Israel backtracks on tax hike to secure austerity package approval

JERUSALEM (Reuters) - Israel's parliament gave final approval to a package of unpopular tax hikes aimed at reining in the budget deficit on Monday after Prime Minister Benjamin Netanyahu backtracked on a planned income tax hike for middle-income earners.

To ensure support for the austerity package, Netanyahu on Monday scaled back a planned 1 percentage point income tax increase on those earning more than the average salary of 8,881 shekels ($2,231) a month from 2013, saying the increase would now not apply to those earning less than 14,000 shekels a month.

The tax hike had been widely criticized in the Israeli media for unduly harming the middle class.

"We prevented harm to the middle class," said Moshe Gafni, chairman of parliament's finance committee, who brokered the deal.

During a special summer session of parliament, or the Knesset, lawmakers approved a series of steps in their third and final readings. Earlier in the day, the plenum had given its initial nod followed by approval by the Knesset's finance committee.

"We approved steps that will prevent a huge deficit with the aim of safeguarding the Israeli economy and jobs for the citizens of Israel. These are responsible steps to protect the Israeli economy from the world economic crisis," Netanyahu said after the vote.

Income tax on salaries above 67,000 a month, or 800,000 shekels a year, will rise by 2 percentage points from 2013. Value-added tax (VAT) is set to rise to 17 percent from 16 percent on September 1, 2012.

Last week, the cabinet trimmed most ministries' budgets by 5 percent and the tax authority is targeting tax evaders to collect billions of shekels. Two weeks ago, Steinitz ordered immediate tax increases on cigarettes and beer.

The Finance Ministry estimates the measures would add 14.4 billion to state coffers next year.

SLOWDOWN SHORTFALL

Netanyahu has come under pressure from the Bank of Israel to maintain credible fiscal policies at a time when the economy is slowing on the heels of a global slowdown and tax revenues are falling short. He also hoped to avoid drastic measures that would upset a public already angered by high living costs.

Polls have shown that close to half of Israelis believe the austerity measures are unjustified. Netanyahu and Steinitz have defended the austerity steps as crucial to preventing the economy from deteriorating and requiring more severe measures.

Israel's economy weathered the global economic crisis well until a year ago when exports began to slow as a result of a downturn in Europe and the United States, Israel's two largest trading partners. Exports account for about 40 percent of Israel's economic activity.

Economists forecast economic growth of around 2.5 percent this year, slowing from 4.8 percent in 2011 and resulting in a tax revenue shortfall that will push the budget deficit closer to 4 percent of gross domestic product. That would be well above an initial target of 2 percent.

The government last month raised the 2013 deficit target to 3 percent of GDP from 1.5 percent, leading Bank of Israel Governor Stanley Fischer to warn that interest rates may have to rise since fiscal loosening is inflationary. Without the new austerity measures economists and Fischer say the deficit could reach 5-6 percent of GDP.

Steinitz said he will present the 2013 budget framework to the cabinet in early September, with an aim of a final discussion of the budget, and possible vote, on September 13.

(Additional reporting by Allyn Fisher-Ilan and Ari Rabinovitch; Editing by Susan Fenton, Ron Askew)

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