Treasury proposes 1.5% income tax hike in budget

Draft budget measures include uniform income tax rise across board, large deficit, biggest spending increase of all OECD states.

May 7, 2013 12:43
Yesh Atid leader Yair Lapid at a faction meeting, February 18, 2013.

Lapid at faction meeting 370. (photo credit: Marc Israel Sellem/The Jerusalem Post)

The budget proposal that Finance Minister Yair Lapid submitted to the government Monday night comprises an income tax increase of 1.5 percent starting in 2014 and boosts 2013 spending by 7% in real terms, the largest budget increase of any OECD nation.

Due to the forthcoming late passage of the budget, its draft proposal, released Tuesday, took extraordinary measures to allow greater spending and a large deficit in 2013. The draft indicated the “limited ability of the government to make necessary adjustments to spending and revenue,” but pegged 2014 as a year for the return to fiscal responsibility.

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For the proposed 2013 budget, Lapid set the deficit limit at 4.65% of GDP, and stretched the allowed growth over the previous year (NIS 9.5 billion) by an additional one-time 2.2% splurge (NIS 6.5b), which alongside an increase in prices (NIS 3.8b.) would bring the overall budget to NIS 304.5b.

In real terms, that growth amounts to a 7% increase over 2012, the highest in the country in the past decade and among all OECD countries for this year.

Because that amount was still lower than originally planned spending, however, the proposed budget also declared itself to contain “the largest cuts in the country’s history.”

If the budget goes into effect, value-added tax will increase by 17% to 18%, tax exemptions will be reduced, the taxation mechanism for retirement savings will be simplified, new taxes on cigarettes and alcohol will be implemented and a new housing tax will be installed. Additionally, the defense budget will be cut by NIS 4b.

Reintroducing “fiscal restraint” with a 3% deficit in 2014, however, will require further tax hikes and deeper cuts to planned spending.

The proposed budget for 2014 will grow less than half as quickly at a rate of 3.35% (not counting the one-time spending splurge), reaching NIS 307.9b.

Income taxes will increase by 1.5% across the board, bringing the highest rate to 49.5%, and corporate taxes will also increase 1% to 26%.

Child allowances will be cut to NIS 140 per child per month until 2015, and the state will cease to subsidize after-school care for children nine years of age and over.

Infrastructure projects will be deferred, and the planned rise in the education budget will be reduced.

Five Israeli diplomatic missions overseas will be closed and trips abroad by ministers will be cut back.

Several magistrate’s courts will also be closed.

In the long run, the budget deficit must stay low enough to bring the nation’s overall debt burden – which was 73.2% of GDP in 2012 – down to the European target of 60%.

“Without a consistent decline in debt to lower levels in the coming years, the credibility of the government’s fiscal will be hurt.”

On the spending side, the budget will cut 1% of civil service staff and install a hiring freeze until the end of 2015.

Salary payments (including retirement) in 2012 comprised 27.3% of spending – 33.9% if indirect wages are included.

The proposed budget sets out plans to improve productivity in the economy, increase competition and participation in the labor force, lower the cost of living and make the public sector more efficient.

The cabinet will have a chance to vote on the draft budget at its meeting next Monday, but does not need to pass it until early June. The Knesset must then approve it by August – otherwise new elections will be called.

Opposition leader Shelly Yacimovich, who supported the higher deficits, said the proposed cuts were a cruel betrayal of the public and an economic mistake. The Labor chairwoman excoriated Lapid for increasing taxes after promising in his campaign that the middle class “would no longer be the government’s ATM,” saying politicians “always make it sound as though this time they really mean it, and then at the moment of truth it turns out that the ones paying the bills are the Israeli middle class.”

Uriel Lynn, president of the Federation of Israeli Chambers of Commerce business lobby, said proposed changes to the law encouraging capital investment “missed the point.”

Following the revelation that the biggest companies paid an effective rate of about 3% due to breaks, Lapid proposed raising minimum rates to 10% in the periphery and 15% in the center.

“While the entire business sector will have to pay a corporate tax of 26% and another 30% for withdrawing profits, the ones in the capital investment encouragement law will pay half, and that is certainly not fair toward the business sector,” said Lynn.

Taking to Facebook to defend the proposed budget, Lapid wrote, “Yes. It’s hard. We knew it would be hard, but it’s not the same thing when it actually arrives. It’s hard and people are angry, but this is exactly what taking responsibility means: doing what’s hard with the clear knowledge that people will be mad at you.”

The alternative, he wrote, was allowing the economy to “collapse,” and allowing the deficit to continue to grow.

“For the first time in years, the middle class is not the only one paying the price. This time, we went to places that nobody dared touch: corporate tax, luxury goods, the capital investment encouragement law, to sectors and areas that until today were immune to politics,” Lapid wrote.

Though the middle class will be hit in the short run, he conceded, it is part of a long-term plan to improve their situation in the long run.

The prices of cigarettes, cigars and tobacco products were set to increase by 10% at midnight on Tuesday, after Lapid signed a special decree on Tuesday night.

The finance minister decided that the minimum tax on a packet of cigarettes will rise from NIS 12 to NIS 15, and from 75% to 90% on cigars.

The move was expected to put an additional NIS 800 million into the state’s coffers.

The Knesset Finance Committee will have to approve the price hikes retroactively in two months time; the decision will take effect on Tuesday night.

Jerusalem Post staff contributed to this report.

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