Israel Weighs Tax Reforms Amid Rising Debt and War Costs

Israel's government is exploring significant tax reforms to bolster state revenues, which have been strained by increased war expenditures and rising national debt. The debt-to-GDP ratio climbed to 68.5% by the end of last year, prompting promises to credit rating agencies and investors to reduce it. This reduction is expected to involve fiscal adjustments, potentially through spending cuts, increased borrowing, or tax hikes.

Several reform proposals are under consideration by joint teams from the Ministry of Finance and the Tax Authority. One prominent plan involves reducing marginal income tax rates for employees while simultaneously eliminating certain tax credits, such as those for parents, which cost the state approximately 14.4 billion shekels annually. This measure aims to provide broader relief but is anticipated to face opposition from interest groups benefiting from current tax advantages.

Another area of focus is adapting the tax system to the digital age and the rise of artificial intelligence. Proposals include reintroducing property taxes on vacant land, which was previously estimated to generate 9.5 billion shekels annually but was removed from legislation due to political opposition. Additionally, a "Netflix tax" on international companies charging Israeli consumers VAT is being considered, potentially yielding around 500 million shekels per year, though it may face opposition from the United States. The government is also looking at taxing luxury goods.

The high-tech sector is also a target, with discussions around increasing taxes on unexercised stock options, potentially raising the tax rate to 30% from the current 25% preferential rate. This initiative faces internal opposition within the Finance Ministry and has been opposed by current Finance Minister Bezalel Smotrich, suggesting it will be decided by the next government. The Tax Authority is also working on agreements for intellectual property transfers and addressing tax discrepancies in secondary share transactions, which could save hundreds of millions of shekels.

Further reforms are being considered for pensions and savings. One proposal aims to reduce or eliminate mandatory pension contributions for individuals under 40 to boost consumption, while others suggest significantly cutting tax benefits on pensions, which currently cost the state nearly 31 billion shekels annually. The Finance Minister has stated his opposition to reducing these exemptions, leaving the decision to the next government. Tax exemptions on study funds, costing about 10 billion shekels annually, are also on the table but are seen as unlikely to pass due to strong union opposition.

Finally, a reform to equalize taxation across savings products like provident funds, savings policies, and mutual funds is being advanced. This would eliminate current tax exemptions and offer a blanket exemption up to 200,000 shekels, though the Capital Markets Authority warns it might increase consumer costs. The feasibility of implementing such a broad range of reforms remains uncertain, with new governments often passing comprehensive "Arrangements Laws" that can face legislative and political hurdles. The success of these proposals will likely depend on the composition of the next government and its willingness to navigate significant political and ideological opposition.