According to the forecasts, total tax benefits in 1998 will be NIS 18.1 billion, equaling 15% of State tax revenues (see Table 1).

This amount includes government tax benefits only, without benefits in National Insurance contributions or in local authority taxation. Of this sum, income tax and property tax benefits will be NIS 15.1 billion, representing 22% of the Income Tax Division revenues; customs and VAT benefits will be NIS 2.9 billion, constituting 6% of the Customs Division revenues. Another NIS 100 million are benefits in fees.

A simple calculation shows that if all tax benefits were abolished, tax rates could be reduced by 22% and indirect taxes by a further 6% without affecting State revenues. For instance, the maximum income tax rate could be reduced from 50% to 40%, the corporate tax rate from 36% to 28% and VAT from 17% to 16%. This calculation did not take into consideration cross influences of changes in taxpayer economic behavior in reaction to abolition of the benefits. However, it does show the extent of the tax benefits and the latitude that abolition thereof would give.

Tax benefits, otherwise known as tax expenditures, are defined as revenues lost because of tax exemptions or reductions given to specific population groups or specific economic activity. The concept of "tax expenditure" was coined by the American Treasury in the late 1960's. The American Congress first demanded that a report on tax benefits be included in the federal government budget in 1974. In Israel a like report was first included in the State budget in 1986 (in pursuance of Section 2(b)(2) of the Foundations of the Budget Law, 1985).

Tax relief can be given by narrowing of the tax base or by reducing its rate. This definition assumes that the tax laws determine the base and the standard rate of taxes, so that any deviation from the standard will be considered a tax benefit. This definition is particularly problematic, since it is not always clear what the standard is against which the benefit is to be calculated. For instance, the Employment Tax Law stipulates that every employer is liable to a 4% tax out of the entire salary which he pays to his employees. Over the years the tax base narrowed, so that most employers are exempt from employment tax and it is levied today only from public institutions (apart from the Government). According to the simple definition of tax benefit, it seems that employment tax "benefits" total over NIS 4 billion while actual revenues are one million shekels.

Another example in which the benefit is considerably higher than the actual revenue is betterment tax on residential apartments. In principle betterment tax must be paid on apartment sales, but most transactions are exempt. In these cases, it was determined that exemptions should not be seen as a benefit and should not be included in the tax benefit budget.

Only benefit items which have a "reasonable" relation to the actual revenue will be included in the budget. Ultimately the definition of "reasonable relation" is also arbitrary and the tax benefits reported here must be viewed accordingly. Other budgeters might well arrive at different amounts and compositions.

While definition of the benefits is controversial, quantification is also problematic. The method selected here for drawing up the estimate assumes that each benefit is self-contained, without calculation of the mutual implications between the different tax benefits and without consideration of the possible changes in economic behavior if the benefit were canceled. Thus a change in one item will not necessarily change State revenues to the same extent. This is all the more valid regarding combinations of items.

Unlike the government expenditure budget, which is approved in legislation each year, tax benefits are not subjected to periodic public debate. Many people seem to regard tax benefits as a device that can create assets ex nihilo, since their cost is not widely known, and some would even argue that tax benefits come at no cost whatsoever. The purpose of the tax expenditure budget is to quantify and disclose their costs, to allow comparison of tax benefits with direct budget outlays. Most items in the estimate assume that the benefits will be utilized in the 1998 Budget Year, with the exception of the capital market benefits, as specified below.

The level of detail in these estimates depends on information gathered by the State Revenues Administration. Specific details are provided for certain items; the estimates for other items are general.

Because it is difficult to predict the rate at which the tax benefits will be used, the estimates are based on data that are as much as three years old, converted into relevant 1998 budget prices.

Tax Cuts for All are Preferable to Special Benefits

Tax benefits profit those who receive them, but shift the tax burden to all other tax payers, thus worsening their circumstances. While they redistribute the tax burden, they also make the tax laws more complicated, encourage tax evasion and impair general economic well-being.

Hence it would be preferable to implement a reform that combines reduction of tax rates for the entire population with the elimination of benefits for special population groups. Such reforms were carried out to varying extents in Israel in 1975, in the United States in 1986, and in many Western countries subsequently.

