Value-added tax will be cut 0.5 percent to 16% starting Friday, in an effort to reduce economic gaps, encourage growth and stem inflationary pressures, the Finance Ministry announced Wednesday.
"The VAT cut will encourage growth in the economy, increase the purchasing power of the weaker classes, help reduce socioeconomic gaps and contribute, together with rising interest rates, to moderating inflationary pressures," Finance Minister Yuval Steinitz said.
In November, the inflation rate rose to 3.8%, breaching the government's 1%-3% price-stability target range, as indirect tax increases helped push up prices.
The VAT cut is expected to reduce state revenues by some NIS 2 billion, while encouraging economic activity. The Treasury raised VAT from 15.5% to 16.5% in July, together with other tax hikes, in an effort to boost state revenues. The VAT increase was intended to remain in place until the beginning of 2011.
"The decision to advance the VAT cut from 2011 to 2010 was made possible by improved economic growth and higher-than-expected state revenues," Steinitz said. "As a result, the macroeconomic repercussions of the global crisis had a more moderate impact on the Israeli economy than was expected."
The decision was praised by business and social groups because VAT is a regressive tax, meaning a lower rate benefits lower-income people more than higher earners. But it was also criticized for being too little of a cut to reduce socioeconomic gaps between rich and poor .
"It would have been better to cut VAT by a full percent in the middle of the year, instead of half a percentage point at the beginning of the year," Ayelet Nir, chief economist at IBI Investment House, said Wednesday. "Due to the cost of updating the prices on shelves and other reasons, the moderate decrease almost won't be felt in consumers' pockets."
The Industry, Trade and Labor Ministry said businesses would have seven days to update prices on goods and services following the VAT cut, and store displays must indicate that prices do not yet reflect the reduced VAT.
The state must do more if it wants to reduce socioeconomic gaps, according to Dr. Roby Nathanson, of the Macro Center for Political Economics.
"The step that the Finance Ministry took was brave and proper and I congratulate them for it," he said Wednesday. "But I would suggest considering a further reduction, to return the VAT to what it was before the 1% increase earlier this year, and I would be pleased to see it done in the near future. The government's duty is to return to the public what was taken from it.
"This is definitely a socially progressive move. Lowering the VAT will contribute to lower inflation, which in turn will provide a basis for not continually raising interest rates. This move will also encourage continued positive economic activity and contribute to the economic stability of the State of Israel," Nathanson said.
Valeria Seigelshifer, of the Woman's Budget Forum, an organization that aims to raise awareness of the gender implications of economic policies, said the VAT reduction would influence all sectors of society equally.
"Two-thirds of all minimum-wage earners are women," she said. "Because it is not linked to income, the VAT reduction may actually decrease social gaps between the genders, even if only minutely.
"If you lower prices on income or on companies, it often serves to increase the gaps. But in this case, it lowers the prices on all products, and everyone, even poor people, will be able to buy more," Seigelshifer said.
Ron Friedman contributed to this report.