Israel Finance Ministry, International Division

Excerpts from the
Annual State Revenue Report for 1997

Forecast of Tax Benefits in 1998

	1. TAX CUTS FOR ALL: BETTER THAN SPECIAL BENEFITS
	2. FORECAST OF INCOME TAX BENEFITS
	3. BENEFITS FOR PRODUCTION FACTORS
	4. CAPITAL-MARKET BENEFITS
	5. SOCIAL WELFARE AND POPULATION DISPERSION
	6. FAMILY BENEFITS
	7. MISCELLANEOUS INCOME-TAX BENEFITS
	8. PROPERTY-TAX BENEFITS
	9. TAX BENEFIT FORECAST—CUSTOMS AND VAT DIVISION
	10. TAX-EXPENDITURE FORECAST—FEES

The level of tax benefits in 1998 will be NIS 19.2 billion16 percent of total state tax revenue. (See Table II-1.)

This includes benefits in government taxes only; benefits in National Insurance contributions or municipal taxes are not included. Of the total, the Income Tax Division will award NIS 16.3 billion in income-tax and property-tax benefits (25 percent of its revenues) and the Customs and VAT Division will award NIS 2.8 billion (6 percent of division revenue). Another NIS 100 million will be benefits in fees.

Simple arithmetic shows that by abolishing all tax benefits, one could, for example, lower the maximum income-tax rate from 50 percent to 40 percent, the corporate tax rate from 36 percent to 33 percent, and the Value Added Tax rate from 17 percent to 16 percent. This reckoning disregards interlocking effects of the benefits and changes in taxpayers' economic behavior in response to their nullification. However, it has the advantage of substantiating the magnitude of the tax benefits and illustrating the latitude one may apply in eliminating them.

Tax benefits, also known as "tax expenditures," are defined as losses of revenue originating in tax exemptions or reductions for certain groups of citizens or economic activities. The concept of a "tax expenditure" was developed in the late 1960s by the United States Department of the Treasury. In 1974, by order of Congress, tax benefits were included in reporting on the federal budget. Notably, Israel introduced this requirement in 1986 (in Paragraph 2[b][2] of the 1985 Foundations of the Budget Law).

A tax benefit can be awarded by reducing tax base and/or lowering the tax rateassuming that the tax laws define the base and the standard tax rate and that any deviation would be considered a tax benefit. This definition is especially problematic, since the standard against which the benefit should be calculated is not always clear. The Employers' Tax Law, for example, states that all employers are liable to a tax of 4 percent of total labor income that they pay employees. The tax base, however, has contracted over the years so as to absolve most employers from employers' tax and to leave it in effect only for nongovernmental public institutions. According to the simple definition of a tax benefit, the "benefit" on account of employers' tax would seem to total more than NIS 4 billion, as against actural collections of NIS 1 billion.

Another example in which the benefit substantially exceeds collection is land-betterment tax on dwellings. In principle, every sale of a dwelling is liable to land-betterment tax; in practice, a large majority of transactions are exempt. In these cases, it was decided that the exceptions are not regarded as benefits and are not included in the tax-benefit budget.

Only benefit items that stand in "reasonable" proportion to actual collection are included in the budget. The definition of "reasonable" is also arbitrary, and this should be kept in mind when evaluating the tax benefit reported here. Another researcher could possibly arrive at a different level and composition of benefits.

Not only is the definition of the tax benefits debatable; so is their quantification. The method we chose to estimate the tax benefits assumes that the benefit being discussed is the only one that exists, irrespective of the effects of this benefit on others and the possibility that revoking the benefit would change taxpayers' economic behavior. Therefore, a change in a given item will not bring about an equivalent in change state revenuesa point of special validity with respect to combinations of items.

In contrast to the government's expenditure budget, which the Knesset approves in legislation each year, tax benefits do not call for periodic public debate. Many believe that tax benefits can accomplish things ex nihilo because their cost is not universally known. Indeed, some argue that tax benefits are cost-free. Thus, the purpose of the tax-expenditure budget is to quantify these costs, bring them to public knowledge, and thereby make it possible to compare tax benefits with direct budget outlays.

The level of detail in the data depends on the information gathered by the Economic Research and State Revenue Division. Some items are set forth in considerable detail; others are expressed in general estimates.