From 1990 the many efforts made in Israel to reduce tax benefits were only partially successful. Benefits were eliminated or reduced for students in institutes of higher education, shift labor, medical expenses, demobilized soldiers, employer rebates for employees, new immigrants receiving "absorption basket" grants and corporate principals in companies "going public". On the other hand, most of the major attempts failed, e.g. benefits for the capital market, old-age pensions and child allowances, VAT on fruit, vegetables and tourism services, and on gambling and lottery income. However, since 1997 income tax has been imposed on the Trains and Ports Authority and on the Airports Authority, and the exemption for car air-conditioners has been canceled.

In other fields there was even retrogression, with expansion of tax benefits: women were given half a tax-credit point, the incidence of the Eilat Law was expanded, a free Manufacturing Zones Law was enacted, self-employed workers were awarded a deduction for contributions to study funds, credit rates were increased for confrontation line residents and further relief was given in property and land betterment taxes.

International and Israeli experience shows that it is difficult to persevere in the elimination of tax benefits. Pressure groups that are liable to suffer on this account are strong enough to reduce or even recoup their losses in various ways. Further, the general public which suffers from the specific benefits generally does not have a spokesman.

Tax Benefit Forecast - Income Tax Division.

In 1998 the tax benefits in this Division will be NIS 15.1 million, distributed as follows:

Encouragement of Capital Investments Law - The tax benefit estimate is based on the difference between the 25% tax rate applying to companies that are Approved Enterprises and the 36% paid by ordinary companies.

A company that attracts foreign investments is taxed at reduced rates of 10% to 20%, depending on the share of foreign investment.

The "alternative track" allows a company owning an Approved Enterprise to forgo the grants in favor of a zero tax rate for two, six or ten years, depending on the type of development area in which the Approved Enterprise is located.

Research and Development, Oil Exploration and Film Production - expenses in these fields are deductible even thought they are not current expenses.

Tax credit for shift work - Industrial employees who work in second or third shifts are entitled to a credit equivalent to 15% of income derived from the shift work up to a maximum of NIS 595 monthly (correct for 1997). Since July 1990, this credit has not been awarded for income from shift work that exceeds NIS 6,800 monthly (correct for 1997) when combined with regular income.

On non-wage income:

Supplementary benefits for life insurance (directors' insurance):

Life insurance plans make use of extra tax benefits that ordinary provident funds do not utilize (see details in State Comptroller report no. 47 for 1996, pp. 1-33):

1.Bypassing of tax liability on employer's contributions for royalties beyond the qualifying income ceiling.

2.Reduction of the tax liability on the severance pay component.

3.A deductible contribution of up to 2.5% for insurance against loss of earning ability, beyond 18.33% of benefit-eligible wage. In comprehensive pension funds, the benefit is limited to 19.8%. The supplementary benefit is therefore 1% relative to comprehensive pension funds, and 2.5% relative to other provident funds.

4.Continuity of benefit rights: The owner of a life insurance policy may transfer compensation in excess of the exemption limit to a pension plan and benefit from a double exemption.

These benefits are estimated at NIS 300 million per annum and are included in the tax expenditure budget under the general heading of "Provident Funds". This item contains a long series of tax benefits, but it is impossible to quantify each of them separately.

Withdrawal from pension fund: There is a tax exemption of 35% of the pension, up to a maximum of NIS 5,380 monthly (correct for 1997). The non-exempt part is taxable at regular rates.

Study funds - employers' contributions of up to 7.5% of income (8.4% for teachers) are tax exempt with respect to the employee, up to a maximum monthly wage of NIS 13,400 (correct for 1997).

The benefit ceiling is indexed to twice the wage ceiling for payment of cost-of-living increases. The ceiling was raised in real terms by scores of percents in 1995: from NIS 8,600 in August 1994 to NIS 12,000 in February 1995. This resulted in an increase of the benefit for study funds.

In July 1985 the 25% tax credit for employee's contributions was abolished.

In 1996 the benefit was extended to self-employed workers. From that time, a self-employed worker who contributes up to 2.3% of his income (up to a ceiling) to a study fund is entitled to a deduction of up to 1.5%. In 1997 these rates will be raised to 4.7% and 3%, and in 1998 to 7% and 4.5% respectively.

