Treasury May Cancel Tax Cuts or Increase Deficit Spending

Tax revenues are falling far short of estimates this year and are expected to fall even shorter in 2009.

Tax revenues are falling far short of estimates this year and are expected to fall even shorter in 2009. The Finance Ministry has two unhappy options: to run a greater deficit than it would like, or to eliminate the income tax cuts it had planned to institute next year.

Cancelling the planned tax cuts would increase the state's tax revenues in 2009 by NIS 3 billion, according to the ministry's estimates.

However, the move could also have a negative impact on economic growth. The problem is that businesses and households have already banked on the tax cut. From their perspective, its cancellation would be equivalent to a tax hike.

The treasury is now weighing which option is the lesser evil: to cancel the planned tax cut, which could weigh on the economy like a tax increase, or allow the deficit to exceed its target by billions of shekels.

According to current treasury assessments, tax revenues to the state could fall NIS 10 billion short of the 2009 budget plan and cause a shortfall of at least 1% in the targeted deficit.

Worse still, an increased deficit would force the state to raise more money than planned through bond issues to the capital market.

Observers agree it would be a bad time for such a move. Plans arealready in place to raise substantial sums to recycle loans of NIS 40 billion to NIS 50 billion that fall due in the first quarter of 2009. In the midst of the current credit crunch, with ready money in the capital market running short, the state inadvertently could find itself competing with private enterprise, worsening the situation in an already stressed credit market.

As a result, the treasury is torn between two difficult options: either to allow the deficit to increase and exacerbate the credit crunch on the corporate bonds market, or suspend the tax cut planned for 2009.

It is still unclear whether the treasury is considering outright cancellation of the tax cut, or whether to merely delay it by a year, and it is also unclear what the treasury means to do about the final state of the tax cut, originally planned for 2010.