By Steven Scheer
JERUSALEM (Reuters) - Israel's cabinet is expected to approve a controversial package of tax hikes and spending cuts 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.
The vote is slated for later on Monday although such discussions in the past have gone on into the night. Prime Minister Benjamin Netanyahu has received the backing of one of his coalition partners, Yisrael Beiteinu, but ministers from the ultra-Orthodox Shas party are likely to vote against the plan.
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.
Israel forecasts 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.
The measures the cabinet will vote on include raising income taxes by 1 percent on those earning more than the average salary of 8,881 shekels ($2,198) a month starting in 2013. Taxes on salaries over 67,000 shekels a month will go up 2 percent. 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, 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.
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.
"Governments that did not act in time, did not take determined action, and did not act responsibly, caused great harm to their people, both in terms of mass unemployment and in terms of crumbling social systems," Netanyahu said at the start of the cabinet meeting. "We will not allow that to happen ... We need to act responsibly."
Details of the plan have dominated the news, with commentators and opposition leaders criticizing the government for attacking the middle class at a time when the public has been protesting the high cost of living.
One of Netanyahu's few supporters is Fischer, who on Sunday called the fiscal steps "brave and essential" to improve Israel's budget situation.
"Due to Netanyahu's determination to act as soon as possible, in order to prevent Israel from sliding into a debt crisis, we believe now that the Bank of Israel will feel more comfortable to continue cutting rates in the near future," said Modi Shafrir, head of ILS Brokers, who forecasts cuts of up to another half-point by the end of 2012.
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.
($1 = 4.04 shekels)
(Editing by Susan Fenton)