Tax Rate for Israel’s Poorest Likely Rose During the COVID Pandemic

Incomes fell more than spending, causing the share paid on VAT to grow

Nati Tucker
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Street shop in Jerusalem closed due to coronavirus third lockdown, in December.,
Street shop in Jerusalem closed due to coronavirus third lockdown, in December., Credit: Ohad Zwigenberg
Nati Tucker

Israel’s lowest-income earners suffered more than others during the coronavirus pandemic from higher unemployment and lost incomes. But it now emerges that they also may have been saddled with higher tax rates.

While no official data yet exist for 2020 household spending, economist Avi Ben-Bassat told TheMarker that the pandemic almost certainly raised the tax burden of poorer Israelis.

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“In 2020, as a result of the coronavirus, many people were left unemployed and we can assume that even if the government helped them with jobless benefits, they had less income than in 2019,” he said, citing reports that lower-income families lost more income on average than wealthier ones.

While Ben-Bassat assumes that poorer families cut their spending, they have less flexibility than wealthier ones and in the end the outlays as a percentage of income for lower-income households likely rose, as did the level of taxes they paid.

The reason is that Israel, like most countries, collects two kinds of taxes – direct taxes on income and capital gains and indirect taxes, most importantly the 17% value-added tax, collected on the basis of spending.

Direct taxes are designed to be progressive, meaning the higher the taxpayer’s income the higher the marginal rate is, which is up to 50% in Israel. In fact, net income is lower than that because of the health tax and National Insurance contributions.

By comparison, VAT is regressive because the rate is the same for everyone. The same applies to other indirect levies, such as purchase taxes, although in some cases the it is only charged on luxury goods. Fresh produce is VAT-exempt.

Nevertheless, critics say VAT contributes to income inequality. A study by the Finance Ministry based on 2015 data for a basket of basic goods found that VAT for households in the lowest decile came to 42.4% of income. Further up the income ladder, the rate declined so that at the top decile VAT amounted to just 9.1% of income. The lower a household’s income, the bigger the percentage of it that goes to buying goods and services. Less goes toward saving.

Indirect taxes have come to account for a larger share of the government total tax take over the year. Prof. Michel Strawczynski, who is now the Bank of Israel’s head of research, found direct taxes accounted for 70% of the total in 2001, had fallen to 65% by 2012 and today makes up a little more than half.

Strangely enough, the pandemic may have seen that trend reverse. An analysis by the Israel Tax Authority found that the government’s collection of more progressive direct taxes rose 0.5% in 2020 while that of regressive indirect taxes decided 3.9%. Household incomes didn’t drop as sharply (thanks to government support) as did household spending (which was constrained by COVID restrictions).

However, government VAT collections fell because of sharp declines in certain segments, such as leisure and culture and restaurant dining, which fell 30% and 27%, respectively. VAT revenues on basic spending categories, such as food, the kind that affects lower-income households, grew 11.8%.

The Central Bureau of Statistics last household-spending survey, taken in 2018, found that for the lowest 20% of households by income spending on food accounting for 20% of the total; for the top 20%, the rate was just 12.5%.

Yaron Hoffmann-Dishon, a researcher at the left-leaning Adva Center, said the government took no tax measures during the pandemic to help lower-income groups.

Despite the trends favoring regressive taxes, government officials said there are no plans to change the mix. They point out that indirect taxes are more progressive than the flat rate makes them appear because wealthier households spend more money on goods and services, and pay more taxes in absolute terms.

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