VAT rise, rotten idea

Repercussions are bad not only for worried individuals but also for our entire economic outlook.

Yuval Steinitz 88 248 (photo credit: Ariel Jerozolimski)
Yuval Steinitz 88 248
(photo credit: Ariel Jerozolimski)
Last week Finance Minister Yuval Steinitz sternly rebuked the Israeli public and economic movers and shakers for purportedly assuming that the recession is fast receding and that happy days are just around the corner. The fact that his remarks were made from the opulent setting of Eilat's Royal Beach Hotel, venue for the Caesarea Conference, hints at why his admonitions might not have been taken in the spirit with which they were intended. We're not saying that Steinitz is wrong, or even that he exaggerates the dangers. Far from it. He may well have cogent reasons for sounding grim just when many of his counterparts throughout the Western world are doing their utmost to appear upbeat and to infuse confidence into their economies. However, there is a discernible disconnect between our economic managers and the sizable segment of the population that no longer enjoys the good life. Steinitz seems to stick up for the recession's victims by warning against complacency. But the policies defended via that very warning are likeliest to hurt those who have already taken a beating or are next in line to suffer the consequences of the economic downturn. Steinitz attempted to defend the decision to cut income tax (but not for below-average earners.) He also sought to rally support for decisions to raise VAT overall, and to impose VAT on fruits and vegetables, which were hitherto exempt from it. These measures, he contends, are mandated by dire economic straits. Tax cuts are essential for economic revitalization. Higher VAT is necessary for refilling depleting government coffers. Recession means less tax and more expenditures and hence the imperative to increase revenues. TRUE, EXCEPT that the tax cuts will apply to those doing relatively well while VAT is a regressive tax that most negatively affects the lower socioeconomic strata. In pure economic terms it is misleading to overstate the implication of raising VAT from 15.5 percent to 16.5% - a measure which went into effect on Wednesday. After all, not too many years back, we paid 18% VAT. One percent more would only marginally raise the prices of staples - like a standard bread loaf, from NIS 4.59 to NIS 4.63. Importers of big-ticket items are likely to absorb the increase, anyhow. Yet when it comes to fruits and vegetables, the full 16.5% would be levied for the first time if Knesset approval is secured later this month, substantially hiking the cost of produce, even if retailers absorb some of it. Treasury officials argue that it is unfair to exempt some foodstuffs and not others from VAT, or to exempt market vendors as opposed to other traders. But besides the difficulty of imposing proper accounting on market stall-holders, there is the question of appearances. In economics, psychology and perceptions count crucially. Produce price spikes would be sharp and would impact directly on those least able to afford them. The healthiest offerings of the Israeli diet would become very expensive. So poor people will rely even more on cheap carbohydrates. Not only would this result in higher medical expenses in the long run, but the appearance of callousness toward the less well-off is also bad for society. MOREOVER, raising VAT makes no sense in pure economic terms. The premise of anti-recessionary logic is to transfuse the marketplace with cash, thereby encouraging the population to consume and reinvigorate a stalled economy. Additional tax does the opposite and is the prescribed remedy for inflation, not deflation. In France, for example, VAT for restaurants has recently been reduced from 19.6% to 5.5% to encourage more dining out and save eateries from collapse. The Israeli consumer, however, is sheltering in the bunker. Recent studies show a significant decline in consumer spending. Some 60% of Israelis have reduced their shopping or delayed purchasing non-essentials. This wasn't so when the economic crisis began, but caution is now clearly evident. And it is most marked among lower-income groups - those liable to be hit hardest by VAT increases. The middle class is also spending less. Instead of persuading it to buy more, higher VAT rates are likely to achieve the opposite. The repercussions are bad not only for worried individuals but also for our entire economic outlook.