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I commend the Housing Cabinet and the government on their efforts to promote programs and steps to deal with home prices.
In my role as advisor to the government on economic issues, I would like to present to the Ministers and Housing Cabinet members the Bank of Israel’s professional position, as it has been formulated based on the Bank’s analyses of proposals regarding incentives to local authorities, the “Target Price” program, and zero VAT on a first home.
 
I will preface my remarks by stating that in general, as noted by the Minister of Finance, the fundamental solution to the increase in home prices is to be found in a consistent increase in supply, with an emphasis on areas with high demand. If construction volumes of 2013, which were slightly above the annual flow of new households, remain in place and are focused on areas in high demand, they will act in the proper direction and are expected to lead to reduced pressure for higher prices, and to a turnaround in the development of home prices.
 
With regard to incentives to local authorities, the Bank of Israel assesses that providing local authorities with incentives to issue residential building permits in their area is an effective tool that will support the expansion of the stock of homes.
 
With regard to the “Target Price” plan, the Bank of Israel assesses that the principles of the plan will be able to lead to the achievement of the goal of reducing housing prices. The plan—the details of which still need to be worked out—is intended to support the increase of stock of homes and the reduction of their prices, and to transmit a credible message to the public that the government is determined to reduce home prices, even at the cost of relinquishing some of the revenue from selling the land. In our assessment, a condition for the success of the plan is the ability of the Israel Land Authority to continue to market land at sufficient quantities for large projects in areas in demand. I would like to emphasize that in our assessment, the Target Price plan has an advantage in that it is a flexible plan, and its size can be appropriately adjusted to the market situation. We commend today’s decision to set up a team that will formulate the plan’s details and will bring the plan to the cabinet in the coming days.
 
In terms of the plan for zero VAT on first-time home buyers, the Bank of Israel assesses that the plan has deficiencies which the cabinet must take into account. Below I will list the main issues raised in the Bank of Israel’s analysis of the proposal for zero VAT:
 

  • Implementing the plan will increase demand for new homes. Granting a VAT exemption for first-time home buyers who meet the criteria that will be set, who make up a notable share of home buyers, is expected to lead to an increase in demand for new homes. To the extent that supply of new homes is inelastic (and it is reasonable to assume that it is especially inelastic in the short term), there will be greater upward pressure on prices. Without effective supervision of prices, prices of homes that are eligible for the zero VAT will increase, and in the end a marked portion of the benefit will not reach buyers’ pockets.

 

  • The plan includes a price supervision component which is complicated and difficult to implement. In order to prevent the expected increase in prices in view of the increased demand from those eligible for zero VAT, the proposal includes a complicated system of supervision over prices and specifications in line with the government assessor’s valuation. However, supervision over prices and specifications for homes that meet the conditions set is very difficult to implement. Such supervision will require detailed information on the price of every home, for homes in various regions and with various specifications. Sharp excess demand that will be created for homes that allow their buyers to be eligible for zero VAT is liable to lead to other distortions, and again, the buyers will not attain the full benefit.

 

  • I note two points related to the target population chosen as eligible for the benefit:

1.      Establishing the maximum value of homes which allow their buyers to be eligible for zero VAT at NIS 1.6 million benefits relatively strong populations.

2.      The eligibility tests which were set do not include the weakest population groups. The increase in the price of new homes as a result of the program will make it even more difficult for population groups who are not eligible for the benefit to purchase a home.

 

  • Zero VAT is expected to permanent and is liable to expand.

From the moment that the zero VAT benefit is granted to the population group determined, it is expected to be permanent, and over time is expected to produce pressure to expand the population groups eligible for it. Even if in the future it turns out that the benefit is not yielding the hoped-for results, and is even causing unintended consequences, it is reasonable that political realities will not allow it to be cancelled (just as attempts to date to cancel the VAT exemption on produce and in the city of Eilat have failed).

 

  • The measure has a large budgetary cost with the potential for increased costs over time, and a funding source should be found for it.

The proposed plan has a budgetary cost of about NIS 2 billion, assuming that only the population which meets the criteria that are set is eligible for zero VAT. With that, it is likely that over time there will be increased pressure to widen the group which is eligible for the benefit, and the budgetary cost will increase over time. Because of the importance of maintaining the deficit framework, we suggest that the proposal be accompanied by reference to the source of funding the benefit. As we understand it, the proposal put forward does not indicate a source of funding, such as imposing another tax or making a further reduction in expenditure.

 

  • The measure negatively impacts the efficiency of the uniform VAT system.

One of the major advantages of the VAT system in Israel which makes it especially efficient is that it is a (nearly) uniform rate. Adding the proposed exemption is projected to increase the pressure for additional exemptions and is liable to erode very noticeably the principle of uniform VAT, and to require other tax increases in order to compensate for the loss of revenue.