Treasury Mulls Raising VAT to 17% in July to Close Budget Gap

The treasury is currently forecasting a NIS 29.7 billion deficit for 2012, much larger than the NIS 18.4 billion deficit it had originally anticipated.

In light of a growing budget deficit, the Finance Ministry is considering raising VAT from 16% to 17% beginning July 1 in order to add NIS 2 billion to this year's tax revenues.

The treasury is currently forecasting a NIS 29.7 billion deficit for 2012, much larger than the NIS 18.4 billion deficit it had originally anticipated, and is looking for ways to meet the shortfall now that the threat of early elections has faded.

The Finance Ministry is predicting a shortfall of NIS 9 billion to NIS 13.5 billion in tax revenues next year, an additional 1% to 1.5% of GDP over the planned budget deficit for the year. Such a deficit would be double the planned deficit of 1.5% of GDP.

The treasury is now drawing up the 2013 budget and intends to present it to the cabinet at the beginning of July. The budget planning process is presently focused on the revenue side - in other words, how to raise taxes. Tax revenues dropped sharply this year, well below forecasts, and are expected to remain low through the end of 2013 due to the economic slowdown - which may well worsen. The head of the treasury's budgets division, Gal Hershkovitz, is pushing the plans to raise taxes.

Originally, the Finance Ministry spoke of raising taxes only as of January 2013. But in light of the most recent revenue forecasts for the remainder of 2012, the state will find it very difficult to meet even its reduced tax revenue target of NIS 221 billion this year, down from the original target of NIS 232.3 billion.

The treasury has decided to present Prime Minister Benjamin Netanyahu with the proposal to raise VAT - value-added tax - by 1% as of July 1 when treasury officials present him with their proposed 2013 budget early next month. The budget will be presented to Finance Minister Yuval Steinitz at the end of May, and after Netanyahu makes his decisions, it will be brought before the cabinet in early July. The cabinet is expected to vote on the 2013 budget by mid-August, and the budget will be presented to the Knesset after it returns for its winter session after the Jewish holidays in October.

The Finance Ministry is also considering other tax hikes on July 1 in addition to the VAT increase. The VAT hike would add NIS 4 billion in revenues in 2013, only about a third of the amount the treasury is seeking.

Although VAT is considered a regressive tax that hits the poor the hardest, hiking VAT does not require Knesset approval or legislation - which most other tax increases do. Netanyahu and his cabinet are not expected to offer strong objections to the hike.

VAT was raised from 15.5% to 16.5% in July 2009 in the wake of the global financial crisis, but lowered to 16% on January 1, 2010. Finance Minister Yuval Steinitz promised that VAT would be lowered back to 15.5% on January 1, 2011, but that date has come and gone with no change - and the state's coffers received an additional NIS 2 billion a year because of the decision not to lower VAT last year.

The Finance Ministry yesterday stressed that the discussions to raise taxes for 2012 and 2013 are still ongoing, and that no decisions have been made.

A number of senior treasury officials have complained about the process for drawing up the budget and deciding on tax increases. The budgets division, which is charge of the spending side and not the revenue side, is well represented in the budgetary process, but the State Revenue Administration and the Israel Tax Authority, which represent the revenue side, are under-represented, according to treasury officials. They complain that the views of the Tax Authority and revenues officials are not being considered carefully enough.

While the treasury expects a NIS 29.7 billion deficit this year, which is 3.3% of GDP, many economists think this is too optimistic. They expect the deficit to reach 4% and surpass NIS 36 billion, if not NIS 40 billion. The original forecast was for an NIS 18.4 billion deficit, some 2% of GDP, and Steinitz has instructed his senior staff to keep the deficit under 3.3% of GDP. Raising VAT would be a major step in this direction.

Another possibility that will be presented to Netanyahu when the budget discussions start is the idea of raising the deficit target, which was originally set at 1.5% for 2013, or about NIS 14 billion. Treasury officials will recommend that Netanyahu raise the deficit target to 3% of GDP, or at least no less than 2.5%. The explanation is that the global economic crisis and slowdown are hurting the Israeli economy.

The problem with increasing the deficit is that it would require changing one of the Finance Ministry's most important goals in recent years: lowering the ratio of government debt to GDP. But many treasury officials say that, in light of the global crisis, such a change might be tolerable if it is only for one year.

The Finance Ministry said it is holding discussions on changing the deficit target for next year, and that many different views have been expressed but no decisions have been made.