Excerpts from the
Annual State Revenue Report for 1997

ADJUSTED STATE TAX REVENUE FORECAST FOR 1998


A. REVENUE ESTIMATE IN THE FIRST HALF OF 1998 AND FORECAST FOR THE SECOND HALF
B. CAUSES OF THE TAX REVENUE INCREASE IN 1998 VS. 1997
C. LEGISLATIVE CHANGES IN 1993-1998


According to the adjusted forecast, state tax revenue in 1998 will be NIS 114.8 billion (current prices), up 1.6 percent in real terms from 1997.

This increase will be attained if the forecast of 1.5 percent growth in Gross Domestic Product proves accurate and because legislative changes will augment tax revenue by an estimated NIS 0.3 billion, despite an NIS 0.9 billion decrease in personal income-tax revenue resulting from a tax-bracket adjustment in excess of the inflation rate.

Collections of central-government taxes will be 32.1 percent of GDP in 1998, similar to the 1997 level but somewhat higher than the 1996 figure (31.4 percent).

This forecast, drawn up in July 1998, corrects the original forecast prepared in September 1997 as part of the state budget.

A. REVENUE ESTIMATE IN THE FIRST HALF OF 1998 AND FORECAST FOR THE SECOND HALF

The corrected forecast for 1998, as stated, was prepared in July 1998 on the basis of actual collections in the first six months of the year.

Tax revenue was 0.9 percent higher in January-June 1998 than in the corresponding period in 1997. (See Table I-1.) Revenues of the Income Tax Division increased by 2.7 percent and those of the Customs and VAT Division by 1.8 percent (all figures in real terms).

Most of the increase in income-tax revenue originated in personal income tax, as revenues on account of corporate and property taxes decreased by 7 percent and 5 percent, respectively. The corporate-tax decline followed a 20 percent increase in 1997, but the decline in property taxes indicates that the downtrend (6 percent in 1997) has continued.

The decline in Customs Division revenues is traceable to the contraction of imports, which affected collection of import taxes.

In sum, the tax-collection data for the first half of 1998 depict a slumping economy characterized by decrease in real-estate transactions and imports of durables, coupled with a real increase in the average wage.

The growth rates of tax revenue are expected to become more vigorous in the second half of the year. According to the forecast, total revenue will increase by 2.3 percent in real terms relative to the corresponding period in 1997-twice the growth rate of the first half.

Table I-1
State Tax Revenue in 1998-First-Half 1998 Performance and Second-Half Forecast
 (NIS millions and percent)

Collection
in 1998		 Real pct.
change vs.
corresponding
period in 1997

Total Estimated
performance,
Jan.-June		 Forecast,
July-Dec.		 Total Jan.-
June		 July-
Dec.
Total 114,800 56,500 58,300 1.6 0.9 2.3
Income
Tax
Division		 64,000 31,508 32,492 3.7 2.7 4.6
Customs
Division		 47,750 23,550 24,200 -1.4 -1.8 -1.0
Fees 3,050 1,442 1,608 7.2 6.4 7.9

Source: State Revenue Administration

 B. CAUSES OF THE TAX REVENUE INCREASE IN 1998 VS. 1997

In 1997, state tax revenues were NIS 108.5 billion (see Table I-2), equivalent to NIS 112.96 billion in 1998 prices. It is assumed that the rate of inflation, in view of the predicted increase in the Consumer Price Index, will be 4.1 percent in 1998 relative to 1997. In 1998, NIS 114.8 billion in tax revenue is expected, for an increase of NIS 1.84 billion in real terms. This increase is traceable to three factors:

Growth: a predicted revenue increase of NIS 1.71 billion as a result of 1.5 percent growth in economic activity.

Legislative changes will augment collections by NIS 0.25 billion, as itemized below.

