Unanticipated tax rebates caused Israel's deficit to soar

Moshe Kahlon  photo: Amir Cohen, Reuters

The Treasury did not foresee that companies would prefer to pay higher tax advances and enjoy 4% annual interest on rebates.

What lies behind the dramatic increase in tax rebates this year, which is putting so much pressure on the Ministry of Finance and the Israel Tax Authority, and is threatening to cause the budget deficit to exceed the target? An investigation by "Globes" shows that the answer to this mystery that is causing so much trouble for officials in the Ministry of Finance and the Tax Authority lies with the accountants and tax advisors, who did not behave as the forecasts and models used by the economists at the Ministry of Finance and the Bank of Israel predicted.

"Globes" found that many representatives of private companies and self-employed people took advantage of the tax cuts instituted by Moshe Kahlon in recent years to carry out a simple, but effective, trick. They continued paying tax advances at the previous higher tax rates and then asked the Tax Authority to rebate the extra amounts paid. The representatives profited two ways: they obtained large rebates, which impressed their clients, and gained a few shekels for the clients at the expense of the Tax Authority, which reimbursed the taxpayers for the extra amount collected from them, plus 4% annualized interest and linkage.

Do tax cuts increase or decrease tax revenues?

The ruse employed by the tax consultants and accountants has macroeconomic consequences in the great dispute between the minister of finance and the prime minister and economists at the Ministry of Finance and the Bank of Israel about whether cutting taxes increased or decreased state tax revenues.

If there is one question on which Benjamin Netanyahu and Moshe Kahlon agree completely, it is the need to cut taxes. As early as September 2015, several months after the government took office, Netanyahu and Kahlon announced a 1% cut in VAT and a 1.5% cut in the corporate tax rate to 25%. A year later, as part of the 2017-2018 budget, Kahlon and Netanyahu further cut the corporate tax rate to 23% in two stages. The income tax brackets were later widened, thereby greatly reducing the tax owed by the top income deciles.

Kahlon boasted that taxes and customs duties were cut by NIS 15 billion during his term. Here, however, is where the "theory" of Kahlon and Netanyahu comes in. The theory says that because tax cuts encourage growth, they increase, not decrease, tax revenues.

Outgoing Governor of the Bank of Israel Karnit Flug, on the other hand, opposed any tax cuts, arguing that at the current relatively low tax levels, more tax cuts would reduce state revenues, and eventually increase the deficit and saddle future generations with debt.

Three years of tax revenue surpluses were enough for Kahlon to declare victory in his economic debate with Flug. Actually, the minister of finance already ridiculed the Governor of the Bank of Israel in 2016, saying, "She was NIS 15 billion off," because state tax revenues in the preceding year were NIS 6 billion higher than the forecast, despite the tax cuts. Kahlon went on cutting taxes, and 2016 also ended with a NIS 4 billion revenue surplus. The surplus in 2017 was even bigger.

This year, however, the party came to an end. As revealed for the first time by "Globes," the budget deficit in 2018 will be 3%, higher than the deficit target for the first time during the current government's term, after three consecutive years in which the deficit was lower than the target. What is especially alarming to the Ministry of Finance is that while spending increased rapidly, revenues slowed by NIS 2.3 billion, as of the beginning of October.

The state pays taxpayers 4% interest

The main reason for the decline in state tax revenues is a jump in rebates paid by the Tax Authority to taxpayers. From the beginning of the year to the end of September, the amount of rebates was 30% higher than in the corresponding period last year, according to figures provided to "Globes" by the Tax Authority. Corporate tax rebates were up 32.6% and individual tax rebates were up 23%.

This amounts to a NIS 2.6 billion increase in tax rebates in the first three quarters of the year, compared with the first nine months of 2017. This unanticipated figure alone is likely to explain the difference in state revenues that Ministry of Finance officials find so troubling.

The tax advisors and accountants have a very simple explanation for the difference in tax rebates. "When I get money back for the client, he hugs me, and when I ask him to pay more, he wants to kill me," a tax advisor says, revealing his profession's all-too-obvious secret.

Tax advisors and accountants admitted to "Globes" that, like many of their colleagues, they continued to deduct corporate tax and income tax for their clients at the higher tax rates, and were in no hurry to lower the tax advances to match the new tax rates.

The Tax Authority's computer systems recorded the reports and did not warn in time about the irregular payments. Formally, the representatives acted with professional caution, given the possibility that the tax rates would not be cut in the end, but what was actually motivating them were their interests as consultants. The taxpayer always prefers getting a rebate to having to pay more money.

This strategy is also financially logical. The Tax Authority pays 4% interest and linkage on tax rebates, in other words, 4% more than can be obtained from bank deposits. The advisors and taxpayers profited from this situation, but the public treasure lost unnecessary interest payments.

The Tax Authority preferred not to respond to the report.

Published by Globes, Israel business news - en.globes.co.il - on November 5, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

Moshe Kahlon  photo: Amir Cohen, Reuters
Moshe Kahlon photo: Amir Cohen, Reuters
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