Interest income - The benefit under this item was calculated on interest income in linked channels, which are now tax-exempt: on resident severance pay deposits, on savings plans and provident funds. No benefit was calculated on unindexed interest, on the assumption (which has not applied for the last three years) that the real element of interest is negligible.

Capital Gains on the Stock Exchange. Because these profits vary greatly from year to year, the estimate of the benefit under this item is based on the assumption that the real capital yield of shares traded on the Stock Exchange (not including taxable dividends) is 5% on annual average.

Until 1991, taxpayers to whom the Inflationary Adjustments Law applied (mostly corporations) were assessed for only part of their real capital gains on the Stock Exchange. From 1992, these taxpayers were considered fully taxable when not corporate principals, while the status of corporate principals remained unchanged.

Today taxpayers to whom the Inflationary Adjustments Law does not apply (individuals and nonprofit organizations) are fully exempt. In August 1994, the Government did decide to extend the tax liability to them (effective from January 1995) and the necessary legislation was enacted by the Knesset. However, the legislation was never implemented and was officially rescinded in March 1995.

Income tax exemption of non-profit organization - Non-business income of non-profit organizations is tax exempt. No data on the scope of this benefit are available.

Exemption for Defense Ministry allowances - An exemption on direct benefits from the Defense Ministry Rehabilitation Division for bereaved families, widows and disabled veterans (not including motor vehicle, housing and rehabilitation).

Child allowance: The benefit was calculated assuming that the Knesset will adopt the government decision to reduce the first and second child allowance in families with up to 3 children where the father's income is over NIS 7,000 monthly

Old-age pensions and survivors' benefits: The Government decided to abolish exemptions for these pensions in September 1991, but rescinded the decision, and they continue to be tax exempt.

Other pensions: exemption on allowances for work injury, general disability, terror acts, mobility and maternity grant. Unemployment pay and maternity grants, on the other hand, are taxable.

Credit for new immigrants - New immigrants are entitled to three supplementary credit points in their first 18 months in the country, two credit points for the next 12 months, and one credit point for the next 12 months.

Credit for medical expenses - Until July 1990, a 25%-35% credit was granted for medical expenses within certain limits. Since then the credit has been given only for expenses of upkeep of a relative in an institution. The credit is 35% of expenses exceeding 12.5% of taxable income.

Credit for the incompetent - A taxpayer who cares for an incompetent parent, spouse or child is entitled to two credit points, provided that he/she has not applied for a medical expenses credit for the same dependent.

Credit for Charitable Donations - credit for 35% of the donation (also for companies) up to a maximum of 30% of taxable income or NIS 401,000 yearly (correct for January 1997), whichever is lowest.

Blind and disabled - Earned income of the blind or the disabled up to NIS 32,500 monthly, or other income up to NIS 3,900 monthly (correct for 1997) are tax exempt. This item also includes people who are temporarily disabled due to serious illness.

Credit for residents of development areas - The tax reduction is given to residents of development localities as defined for this purpose. The credit is set at rates of 3%, 5% and 7% according to the residential area, up to a ceiling. Residents of "confrontation line" communities, Yeroham and Eilat, benefit from a 10% income credit (this was raised to 15%-20% for confrontation line residents in 1996-1998); residents of Mitzpeh Ramon receive a 25% rebate. (The VAT exemption in Eilat is not included under this item, but under indirect tax benefits; see below.)

Conditions for employers in Eilat: To reduce the cost of labor in Eilat, employers there are given a credit at the rate of 20% of their employees' taxable income, up to the limit of the tax deducted from these employees' wages. This credit is in addition to the employees' 10% credit. (See previous paragraph.)

Credit for one-parent families and divorced persons - one credit point is given to the head of a one-parent family (in addition to one credit point for each child) and to a divorced person who participates in the support of children in the custody of his ex-spouse.

Half a credit point to women - women who fill out separate tax returns, receive an additional half credit point. Women who fill out joint returns with their spouse receive the credit, provided that they are the registered spouse.

