Cabinet to Vote on Tax Package That Would Increase VAT From 16% to 17%

VAT hike would take effect Wednesday; income tax rise would wait until 2013.

As state revenues fall and concerns about the budget deficit grow, the cabinet is expected to vote on a tax-increase package Sunday designed to boost revenues in 2013 by between NIS 14.4 billion and NIS 15.4 billion.

The plan includes raising value added tax from 16% to 17% as of Wednesday. Meanwhile, many Israelis would see their income tax increase next year.

There is to be an across-the-board 5% cut in ministry spending this year, which provides a lower baseline for next year's budget. The 2013 budget is to feature a 3% spending cut.

Government sources say these cuts are necessary to fund projects such as a fence on the Egyptian border to stop migrants, as well as upgrades to the firefighting and civil defense systems. Most of the cabinet other than ministers from the ultra-Orthodox Shas party are expected to support the package.

The measures would let the government meet its 2013 budget deficit target and address the implications of the global economic crisis while maintaining growth and keeping unemployment in check, the Finance Ministry said on Friday. The government recently revised up next year's budget deficit target to 3% of gross domestic product. The ministry said the plan to be presented tomorrow was crafted over the past two weeks in consultation with Prime Minister Benjamin Netanyahu and Bank of Israel Governor Stanley Fischer.

"The steps the prime minister and finance minister have presented over the past several days are necessary to deal with the complicated economic situation the Israeli economy is facing," Fischer said.

"On the one hand, the world economy is in a difficult situation that has begun to affect the Israeli economy's growth, and there's even the possibility that in the near future we will need to address the consequences of a worsening euro zone crisis," he said.

"On the other hand, there are problems stemming from [Israel's] large budget deficit. If we don't deal with them, we will find ourselves in 2013 with an even larger state deficit."

Under these circumstances, the prime minister and finance minister's steps are "courageous and essential" to improve the budget situation in 2013, supporting growth, Fischer said. The Bank of Israel will continue its monetary policy of maintaining price stability, economic growth and the overall stability of the financial system, he said.

No need to ask the Knesset

Finance Ministry officials say the VAT hike from 16% to 17% will generate NIS 4.4 billion a year, but the figure is based on economic growth next year of 3.5%, which some economists consider optimistic. The VAT increase does not require the approval of the Knesset and can be pushed through following consultations between Finance Minister Yuval Steinitz and the Knesset Finance Committee.

The income tax hike involves a 1 percentage point increase on January 1 on everyone earning more than NIS 8,881 per month - the average wage. There would also be a 2% surtax on the wealthy. It would apply to everyone earning at least NIS 66,700 per month or NIS 800,000 from any source, including interest, dividend or investment income.

Netanyahu and Steinitz had opposed the surtax on the rich, but concluded that increasing taxes on the middle class without the surtax would be hard to defend.

The income tax hike is projected to raise an additional NIS 3.4 billion next year, while the surtax is forecast to bring in NIS 600 million. Those two tax increases require Knesset legislation. Also, the top three tax brackets (4 to 6 ) will not be adjusted for inflation, effectively increasing the tax rate and generating about NIS 300 million a year.

There would also be changes to the employment tax, as well as major tax breaks for multinational companies that benefited from investment incentives and would now receive tax concessions. In the short term, however, the tax break on could trigger a one-time spike in tax revenues of at least NIS 3 billion by the end of 2013, Steinitz said. This is because some companies are sitting on profits they have not paid taxes on. The package also includes a plan to crack down on unreported income.

Steinitz said Friday he hoped that no further cuts or tax increases would be required to meet the 2012 and 2013 targets, but some economists said additional spending or tax measures were necessary to keep the budget deficit at or below 3% next year - a maximum deficit of about NIS 29 billion.

Cigarettes and beer

Some new taxes, generating about NIS 1 billion a year, went into effect last week, including tax hikes on cigarettes and beer. After five years of global economic crisis, Israel is joining much of the world in major government spending cuts and tax increases. On Friday, Netanyahu called his provisions "measured and necessary" in the face of the global economic crisis.

"We will collect more from those who have more and collect less from those who have less. We won't act like other countries that irresponsibly brought upon themselves huge deficits, continued recessions and mass layoffs," he said.

"We won't listen to the inexperienced and irresponsible populists who say the country can spend without thinking about it, and without having the funds for it," Netanyahu added.

"That approach led to the destruction of many economies, unemployment of huge dimensions and major economic distress. Steps such as free education from age 3, construction of a fence [on the Egyptian border] to stop infiltrators and enhanced defense cost money. We have been managing the economy responsibly for three years and we will continue to do so."

Due to opposition from Netanyahu and Steinitz, the package does not include raising corporate tax from its current 25%. It also does not include the repeal of tax exemptions which, if scrapped, could generate about NIS 40 billion next year and reduce the impact of the new measures on the middle class.

Cabinet debate on the following year's budget is usually wrapped up around the end of July each year. This year, however, the debate has not even begun, so formal targets for 2013 spending and revenue have not yet been set.

Nor have discussions been held with the ministries on their budget demands, including the Defense Ministry. The Defense Ministry usually claims a major share of state spending, but it is not clear what the ministry will demand next year in terms of additional budget items.

Because consultations with the ministries have not yet begun, more cuts at some ministries might be required next year, or more taxes. Finance Ministry officials acknowledged yesterday that additional tax measures could not be ruled out for next year.

How Israel plans to plug its budget deficit infographic
Fischer, with Steinitz and Netanyahu, earlier this year.
Olivier Fitoussi