Other: This item will reduce revenues by NIS 0.12 billion by adding NIS 1.26 billion to collections of the Income Tax Division and decreasing those of the Customs Division by NIS 1.37 billion. This figure is the total of a lengthy series of factors, only some of which can be quantified, that affect tax revenues in various ways:

Disinflation: Income-tax brackets are adjusted once a year in view of price increases in the previous year. Thus, the real value of the brackets rises during a time of disinflation, resulting in a de facto decrease in effective tax rate. In January 1998, income-tax brackets and other personal income-tax parameters were adjusted by 8.2 percent, in step with the rise in consumer prices in 1997. The decline in inflation to about 4 percent lowered the effective tax rate and caused an NIS 0.9 billion revenue loss.
Progressivity of the tax system: In contrast to the decrease in the effective income-tax rate, as measured in the previous paragraph, income-distribution inequality may have widened. If this occurred, wage-earners and the self-employed will generate more revenue for the Income Tax Division.
The composition of GDP: Since different components of product are taxed at different rates, the rate of change in tax collection is faster (slower) then the rate of change in GDP if tax-intensive components grow more (less) rapidly than the average. GDP in 1998 is expected to rise by 5.7 percent in nominal terms (1.5 percent real, 4.1 percent in prices), imports of goods (excluding defense, fuel, and diamonds) will expand less rapidly and imports of tax-intensive motor vehicles will decrease substantially, thus explaining the downturn in revenues of the Customs Division.
Capital gains: Capital gains do not find expression in GDP. In a year in which on the stock exchange rises or larger number of businesses change ownership- as happened in 1997 and is happening in 1998-accrued capital gains are realized and revenues of the Income Tax Division may increase more rapidly than product.
Real-estate taxes: Another explanation for the stagnation of Value Added Tax revenues, despite the increase in private consumption, is the decrease in VAT on the component of land in the sale of new dwellings. Furthermore, the downturn in the number of residential transactions has depressed revenues on account of real-estate purchase tax. The bases of these two taxes, like capital gains, are not reflected in the GDP data.
Lag in collections: Except for import taxes, there is a lag between the creation of tax liabilities and the time the taxes are paid-especially with respect to income tax on businesses. Self-employed taxpayers and corporations make advance payments during the fiscal year, but their exact tax liability becomes clear only several months into the next year. Only then do these taxpayers make up the difference, if their liabilities exceed their advances, or receive refunds if they overpaid. The net tax differential (less refunds) on account of the business sector will evidently rise in 1998, explaining some of the increase in collections of the Income Tax Division.
Collection efforts: The item "other" includes the effect-admittedly unquantifiable-of the tax divisions' collection efforts.

Table I-2
Updated State Tax Revenue Forecast, 1998 (NIS millions)


Total Income
Tax
Division		 Customs
Division		 Fees
1. Actual
collection,
1997		 108,508 59,280 46,495 2,733

increase
reflecting
price
increases
(4.1 percent
inflation)		 4,450 2,430 1,910 110
3. Estimated
collection
in 1997 (in
current
1998 prices)		 112,958 61,710 48,405 2,843
4. Total real
increase in
collection
in 1998		 1,842 2,290 -655 207

Thereof:



5. From
economic
growth		 1,710 960 680 70
6. From
legislation
(see Table I-3)		 250 70 40 140
7. From "other"
(including
collection
efforts)		 -118 1,260 -1,375 -3
8. Forecast
for 1998
(in 1998 prices)		 114,800 64,000 47,740 3,050

In percent
of GDP




1997 32.1% 17.5% 13.8% 0.8%

1998 32.1% 17.9% 13.4% 0.8%

Source: State Revenue Administration

 C. LEGISLATIVE CHANGES IN 1993-1998

In 1998, as stated, legislative changes will augment collections by a negligible NIS 0.25 billion, pursuant to an increase of 0.7 percent of GDP in 1997. In contrast, in 1993-1996, such changes had a downward effect on collections of 2.2 percent of GDP in cumulative terms-0.8 percent of GDP at the Income Tax Division and 1.4 percent of GDP at the Customs Division. (See Table I-3.) Numerous taxes were reduced during those years (personal and corporate income tax, Value Added Tax, customs, and purchase tax) and several were cancelled (employers' tax in the business sector, travel duty, general import duty, and imported services duty) in order to stimulate economic growth and enhance Israel's integration into the world economy.

