Israel's VAT Revenue Nears Quarter of State Income in 2026 Budget

The Israeli state budget for 2026 anticipates Value Added Tax (VAT) revenue totaling 192.9 billion shekels, a figure that constitutes nearly a quarter of the projected total state income of 850.59 billion shekels. After accounting for loans, VAT represents 32.9% of the state's net income, second only to income tax, which accounts for 49.2%. This VAT sum is derived from two main components: 170.42 billion shekels in gross VAT receipts and an additional 22.47 billion shekels categorized under 'taxes on payroll expenses.'

The primary VAT collection, amounting to 170.42 billion shekels, is broken down into VAT on local production (91.83 billion shekels), VAT on civilian imports (75.72 billion shekels), and VAT on defense imports (2.87 billion shekels). Notably, 46% of all VAT revenue is collected at the border upon import, making it sensitive to exchange rates, shipping costs, and import volumes rather than just domestic sales.

The 22.47 billion shekel portion, listed as 'taxes on payroll expenses,' is further divided. It includes 16.26 billion shekels from non-profit organizations (like local authorities, health funds, universities, and charities) and 6.21 billion shekels from financial institutions (banks and insurance companies). These entities pay a payroll tax of 7.5% and a payroll and profit tax of 18% respectively, as they cannot operate under the standard VAT deduction mechanism.

Israel's VAT rate increased from 17% to 18% on January 1, 2025, as part of deficit reduction measures. This rate, while lower than the OECD average of 19.3%, contributes significantly to state revenue due to efficient collection and a broad tax base with fewer exceptions compared to other European nations. Despite the lower VAT rate, VAT constituted 21.9% of Israel's total tax revenue in 2023, above the OECD average of 20.5%.

VAT is considered a regressive tax, as it is levied on expenditure rather than income. This means individuals with lower incomes spend a larger proportion of their earnings on VAT compared to higher earners. For instance, a 900 shekel VAT on a 5,900 shekel washing machine represents 10% of a low-income earner's monthly income but only 2% for a high earner.