Because the rate of use of tax benefits is difficult to predict, the estimates are based on three-year-old data, restated in the relevant 1998 budget prices.

1. TAX CUTS FOR ALL: BETTER THAN SPECIAL BENEFITS

Tax benefits are, of course, good for their recipients. However, they shift the tax burden to all other taxpayers and, by so doing, worsen their circumstances. Tax benefits redistribute the tax burden, but their principal effects are to make the tax laws more complicated, encourage tax avoidance, and impair general economic well-being.

Hence, a better course of action is a reform that combines reduction of tax rates for the entire population with the elimination of benefits for special population groups. Such reforms, on various scales of magnitude, were carried out in Israel in 1975, in the United States in 1986, and in many Western countries afterwards.

Since 1990, many attempts have been made in Israel to cut back on tax benefits. Some of these efforts managed to eliminate or mitigate benefits for various groups: students in institutions of higher education; shift workers; credit for health expenditures, demobilized soldiers, and fringe benefits; and new immigrants who receive "absorption basket" grants. However, most of the major attempts failed, e.g., capital gains; old-age pensions; Value Added Tax on fruit, vegetables, and tourism services; and income from gambling and lotteries. Notably, however, since 1997 the income of the Ports and Railroads Authority and the Airports Authority has been taxed and the exemption on automobile air-conditioners has been abolished.

In other spheres, a retreat took place and tax benefits expanded. Thus, women were given half a tax-credit point, the scope of the Eilat Law was expanded; a Free Export Processing Zones Law was enacted, self-employed taxpayers were awarded a deduction for contributions to advanced-training funds, tax credits for residents of confrontation-line localities were raised, and further relief in property and land-betterment taxes was given.

International and Israeli experience shows that it is difficult to persevere in the elimination of tax benefits. Pressure groups that are liable to suffer from such action are strong enough to mitigate or even recoup their losses in various waysand the public at large, adversely affected by the specific benefits, seldom has a voice.

2. FORECAST OF INCOME TAX BENEFITS

In 1998, the Income Tax Division will award NIS 16.3 billion in tax benefits, as itemized below:

Table II-1
Income Tax Division Tax Benefits
(NIS billions and percent)

	NIS billions	Percent
Production factors	1.2	7.1
Capital market	10.0	61.6
Welfare and population dispersion	2.8	16.9
Family benefits	1.4	8.8
Property taxes	0.6	3.7
Miscellaneous	0.3	1.9

Total	16.3	100.0

3. BENEFITS FOR PRODUCTION FACTORS

Encouragement of Capital Investments LawThe tax-benefit estimate is based on the difference between the 25 percent tax rate applying to companies that own Approved Enterprises and the 36 percent rate that applies to ordinary companies.

Companies with foreign investment benefit from a reduced tax rate of 10-20 percent, depending on the proportion of foreign investment.

The "alternative track" allows companies that owns Approved Enterprises to waive the grants and pay tax at a zero rate for two years, six years, or ten years, depending on the type of National Priority Area in which the enterprise is situated.

Research and development, oil exploration, and film productionThese activities may be "expensed" in the current tax year even though they are not current expenses.

Shift-work creditIndustrial workers on second or third shifts are eligible for a tax credit at 15 percent of income that originates in shift labor, up to a maximum of NIS 645 per month (as of 1998). Since July 1990, the shift-labor credit has not been given where the shift-labor incomecombined with the ordinary incomeexceeds NIS 7,360 per month (as of 1998).

4. CAPITAL-MARKET BENEFITS

Provident Funds

Benefits for Provident-Fund Savings at Point of Deposit

On wage income that serves as a pension base:

Employers' deductible expenses 8.33 percent of income for a severance-pay fund and another 5 percent of income for a pension-type provident fund, or 6 percent for an allowance-type provident fund. In the case of pension-type contributions, the tax benefit is recognized only up to an income ceiling (NIS 8,500 per month in 1998); any additional contribution is considered employee-taxable income. Severance-pay and allowance contributions are not subject to any maximum.

Tax credit for employees35 percent of the contribution made by the employee, up to 5 percent of income until the qualifying-income ceiling is reached.