Table I-3
Effect of Legislative Changes on Tax Collection-Each Year vs. Previous, 1993-1998
(NIS millions and percent of GDP, current prices)
Year Total Income
Tax
Division		 Customs
Division		 Fees

(NIS millions)
1993 -860 1,010 -1,870 0
1994 -1,540 -490 -1,050 0
1995 -2,360 -1,820 -560 20
1996 -200 -1,100 900 0
1997 2,350 1,370 640 340
1998 250 70 40 140






(Percent
of GDP)
1993 -0.5 0.5 -1.0 0.0
1994 -0.7 -0.2 -0.5 0.0
1995 -0.9 -0.7 -0.2 0.0
1996 -0.1 -0.4 0.3 0.0
1997 0.7 0.4 0.2 0.1
1998 0.0 0.0 0.0 0.0





Cumulative,
1993-1996		 -2.2 -0.8 -1.4 0.0
Cumulative,
1993-1998		 -1.5 -0.4 -1.2 0.1

Source: State Revenue Administration

 Only in 1993-seemingly in contrast to the aforementioned trend-did legislative changes augment Income Tax Division collections by 0.5 percent of GDP. Here a methodological remark is needed: tax increments on account of a legislative change are recorded in the year the change affects collections and not at the time the change is legislated. Because of the time lag between the creation of tax liability and collection of tax, there may be a large difference between the year in which a legislative change is made and that in which the change is reflected in collections. For example, an increase in the depreciation rate to 100 percent in 1991 reduced collections in 1991 and 1992 and explains the increased revenue of the Income Tax Division in 1993. A legislative change passed in mid-year has a partial effect on collections during that year; the remaining effect is recorded in the following year.

Unexpectedly small budget deficits in 1993 and 1994 made it possible to introduce substantial tax cuts during those years. In early 1995, when it seemed as though the trend could be sustained, the government decided on a further decrease in personal income tax. Since this decision went into effect in September, most of its impact on collections was recorded in 1996. By the second half of 1995, it had already become clear that the budget deficit would overrun its target. Since then, the government has not only taken actions to restrain its spending but has reversed the trend in legislative changes and raised several tax rates. In late 1995 and early 1996, indirect taxes (on cigarettes and gasoline) were increased, and a year later direct taxation, when it became clear that this did not suffice to narrow the deficit, another tax increase was effected by postponing adjustments of credit points and income-tax brackets.

Below is an itemization, by tax divisions, of the expected increase in 1998 tax revenues as a result of legislative changes. (See Table I-4.)

Legislative Changes in 1998-Income Tax Division

Previously implemented legislation is expected to augment net tax revenue in 1998 by NIS 70 million. No new legislation in reference to the 1998 budget is being planned.

Training-fund benefit for the self-employed: Until 1995, only wage-earners qualified for a tax benefit for contributions to training funds. In 1996, the benefit was extended to the self-employed as well. That year, self-employed taxpayers who contributed up to 2.3 percent of their income (up to a ceiling) to a training fund were entitled to a credit of up to 1.5 percent. These rates were raised to 4.7 percent and 3 percent, respectively, in 1997, and to 7 percent and 4.5 percent, respectively, in 1998. The cost of this benefit is NIS 330 million, spread over three years starting in 1997.

Accelerated depreciation for computers: The depreciation rate was raised from 20 percent in 1996 to 25 percent in 1997 and 33 percent in 1998 for personal computers, and to 25 percent for other computers. The depreciation rate for other computer equipment remains at 15 percent.

Table I-4
Effect of Legislative Changes on Collection-Each Year Versus Previous, 1998-2000
 (NIS millions, 1998 prices)

1998 1999 2000
Total 250 -100 -60




Income
Tax
Division		 70 -40 0
Training-fund
benefit for
self-employed		 -110 -110 0
Accelerated
depreciation on
computers
(companies)		 -40 0 0
Higher
credit for
residents of
northern-border
areas (1996-1998)		 0 70 0
Non-adjustment
of tax
brackets
in 1997		 310 - -
-Wage-earners 90 0 0
-Corporate
directors		 20 0 0
- Self-employed 200 0 0
Increase in
withholding
rate from
second
jobs and
writers'
earnings		 -30 0 0
Increase
in use
value of
commercial
"company
car"		 -60 0 0
-Wage
earners		 50 0 0
-Companies -110 0 0




Customs
Division		 40 -60 -60
Reduction
of tariffs
on imports
from "third
countries
" (liberalization
program)		 -50 -60 -60
Revocation
of "inputs
tax"
deduction on
commercial
vehicles		 30 0 0
Lowering
of exemption
limit on
air bags
and ABS
systems		 60 0 0




Fees 140 0 0
Sale of
1,000 taxi
licenses		 110 0 0
Increased
use fees
for broadcast
frequencies		 30 0 0

