Israel's cabinet approved a package of tax hikes and spending cuts on Monday aimed at reining in the budget deficit, which analysts say will give the central bank room to resume monetary easing to support a weakening economy.
Ministers voted 20-9 in favour of the measures in a victory for Prime Minister Benjamin Netanyahu, who has been under pressure from the central bank to maintain credible fiscal policies at a time when the economy is slowing and tax revenues are falling short. He also hoped to avoid drastic measures that could upset a public already angered by the high cost of living.
"This is a responsible step to protect the Israeli economy and jobs for its citizens," Netanyahu said after the vote that was opposed by two of the five coalition partners - the ultra-Orthodox Shas and centrist Independence parties.
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.
The new measures include raising income taxes by 1 percentage point on those earning more than the average salary of 8,881 shekels (1,400 pounds) a month starting in 2013. Taxes on salaries over 67,000 shekels a month will go up 2 percentage points. Income tax rates in Israel range between 10 and 48 percent.
Value-added tax (VAT) is also set to rise to 17 percent from 16 percent on August 1, most ministries' budgets will be trimmed by 5 percent and the tax authority is targeting tax evaders to collect billions of shekels. Last week, Finance Minister Yuval Steinitz ordered immediate tax hikes on cigarettes and beer.
The Finance Ministry said the measures would add 14.4 billion shekels to state coffers next year.
Parliament will debate the steps next week.
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 (GDP). That would be well above an initial target of 2 percent.
The government last month opted to raise the 2013 deficit target to 3 percent of GDP from 1.5 percent, leading Bank of Israel chief Stanley Fischer to warn that interest rates may have to rise since fiscal loosening is inflationary. Without the new austerity measures economists say the deficit could reach 5-6 percent of GDP.
ATTACK ON MIDDLE CLASS?
Netanyahu and Steinitz have defended the austerity steps as crucial to preventing the economy from deteriorating and requiring more severe measures.
Prior to the vote, Netanyahu told ministers that governments - in a reference to some European countries - that did not act promptly and responsibly caused great harm to their citizens in the form of crumbling social systems and mass unemployment.
"We will not allow that to happen ... We need to act responsibly," he said, stressing that populist measures that involve large public spending lead to economic collapse. "We will maintain the Israeli economy and Israelis' jobs."
Still, details of the plan have dominated the news in recent days, with commentators, opposition leaders and some government officials criticising the government for attacking the middle class at a time when the public has been protesting the high cost of living.
Welfare Minister Moshe Kahlon, a member of Netanyahu's Likud party, voted against the plan. "My heart wouldn't let me vote in favour when I know there are people making 2,100 shekels a month and this deducts another 70 shekels from it, which is their budget for chicken and vegetables," he told reporters.
Netanyahu said the measures would help put more money in the pockets of the poor although some officials believe the economy will suffer more under the weight of higher taxation.
One of Netanyahu's few supporters is Fischer, who on Sunday called the fiscal steps "brave and essential" to improve Israel's budget situation.
Last week, the Bank of Israel held its benchmark rate at 2.25 percent, after cutting it in June for the first time in five months, with some analysts citing concerns over the budget as a key reason for the central bank staying on hold.
"If progress is made towards improving fiscal prospects, the Bank of Israel will likely cut its base rate 25 basis points to 2.0 percent at its next meeting" on August 27, said Barclays Capital emerging markets economist Daniel Hewitt.
(Additional reporting by Allyn Fisher-Ilan; Editing by Susan Fenton)