On wage income that does not serve as a pension base:

Employee deduction-5 percent of the income up to the qualifying-income ceiling.

Employee credit25 percent of the employee's contribution that was not taken into account for the aforementioned employee deduction.

On non-wage income:

Deduction for the self-employedup to 7 percent of income until the qualifying-income ceiling is reached, and up to 11 percent in the case of contributions to an allowance-type provident fund.

Tax credit for the self-employedidentical to the credit given to wage earners for the portion of income that does not serve as the basis for a pension.

Extra benefits for comprehensive pension plans as against provident funds:

In practice, comprehensive pension plans are given several tax benefits that ordinary provident funds do not utilize:

a.	Circumvention of tax liability on employers' pension contributions that exceed the qualifying-income ceiling.
b.	Reduced tax liability on account of the severance-pay component.
c.	A deductible contribution of up to 2.5 percent for insurance against loss of earning ability, beyond 18.33 percent of benefit-eligible wage. In provident funds that pay a comprehensive allowance, the benefit is limited to 19.8 percent. Therefore, the supplementary benefit is 1 percent relative to the comprehensive-allowance fund and 2.5 percent relative to other types of provident funds.
d.	Continuity-of-benefit rights: Owner of comprehensive pension plans may transfer compensation in excess of the exemption limit to a pension plan and gain a double exemption.

These benefits cost an estimated NIS 300 million per year and are included in the tax-benefit budget under the general heading of "Provident Funds." This item contains a lengthy series of tax benefits, but there is no practical way to quantify each of them separately.

Taxation of Provident-Fund Savings at Point of Withdrawal

Withdrawal from pension-type provident fund a tax exemption on 35 percent of the pension up to a maximum of NIS 5,820 per month in 1998. The non-exempt portion of such withdrawals is taxable at the regular rates.

Withdrawal from benefit-type provident fund fully exempt.

Withdrawal from severance-pay provident fund -One month's income up to NIS 8,490 (in 1998) is exempt for each year of work for which retirement or severance-pay contributions are made. The exemption is doubled for benefits upon death. The non-exempt portion of these benefits is taxable at the regular rates.

Advanced-Training Funds -employers' contributions of up to 7.5 percent of income (8.4 percent for teachers) are tax-exempt with respect to the employee, up to a maximum monthly wage of NIS 14,000 (in 1998).

The benefit ceiling is indexed to twice the wage ceiling for payment of cost-of-living allowancesa ceiling that was raised by dozens of percent in real terms in 1995: from NIS 8,600 per month in August 1994 to NIS 12,000 in February 1995. This had the effect of increasing the imputed benefit in advanced-training funds. The 25 percent tax credit for employees' contributions was abolished in July 1985.

An expansion of the benefit for the self-employed began in 1996. Since then, self-employed taxpayers who contribute 2.3 percent of their incomes (up to a maximum) to an advanced-training fund have been entitled to a deduction of up to 1.5 percent. In 1997, these rates were raised to 4.7 percent and 3 percent, respectively, and in 1998 to 7 percent and 4.5 percent, respectively.

Interest income The benefit under this item includes the exemption on interest income from indexed plansresident restitution deposits, savings plans, and provident fundsand the exemption of the non-indexed component of interest income from non-indexed plans.

Capital gains on the stock exchange -Because these gains vary widely from one year to the next, 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 percent 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. Since 1992, such taxpayers who are not corporate principals have been fully tax-liable. The situation of principal shareholders has not changed.

Gains on the stock exchange of taxpayers to whom the Inflationary Adjustments Law does not apply (individuals and nonprofit organizations) are fully exempt. As stated, in August 1994 the government decided to extend the tax liability to them (effective January 1995) and the necessary legislation was enacted by the Knesset. However, the legislation was never implemented and was officially rescinded in March 1995.

5. SOCIAL WELFARE AND POPULATION DISPERSION

Income-tax exemption for nonprofit organizations-Nonbusiness income of nonprofit organizations is tax-exempt. No data on the scale 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).

Exemption for Benefits from the National Insurance Institute (NII)

Child allowancesThe exemption is reckoned on the assumption that the entire allowance will be taxed at the head of household's rate.

Old-age and survivors' pensions In September 1991, the Government decided to eliminate the exemption; subsequently the Government rescinded the decision, meaning that these benefits remain tax-exempt.