Credit for working mothers - A working woman, who fills out separate returns, was entitled until July 1990 to one credit point for each of her children, aged under 18. From July 1990 until 1995, only half a credit point was given for each child, while one-parent families continued to receive a full credit point for each child. Since 1996, a woman who fills out separate returns again receives one credit point for each child, except for children born in the same tax year or who reached aged 18 in that year, for whom only half a credit point will be given. A couple filling out joint returns is entitled to a quarter of a credit point for each child aged under 18.

Exemption on gambling and lottery income - gambling and lottery income is tax exempt. In July 1996 the government decided to impose a 20% tax on gambling and lottery income of over NIS 1,000. However this decision was not actually implemented, and instead the Israel State Lottery was required to transfer NIS 100 million to the State Budget.

Exemption on apartment rental - residential apartment rental is tax exempt up to a maximum of NIS 6,140 monthly (as of July 1997). Over this sum the exemption decreases shekel for shekel. For instance, for an income of NIS 7,140, an exemption will be given only on NIS 5,140.

Purchase tax benefits - a partial exemption from purchase tax is accorded to the disabled, the injured, bereaved family members, immigrants (up to a ceiling) and persons relocating to a development area. In a sale without consideration by an individual to a relative, a reduction of two-thirds is accorded.

Betterment tax benefits for residential apartments - In pursuance of the Betterment Tax Law, the owner of one dwelling is entitled to a full exemption on sale once every 18 months. Owners of more than one apartment, may sell one residential apartment every four years, with a tax exemption.

In 1992 an ad hoc provision was introduced and extended through 1996, creating an exemption for the owner of more than one dwelling who sells two dwellings per year, up to a maximum of NIS 1.5 million. In 1996, the last year of its application, the cost of this ad hoc provision was NIS 100 million.

Land Betterment Tax Benefits for Historical Land Value

Properties purchased up to 1960 are liable, upon sale, to land betterment tax at reduced rates of 12% - 24%.

Property tax benefits - By law, undeveloped land is exempt from property tax provided that it meets the following two conditions:

It was defined as agricultural land in an outline plan;
It has actually been used for agriculture. The law also exempts developed land.

In 1995 two legislative amendments were enacted which extend the exemption to include land that meets only one of the above criteria (zoning as agricultural land or use as agricultural land) and land being developed during the 30 months preceding completion of construction. The latter amendment is an ad hoc provision that will expire in July 1998.

The cost of the first amendment is estimated at NIS 90 million and of the second at NIS 40 million. In 1996, a further legislative amendment was enacted which accords the right to owners of lands purchased prior to 15.5.1948 to demand deduction, for purposes of property tax, of NIS 73,200 (correct for 1997) per dunam of land up to a maximum of 10 dunams. The cost of this benefit is estimated at NIS 110 million.

Tax Benefit Forecast - Customs and VAT Division

Benefits accorded by the Customs and Income Tax Division in 1998 will total NIS 2.9 billion: NIS 1.0 billion in customs and purchase tax (35%) and NIS 1.9 billion in VAT (65%).

New immigrants - The estimate of revenue loss caused by immigrants' indirect tax reduction is based on a maximum exemption of NIS 35,000 per family, except for vehicles, and another NIS 28,000 for motor vehicles.

Returning residents - The estimate of the cost of returning residents' benefits is based on a maximum benefit of NIS 25,000 per family.

Tourists - Israelis over the age of two are entitled to bring in merchandise worth $200, free of customs and purchase tax, when returning from abroad.

Vehicle parts - A 95% exemption from purchase tax on vehicles is accorded for air cushions and ABS system.

Conditional expenses - This item includes miscellaneous customs and purchase tax exemptions: an exemption for higher education institutions that import scientific and educational materials, exemptions under international conventions, an exemption for health institutions, etc.

VAT- Fresh fruit and vegetables, and services for foreign tourists in hotels are subjected to zero-rate VAT. The same benefit applies to consumption in the Eilat area (other than consumer durables and cigarettes).

Tax Benefit Forecast - Fees

Since 1994, users of civilian broadcasting frequencies are liable to a user fee. In 1995, the fee was extended to cable television companies. However, the defense system (including the police), the major user of broadcast frequencies, remains exempt.