Hirchson to Present VAT Cut, 2007 Budget Goals to PM Today

Governor Stanley Fischer is not expected to object to the 1 percent VAT cut to 15.5 percent

Finance Minister Avraham Hirchson will be presenting the goals of the 2007 budget to Prime Minister Ehud Olmert today, at a meeting in which Bank of Israel governor Stanley Fischer will also be present, as will top treasury officials.

But Hirchson has plans that predate 2007. First and foremost, the minister means to cut VAT by 1 percent, from 16.5 percent to 15.5 percent, as Haaretz reported on Friday. The tax cut will come into force almost immediately, from July 1, 2006.

At this stage, the treasury has shelved plans to reduce direct taxes - income tax and corporate tax, at least for the foreseeable future.

The treasury predicts that Israel's economy will grow by slightly over 4 percent in 2007, Hirchson will be telling Olmert. It predicts that the government will again run a relatively low deficit. Its deficit target this year is 3 percent of GDP.

The top treasury officials at the meeting recommend that the treasury persist with the economic policies guiding it in recent years, next year and in 2008 as well.

Cutting VAT is easy to do and does not require the Knesset's approval. The Knesset Finance Committee can, in retrospect, within 60 days, announce that it opposes the move, but it has no record of ever objecting to a VAT cut.

Olmert is expected to approve the VAT reduction, giving the Income Tax Authority two weeks to prepare itself for the change.

Reducing VAT is a progressive move, that improves the allocation of resources. The poorest spent all their disposable income, while the rich save part of their money. Therefore, VAT cuts help the poorest more than the wealthier segments of society.

Cutting VAT by 1 percent will reduce the treasury's income by NIS 3.4 billion a year, in gross terms.

An analysis by Dr. Adi Brender of the Bank of Israel research department found that the treasury winds up getting back 20 percent to 30 percent of that amount, because the tax cut stimulates economic growth.

The treasury notes that the VAT cut will reduce the consumer price index by 0.6 percent to 0.7 percent, on a one-off basis. It will also free economic resources, as the state also pays VAT.

The treasury basically has two-pronged reasoning behind the recommendation to lower VAT: tax cuts spur economic growth, and Israel has been collecting surplus tax compared with projections for two years now.

In the past Bank of Israel governor Stanley Fischer pressed for a half-percent cut in VAT, and recommended that the government use any surplus tax to reduce Israel's national debt, which is equivalent to 100 percent of GDP. But Fischer is not expected to object to the 1 percent cut at the meeting with Olmert and Hirchson.

The treasury officials are also expected to advise the prime minister today, that the treasury will be retiring more debt this year than it raises. In 2006, the Israeli government will be receiving back more credit than it extends, for the first time in its history.