Economists iffy on PM's plan for 0 VAT on food

Some argue the plan has no significant effect on income distribution.

Prime Minister Benjamin Netanyahu. (photo credit: REUTERS)
Prime Minister Benjamin Netanyahu.
(photo credit: REUTERS)
Several economists and studies have found that plans like Prime Minister Benjamin Netanyahu’s proposal to eliminate the 18 percent value-added tax on supervised food items are suboptimal.
“It sounds good. It’s not a good plan,” former Finance Ministry chief economist Michael Sarel said in an interview on TLV1 Internet radio’s The Cost of Doing Business on Wednesday. Sarel, who quit in protest of then-finance minister Yair Lapid’ zero-VAT plan for some first-time home purchases, argued that the prime minister’s plan wouldn’t “have any significant effect on income distribution.”
An OECD study on VAT in 2010 agreed, noting that “research on the merits of reduced rates suggests that they are rarely effective in achieving distributional objectives,” especially because the rich, who consume more, may benefit from them more than the poor.
“A more effective policy would be to apply a single VAT rate and to implement compensatory measures that are directly targeted at increasing the real income of poorer households,” the study found.
A Calcalist analysis of Central Bureau of Statistics data from 2011 found that, assuming the full value of the benefit was passed on to consumers, it would save an average family NIS 451 a year. But because rich families spend more on even basic food than poor families, it would save the rich more than the poor – NIS 503 a month for the richest fifth of the population, versus NIS 405 for the poorest fifth.
Several objections came, indirectly, from Bank of Israel Gov. Karnit Flug, who has not spoken to the specific plan, but has laid out several objections to zero VAT policies in general. Speaking at the same conference where Netanyahu announced the plan on Monday, Flug noted that fiscal costs of plans for tax relief in one area would require raising taxes in other areas.
“There is a budget cost – the taxes that are cut will need to be replaced with other taxes, and that is of course a different discussion already,” she said. Though Netanyahu estimated the cost of the plan at NIS 2 billion per year, but an unreleased 2013 Tax Authority paper cited by TheMarker on Tuesday put the figure at NIS 5.5b.
In March, Flug noted that once such benefits are put in place, they are politically difficult to undo.
“Even if in the future it turns out that the benefit is not yielding the hoped-for results, and is even causing unintended consequences, it is reasonable that political realities will not allow it to be canceled (just as attempts to date to cancel the VAT exemption on produce and in the city of Eilat have failed),” she said in reference to Lapid’s proposed 0 VAT policy for homes.
In general, the BoI prefers the tool of negative income tax to help the poor and encourage work. That benefit helps the weakest in the population buy more, and is not wasted on the well-off who do not need.
Sarel echoed those arguments as well.
Economists generally dislike differential VAT, because tracking and enforcing the systems require time-consuming and costly bureaucracy, and opens up the possibility of cheating.
“Adding the proposed exemption is projected to increase the pressure for additional exemptions and is liable to erode very noticeably the principle of uniform VAT, and to require other tax increases in order to compensate for the loss of revenue,” Flug said in March The Federation of Israeli Chambers of Commerce said that a better approach would be reducing import tariffs on food to increase competition in the food market, a proposal Netanyahu’s office called for in November, but has not advanced.
Lowering food prices “must be based on action, not promises for after the election,” FICC president Uriel Lynn said.
Prof. Dov Chernichovsky, director of the Health Program at the Taub Center for Social Policy Studies in Israel, has been conducting research on food expenditure, and argues that food policy should focus not only on price, but on nutritional value.
“There are foods that we prefer from a nutritional perspective and we believe we can modify consumption on some items by changing relative prices,” he said.
“There are some foods that I wouldn’t mind if the prices increase. We have an epidemic of hypertension, diabetes that are derived from the diet.”
Chernichovsky said new data on the issue was forthcoming.