Other benefits workers' compensation, general disability, enemy action, mobility, and maternity grant are exempt. The maternity benefit and unemployment compensation, in contrast, are tax-liable.

New immigrants' credit -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.

Medical-expenses credit -Until July 1990, a 25-35 percent credit was given for medical expenses within certain limits. Since then, the credit has been given only for expenses connected with the upkeep of a relative in an institution. The rate of credit in this case is 35 percent of expenses exceeding 12.5 percent of taxable income.

Credit for the disabled A taxpayer who cares for a disabled 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 -A credit for 35 percent for the sum of donation, up to a maximum of 30 percent of taxable income or NIS 438,000 per year (in 1998), whichever is lower.

Blind and disabled-Earned income of the blind or the disabled up to NIS 35,200 per month or other income up to NIS 4,220 per month (in 1998) are exempt. This item includes persons with temporary disabilities caused by serious illness.

Credit for residents of development areas -The tax reduction is given to residents of development localities as defined for this purpose, up to a ceiling. The credit is set at rates of 3 percent, 5 percent, and 7 percent of income, in accordance with different rankings of development areas. Residents of "confrontation line" communities, Yeroham, and Eilat may deduct 10 percent of their income. (For residents of confrontation line localities, this rate was raised to 15-20 percent for 1996-1998.) Residents of Mitzpe Ramon deduct 25 percent. (The VAT exemption in Eilat is not included under this item; it is recorded under indirect-tax benefits and is discussed below.)

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

6. FAMILY BENEFITS

Credits for single -parent families and divorced personsOne credit point is given to single-parent families (in addition to one credit point for each child) and to divorced persons who participate in the support of children in the custody of their ex-spouse.

Half credit point for women Women who file separately are entitled to another half credit point. Women who file jointly and are the other taxpayer's registered spouse are eligible for the same benefit.

Credit for working mothers -Women who worked and filed separately were entitled until July 1990 to one credit point for each child under age eighteen. From July 1990 to fiscal 1995, one credit point was given for each odd-numbered child only, and single-parent mothers or fathers continued to get the full credit point for each child. Starting in fiscal 1996, each woman who filed separately has again been given one credit point for each child, with the exception of children in their first year and in the year in which they turn eighteen, for whom they receive only half a credit point. Couples who have children and file jointly are entitled to one-quarter of a credit point for each child who has not completed his/her eighteenth year.

Credit for non-working spouse -A person whose spouse is his/her dependent is entitled to one credit point.

7. MISCELLANEOUS INCOME-TAX BENEFITS

Exemption on gambling and lottery income -Income from gambling and lotteries is tax-exempt. In July 1996, the government resolved to tax such incomes in excess of NIS 1,000 at 20 percent, but the resolution was not applied. Instead, the state lottery organization was instructed to contribute NIS 100 million to the state budget.

Exemption for leasing of dwelling -Income from leasing a dwelling is tax-exempt up to NIS 6,350 per month (in 1998). Above this sum, the exemption is reduced sheqel for sheqel. For example, on an income of NIS 7,350, only NIS 5,350 would be exempt.

8. PROPERTY-TAX BENEFITS

Real-estate purchase tax benefits - The disabled, casualties of enemy action and their relatives, and recent immigrants (up to a ceiling) are charged real-estate purchase tax at a reduced rate. Where an individual sells real estate to a relative for a zero return, a reduction of two-thirds of the standard rate is given.

Land-betterment tax benefits for dwellings -Under the Land-Betterment Tax Law, the owner of one dwelling is entitled to an unlimited exemption from land-betterment tax upon selling it. The owner of more than one dwelling may sell one tax-exempt dwelling every four years.

Because most dwellings sold qualify for exempt status under the lawmeaning that very few are liable to land-betterment taxthe quantification of this benefit is meaningless and is not cited here.

An ad hoc provision introduced in 1992 and extended through 1996 created an exemption for the owner of more than one dwelling who sold two dwellings per year, up to a maximum of NIS 1.5 million.In 1996, the last year in which this arrangement was implemented, the ad hoc provision cost NIS 100 million.

Land-betterment tax benefits for historical land -Real estate purchased up to 1960 is liable upon sale to land-betterment tax at reduced rates of 12-24 percent.

