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Tax cuts are incontrovertibly popular moves. This is particularly true in the case of VAT, an inherently regressive tax. Even a marginal VAT reduction would allow the Treasury to legitimately claim to be extending a helping hand to the have-nots and to the economy as whole.
Thus when Finance Minister Avraham Hirchson announced his intention to lop 1.5 percent off VAT and reduce it to 15%, his move could be characterized as populist and hardly one that could cost him support. That said, this is nonetheless a constructive move in the right direction.
VAT isn't Israel's most outrageously excessive tax. Indeed, in many European states, VAT rates are higher (in Sweden they reach a whopping 25%). In some US locales, the sum total of the sales taxes levied by the different levels of government roughly matches Israel's VAT.
The real excesses in Israeli taxation are found in income tax, which may lead us to wonder why it was urgent to give priority to lowering VAT.
One reason is that a VAT reduction was already in the pipeline when Hirchson took over the Treasury recently. For most of Binyamin Netanyahu's stint as finance minister, which began with the economy in truly dire straits, VAT was at 17%. As the economy was steadily and painfully rehabilitated, Netanyahu undertook to bring VAT down.
The 0.5% reduction of last September was still a move put in motion by Netanyahu and it was to be followed up by an identical cut in early 2007. What Hirchson did was to speed up Netanyahu's timetable and hack off 1% more than Netanyahu contemplated a year ago.
But the principle is the same.
As the state coffers are gradually refilled and the country's economic lot improves, some of the additional revenue can be returned to the taxpayer, and not necessarily to those who paid in most but to those most in need.
The initial cuts that Netanyahu instituted were in income taxes, to spur growth in the sluggish marketplace. Yet income tax cuts triggered a great hue and cry as they were perceived to benefit those who paid the most taxes, i.e. those who earned more. The poor were portrayed as being cheated out of the Treasury's largesse. This is not true, as we are now seeing that the fruits of economic growth are allowing further tax cuts.
Now that reduced income taxes have at least contributed to the economic mini-miracle of the last three years, it's time to let the dividends reach those most aggrieved by fiscal belt-tightening.
Since VAT taxes consumption, as distinct from earnings, its reduction is bound to benefit most those who earmark most of their income to consumption. These tend to be households on the lower side of the socioeconomic scale.
The higher one's income, the smaller proportion thereof goes to pay the rent or purchase provisions, and vice versa.
At the same time, a note of caution must be sounded against future facile, populist moves designed to rake in political and PR capital at the expense of sound economics. It would be a mistake to refrain from income and capital-gains tax cuts, which more significantly stoke the furnace of economic growth.
Most economists agree that income taxes discourage investment while taxes on consumption, such as sales taxes, do not. Moreover, while on paper income taxes are more regressive than sales taxes, the wealthy have found so many loopholes in the income tax system that the actual difference is less than imagined.
Income tax cuts would be better for the economy, and might even reduce income gaps faster by encouraging investment. Such a process would, in turn, tend to increase wages, benefiting the poor and the middle class more than wealthier people, who earn principally from their capital.
Current growth is encouraging but not sufficient. The growth we have experienced amounts to about 3% per capita annually, which is below the average for OECD countries over the last decade.
We hope, therefore, that the government will not rest on its laurels. It should continue its efforts to take advantage of and foster further economic growth by trimming taxes as well as via acceleration of privatization, deregulation and the fostering of competition in the economy.
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