Treasury Weighs Sweeping Tax and Pension Overhauls to Tackle Post-War Debt
The Israeli Ministry of Finance and Tax Authority are preparing extensive tax reforms to address high war-driven debt and deficits. Proposals include labor tax cuts, property and luxury taxes, and contentious changes to high-tech options and pensions.
Israel's tax revenues have broken records in recent years, but government expenditures have also surged due to the war effort. Financial professionals within the government recognize that the defense budget will remain substantial, alongside high interest payments on public debt and the urgent need to increase civilian spending.
The government's debt-to-GDP ratio jumped from about 60% on the eve of the war to 68.5% at the end of last year, and it is not expected to decline despite the likelihood of ending the current year with a lower-than-planned deficit. However, Israel has promised rating agencies and investors that this ratio will decrease in the coming years, meaning adjustments must be made—whether through spending cuts, increased debt and deficits, or tax hikes.
Consequently, joint teams from the Ministry of Finance and the Tax Authority have been working in recent months on plans designed to increase state revenues and adapt the tax system to changes in the Israeli economy. Globes maps out the main plans on the table and their chances of passing.
The Popular Move: Reduced Labor Taxes in Exchange for Eliminating Credit Points
The significant tax reform being planned is the reduction of marginal income tax for workers alongside the abolition of income tax credit points. This has already been discussed publicly by senior officials in the Treasury and the Tax Authority. This means the possibility of further widening income tax brackets, to which health tax and national insurance are added.
It is possible that this popular step will be coupled with less popular measures, such as eliminating income tax credit points, with public statements spotlighting geographic credit points, as well as credit points for parents (costing NIS 14.4 billion annually) and numerous other benefits.
Response to the AI Era: Property Tax, Netflix Tax, and Luxury Goods Taxation
The Treasury understands that the share of labor taxes in state revenues is expected to decline in the coming years due to changes brought on by the AI era. These changes are estimated to reduce labor tax revenues, at least for a certain period, partly due to layoffs the economy is expected to absorb.
Therefore, as part of recent staff work conducted by the Chief Economist's Department, changes to the tax system were recommended to increase the share of capital taxation relative to labor taxation.
Among these measures, a property tax on vacant land is expected to return to the discussion table. This tax already appeared in the latest Economic Arrangements Law but was dropped during the legislative process. At the time, the Treasury estimated that the tax could bring in NIS 9.5 billion annually once fully matured. Although agricultural land was exempted during the legislative process, the tax faced political opposition, including from within the coalition, and was ultimately shelved.
The staff work also recommended considering the taxation of luxury goods and the "Netflix tax," which requires international companies to collect VAT from Israeli consumers. A similar proposal from 2023 estimated the tax would yield about NIS 500 million annually for the state treasury.
High-Tech in the Crosshairs: Increased Tax on Options and Secondary Transactions
In recent years, the high-tech sector has established itself as the engine of the economy and the primary driver of growth in Israel during the war years. A joint team of the Treasury and the Tax Authority is discussing an initiative whereby high-tech employees who do not exercise their company-granted options at the end of the vesting period will be required to pay a 30% tax upon selling the shares, rather than enjoying the preferential 25% tax rate currently provided by law.
However, this proposal faces opposition not only from the industry but also from within the Ministry of Finance.
It is possible that this measure will be coupled with the widening of income tax brackets that increases net wages for workers, helping to sweeten the pill. In any case, Minister of Finance Bezalel Smotrich has announced he will oppose such a measure, so it is likely to be decided by the next government.
Additionally, learning from the Wiz deal, the Tax Authority is advancing a move where, instead of paying billions of dollars in taxes on transferring intellectual property from Israel to the US, companies will reach an agreement with the Tax Authority to share the intellectual property and product sales rights according to a pre-determined arrangement.
Also in the crosshairs: secondary transactions where investors purchase shares from existing shareholders in a company. The industry views this tax as capital gains while the Tax Authority views it as labor tax, with the collection gap estimated at hundreds of millions of schekels.
Pensions and the "Goat": Will Mandatory Deposits be Abolished?
Another team is working on far-reaching changes in the field of pensions and savings. The Treasury estimates the tax break on pensions as the largest benefit currently granted by the state, costing nearly NIS 31 billion annually. From here, several possibilities emerge. Senior Treasury officials, joined by the National Economic Council, are pushing to reduce mandatory pension deposits or abolish them entirely up to age 40 to increase consumer spending.
In contrast, others are pushing not to reduce deposits, but to significantly lower tax benefits since it is already a legal requirement. Smotrich recently boasted that he blocked initiatives to curtail pension exemptions, and the issue will be decided by the next government.
Another exemption that arises every few years is on the taxation of advanced training funds (keren hishtalmut), costing about NIS 10 billion annually. However, the chances of passing it are low, and it is sometimes presented as a "goat" in negotiations with the Histadrut labor federation, which has made it a banner and a symbol. Therefore, it is likely not to be the centerpiece of planned tax measures when so much else is on the table.
Also in the savings sector, a ready plan sits on the table: the arbitrage reform, designed to level the playing field and eliminate tax distortions among savings products such as investment provident funds, savings policies, and mutual funds. Current tax exemptions will be canceled, and a sweeping exemption of up to NIS 200,000 will be granted on all products. Capital Market Commissioner Amit Gal warned that the reform might actually raise prices for consumers and fail to contribute to competition. The current Minister of Finance chose to advance the reform anyway, but its legislative enactment will be decided by the next government.
The Question of Feasibility
It is doubtful whether the Treasury will succeed in advancing such a long series of reforms. New governments tend to adopt a broad Arrangements Law upon taking office. Therefore, given the economy's challenges and the incoming new government, a relatively extensive law is likely to appear, but it will encounter the familiar legal difficulties of a law intended to directly support the state budget rather than introduce standalone expedited legislation.
To bypass this difficulty, a Knesset committee may be established, as in the past, to handle financial reforms through similar legislation that might otherwise not enter or would drop out during the Arrangements Law process.
Nevertheless, as with every budget, the solution will also involve pairing harsh decrees with benefits. Even so, the Treasury will have to choose its battles given that many initiatives may face political, substantive, and ideological opposition determined by the composition of the next government and its ministers. Another difficulty lies in the power of the Budget Department, where Commissioner Mehran Frozanfar was appointed by the current minister, and in the event of a different government, the relationship and trust between him and the politicians will be put to the test.