Source: State Revenue Administration
Increased tax credit for residents of northern-border localities: These residents are entitled to a credit of 10 percent of their income, with no ceiling. In 1996-1998, the credit was raised to 20 percent for residents of Qiryat Shemona and to 15 percent for residents of other northern localities, up to an income ceiling of NIS 153,240 per year. Unless the existing legislation is amended, the credit rate will return to its original level in 1999.
Non-adjustment of personal income-tax brackets: Until 1996, income-tax brackets, credit points, and other tax-function indices were adjusted three times per year (on January 1 and whenever a Cost-of-Living Allowance was paid-in February and August) for the full increase in the Consumer Price Index. These adjustment rules were introduced when inflation was running at 15-20 percent a year. Since 1992, the inflation rate has fallen to about 10 percent per year. Under these circumstances, one yearly adjustment of tax-function indices suffices to prevent large real disparities during the year. Consequently, it was decided that starting in 1997 the indices in the income-tax personal function would be adjusted for the full increase in the CPI on January 1 only. One annual adjustment at an inflation rate of 7-8 percent is equivalent to three adjustments per year at 15-20 percent inflation.
As an ad-hoc measure to reduce the budget deficit, it was decided that the income-tax brackets and credit points, after their August 1996 adjustment, would not be adjusted in January 1997 and would remain unadjusted until January 1998, when they would be updated in view of the CPI increase in 1997 (to be precise, the CPI increase between November 1996 and November 1997).
Non-adjustment of these indices of the income-tax function boosted tax collections by NIS 1.2 billion. Most of this sum was collected in 1997, but NIS 310 million is expected to come in 1998 (mainly from the self-employed, when they file their 1997 tax returns).
Increasing the withholding rate on income from second jobs and writers' earnings: In February 1997, the withholding rate on income from second jobs and writers' earnings was raised to 50 percent, thus bringing this rate into alignment with the maximum rate of income tax. Although this change increased collections in 1997, some of the increment will be refunded in 1998 to those who fell short of the highest tax bracket.
Raising the use value of commercial "company cars": In April, the use value of commercial vehicles in employees' possession was increased from NIS 310 per month to NIS 750. This boosted the tax collected from employees by NIS 160 million-NIS 100 million in 1997 and NIS 60 million in 1998. However, the tax paid by employers decreased by NIS 110 million-all of which in 1998-because employers may deduct the sum of the benefit from their tax liability.

Table I-5
Effect of Change in Adjustment Method on Value of Tax Brackets
 (NIS per month)

Value of point
credit		 Upper limit of income-tax
brackets (percent and NIS)

10% 15% 20% 30% 45%1
Old
adjustment
method





1997





January 144
3,350
8,820 15,990
February 146
3,390
8,930 16,180
August 154
3,580
9,430 17,080
Average
for year		 149
3,466
9,129 16,539







1998





January 156
3,620
9,540 17,270
August 158
3,670
9,660 17,520
Average
for year		 157
3,641
9,590 17,394







New
adjustment
method





1997 141 1,640 - 3,280 8,630 15,640
1998 153 1,770 - 3,540 9,330 16,910


Source: State Revenue Administration

Note to the table:
1. Beyond the upper limit of the 45 percent bracket, a tax rate of 50 percent applies.
Legislative Changes in 1998-Customs Division

In 1998, the Division expects a net revenue increase of NIS 40 million.
Tariff reductions: Customs revenues will decrease by NIS 50 million as a further stage in the import liberalization with "third countries," within the framework of the program introduced in 1991, goes into effect.

Prohibition of deduction of "input tax" on 4x4 vehicles and minivans: The VAT regulations allowed the deduction of input tax on purchases of commercial vehicles, 4x4 vehicles, and minivans, but not on purchases of private cars. In view of the growth in private use of 4x4 vehicles and minivans, it was decided to discontinue the deductibility of input tax on these vehicles starting in April 1997. This measure augmented revenue by NIS 40 million in 1997 and by NIS 30 million in 1998.

Lowering the exemption limit on air bags and ABS systems: Air bags and ABS systems are exempt from the 95 percent purchase tax that applies to motor vehicles, provided that their price is lower than a given limit. In January 1998, the limit for these two accessories was lowered from NIS 3,500 and NIS 2,370 to NIS 2,500 and NIS 1,700, respectively.

Legislative Changes in 1998-Fees of Government Ministries

 Taxi licenses: The elimination of taxi-license quotas and an increase in the level of the fee boosted projected revenue on this account in 1998 by NIS 110 million relative to 1997.

Increase in the broadcast-frequency use fee: This measure is expected to augment revenues by NIS 30 million.


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