea but gave in to Lapid to avoid a coalition crisis.

Forswearing his campaign promises, Lapid is using the tactics of old politics to make a deal with Nissan Slomiansky, the Habayit Hayehudi lawmaker and chairman of the Knesset Finance Committee, to transfer 20 million shekels ($5.7 million) to the settlements in return for Slomiansky’s support of the zero-VAT bill.

Even the war in Gaza, with all its costs, has not changed Lapid’s position for now. Treasury officials, busy trying to dredge up from anywhere money to finance the war and the defense budget, thought that would provide a convenient ladder for Lapid to climb down from the zero-VAT tree. But Lapid won’t listen. The Yesh Atid ministers who want to advance the interests of their own ministries — health, social services and education — know there is no one to talk to about zero-VAT. Lapid decided he wants to score this victory, come what may.

Lapid is making a huge political bet. To invest all his energy and prestige and 3 billion shekels of lost tax revenue in a problematic law is almost suicide.

Unfulfilled promises

But you can see why. Since he entered politics Lapid has made many promises that have been left unfulfilled.

He said before the elections that he opposed raising taxes, but he then raised the VAT by one percentage point. When he was appointed finance minister he promised that things would be better in a year and a half or two. This promise will be put to the test very soon when the Treasury is forced to make an across-the-board budget cut, increase the deficit or impose new taxes to pay for the Defense Ministry’s appetite. As recently as last week, he said would not raise taxes, but that looks like another promise that at most will be honored in the breach: The Treasury is already preparing plans to cancel a host of tax exemptions, which is tantamount to raising taxes.

Well into his second year in office, he needs a signal victory. Otherwise, what will he have to show when the next elections roll around? That is the main reason that he is clinging to zero-VAT. He may indeed view it as part of the slightly more complete picture of the fight for sharing the burden of military service that he has tried to promote without much success.

The Finance Committee has put off approval of zero-VAT for now, which means it will not go to a final vote in the Knesset to make it law before October or November at the earliest.

That’s more than a political embarrassment for Lapid. As the law gets delayed, the housing market has been stuck in a state of uncertainty. Home-construction starts are falling. Buyers don’t know what to do. Contractors don’t know what the final version of the law will look like and what they should be building to make money off it.

Unmet demand for housing is building up and it will burst open when the law is finally approved or disappears from the agenda. That will cause even further rises in housing prices.

Lapid is taking a big political and economic gamble here. His desire to achieve a victory picture for the future of his political career could cost him, and mostly the housing market, dearly.

A final point: The housing market is made up of and influenced by a large number of factors, including land prices, the costs of construction and building materials, interest rates and financing costs, and macroeconomic variables such as wages and unemployment.

The problems with the zero-VAT proposal are many, among them the discrimination it creates between different groups and the incentive for contractors to manipulate home prices. A 1.7-million-shekel home will be built to a lower standard to reduce the price and qualify for zero-VAT, while the price of a 1-million-shekel property could rise significantly since the Treasury is giving the contractor a gift of the VAT, which can be split between the buyers and the contractor.

And then there’s the damage to the tax system and the pressure to come from various interest groups to exempt them from VAT, too. And what will happen in a year or two if a housing crisis erupts due to a rise in interest rates or a jump in unemployment? How will the government deal with those who bought homes at high prices without a VAT break?

All these things are being pushed to the back for the sake of the hoped-for young couple who fulfilled their “dream of buying their own home” thanks to zero-VAT. A finance minister who also thinks about the economy and not just politics must think about an all-encompassing solution for the housing market that increases the supply of homes and reins in prices.