OECD: Israel should stop forex buying, refrain from tax cuts

Group "surprised" by VAT, corporate tax cuts.

Lieberman meets Gurria in Jerusalem, Tuesday (photo credit: AP)
Lieberman meets Gurria in Jerusalem, Tuesday
(photo credit: AP)
The Bank of Israel should cease foreign currency intervention, while the government ought to be more cautious in slashing taxes and imposing high car purchase taxes, the Organization for Economic Cooperation and Development said in a report on Wednesday ahead of Israel's accession to the organization.
"None of these set conditions for Israel's accession. The recommendations are not binding, but they are expected to be absorbed in the OECD's spirit of cooperation and collaboration, which is now at the disposal of Israel," said OECD secretary-general Angel Gurria at a seminar in Jerusalem on Wednesday. "We are in the home stretch." Israel started the accession process for entry into the OECD in 2007 and has a target of joining in May this year.
In light of the pick-up in economic activity in recent months, which the OECD says will likely prompt monetary tightening at some point, heavy intervention into foreign exchange rate would work against the policy-rate hikes and damage transparency in policy.
"The exchange rate needs to be given a boost every now and then but it cannot be weakened artificially for too long. The market does not buy that for too long and we are also telling other member countries not to do that," said Gurria.
In its economic survey of Israel, the OECD noted that although regular interventions were stopped in early 2009, the central bank announced a policy of discretionary intervention, and foreign currency purchases have continued.
"The build-up of international reserves proved useful, attenuating external vulnerabilities when concerns about a downturn were at their greatest," stated the report. "However, foreign exchange reserves are now more than adequate. The Bank of Israel should cease heavy exchange rate intervention to avoid damaging its credibility."
The OECD said it was surprised by the government's decision to go ahead with personal income and corporate tax cuts in 2010 under the prevailing macroeconomic circumstances and cautioned against further cuts, while criticizing the abolition of some VAT exemptions and bemoaning the continuation of high purchase taxes on cars.
According to the government's tax reduction plan the corporate rate will be cut to 18% by 2016 from 25%, while personal income tax will be lowered from a maximum rate of 45% to 39%.
"Although cuts in corporate and personal income tax rates have beneficial effects on business activity and competition, tax burdens are not the only concern of investors (who are also put off by red tape). They need to be put into context, and a degree of caution is required in pursuing them," stated the report.
In addition, the organization urged the government to leave last year's temporary step to raise value-added tax by 1 percentage point to 16.5%. This comes as the Finance Ministry decided to lower the VAT rate to 16% from January 1, earlier than planned in light of improved growth and revenues.
"Trade-offs in fiscal policy would be eased by making the recent temporary increase in the VAT rate to 16.5% permanent," said the report. "Also, the abolition of some VAT exemptions should be revisited, notably those on some tourist services (including those for the town of Eilat) and for fruit and vegetables."
At the same time, the OECD sees no strong justification for the imposition of the high purchase tax on cars.
"The schedule of rates has been recently adjusted to reflect environment considerations, but the attractive revenue-raising properties of such taxation probably remain the primary motivation," stated the report.
Furthermore, Gurria called upon Israel to transfer the Finance Ministry's supervisory bodies into a more independent body.
"Supervisory bodies in Israel should be kept at arm's length from political power and could be more independent," said Gurria. "Like in other OECD member countries, they should be put into an independent body."
In the report, the establishment of a "fiscal council" was suggested along the lines of those operating in Austria, Sweden, Canada and the Netherlands, in order to devolve power from the Finance Ministry.
Also speaking at the conference, Governor of the Bank of Israel Prof. Stanley Fischer was optimistic about the country's acceptance to the OECD, saying that the message received was that solutions to unresolved issues can be found.
"Full compliance with the findings of the two reports are not conditions for membership," said Fischer. "There are still still unresolved technical conditions of entry such as anti-corruption policy measures and compliance with intellectual property legislation common in OECD member countries, which still need to be resolved. But the message we got is that solutions can be found."