Property-tax benefits -Under the law, undeveloped land is exempt from property tax provided that it is zoned as farmland in an outline plan and has actually been used for agriculture.

In 1995, two legislative amendments expanded the exemption to include land that meets only one of the aforementioned stipulations (zoning as farmland or use as farmland) 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 costs of these changes are estimated at NIS 90 million and NIS 40 million, respectively. A further legislative change, adopted in 1996, entitles landowners who made their purchases before May 15, 1948, to apply for a property-tax deduction of NIS 78,800 (as of 1998) per dunam for up to ten dunams. The cost of this benefit is estimated at NIS 110 million.

9. TAX BENEFIT FORECASTCUSTOMS AND VAT DIVISION

The Customs and VAT Division will dispense NIS 2.8 billion in tax benefits in 1998: NIS 0.9 billion in customs and purchase-tax benefits (32 percent) and NIS 1.9 billion in VAT benefits (68 percent).

Customs and Purchase Tax

New immigrants -The estimated revenue loss caused by the immigrants' indirect-tax reduction is based on a maximum exemption of NIS 35,000 per family not including purchase of motor vehicle and NIS 28,000 for a motor vehicle.

Returning Israelis -The estimated revenue loss caused by the returning-Israelis exemption is based on a maximum benefit of NIS 25,000 per family.

Tourists -Residents over the age of two are entitled to a purchase-tax exemption on merchandise worth $200 when returning from abroad.

Automotive parts -Air bags and ABS systems are exempt (up to a ceiling) from the 95 percent purchase tax that applies to motor vehicles. In 1998, the ceiling was lowered to reduce the extent of this benefit.

Conditional exemptions -This includes miscellaneous customs and purchase-tax exemptions, such as an exemption for higher-education institutions on imports of scientific and educational materials, exemptions under international conventions, and an exemption for health institutions.

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

10. TAX-EXPENDITURE FORECASTFEES

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

Table II-1
Estimate of Tax Benefits in 1998
(NIS millions, 1998 budget prices)

Total	19,150
I. Income Tax Division	16,260
A. Production factor benefits	1,130
1. Encouragement of Capital Investments Law	950
General	250
Nonresident investors	200
Alternative track	500
2. R&D, oil exploration, and films	30
3. Credit for shift labor	150

B. Capital market benefits	10,030
1. Provident funds, net:	3,430
Benefits at point of deposit	3,800
Less taxation at point of withdrawal	-370
2. Advanced-training funds	900
3. Interest income on indexed assets	2,600
4. Interest income on unindexed assets	1,000
5. Capital gains on the stock exchange	2,100

C. Welfare and population dispersion	2,750
1. Income-tax exemption for nonprofit organizations	N/A
2. Exemption for Ministry of Defense benefits	210
3 Exemption for National Insurance benefits	1,670
Child allowances	1,200
Old-age and survivors' benefits	370
Other benefits	100
4. New-immigrant credit	90
5. Medical-expense credit	10
6. Credit for care of the disabled	40
7. Credit for charitable donations	100
8. Benefits for the blind and the disabled	100
9. Credit for development-area residents	480
10. Credit for employers in Eilat	50

D. Family benefits (other than exemption on child allowances	1,430
1. Credit for single-parent families	30
2. Half credit point for women	300
3. Credit for children (including children in single-parent families)	600
4. Credit for non-working spouse	500

E. Miscellaneous income-tax benefits	310
1. Exemption on income from gambling	100
2. Exemption for rental	200
3. Exemption for redemption of share in cooperative association	10

F. Property-tax benefits	610
1. Real-estate purchase tax reductions	80
2. Land-betterment tax exemption for dwellings	0
3. Reduced land-betterment tax for historical properties	330
4. Property-tax benefits	220

II. CUSTOMS AND VAT DIVISION	2,790
A. Customs and purchase tax	880
1. New immigrants	270
2. Returning Israelis	60
3. Israeli tourists	50
4. Automotive parts (air bags and ABS)	200
5. Conditional exemptions	300

b. Value Added Tax	1,910
1. Fruit and vegetables	1,240
2. Tourism services	550
3. Eilat Law	120

III. FEES	100