The Finance Ministry is considering raising the country’s value-added tax (VAT) by one percentage point, from 18% to 19%, to fund a significant increase in the defense budget and prevent a widening deficit, sources told ynet.
The proposal, floated during recent internal ministry discussions, aims to offset a potential NIS 30 billion ($9.2 billion) gap in defense funding, which Prime Minister Benjamin Netanyahu has tentatively approved in principle. The Defense Ministry is seeking a long-term boost that could reach NIS 350 billion ($107.4 billion) by 2035.
Despite growing fiscal concerns, Netanyahu and Finance Minister Bezalel Smotrich rejected the VAT hike during a one-on-one meeting Sunday night ahead of Thursday’s Cabinet session to finalize the 2026 state budget. However, neither ruled it out entirely.
Senior Treasury officials expressed disappointment over Netanyahu’s backing of defense spending plans, fearing it undermines broader fiscal discipline. “If we have no other choice, the simplest and most efficient tax to raise is VAT,” a top official said, noting each percentage point generates an estimated NIS 7.5 billion in annual revenue.
Officials added that a 1% VAT hike would raise consumer prices by just 0.4% on average. “No one is going to raise a candy bar from 5 shekels ($1.53) to 5.05, or a refrigerator from 10,000 shekels ($3,067) to 10,100,” one official said.
Netanyahu, for his part, emphasized in the meeting that any increase in defense funding must align with the economy’s capacity and not trigger broad-based tax hikes or across-the-board budget cuts. Smotrich echoed this, insisting the defense establishment must undergo significant efficiency reforms.
Smotrich has recently proposed easing income tax brackets for middle-class earners rather than raising taxes, positioning himself against the defense budget surge. He warned that Israel “cannot afford sweeping tax hikes” as it transitions from war to recovery.
As of now, Israel’s VAT rate remains lower than many European countries. Hungary leads with 27%, followed by Nordic countries with rates around 25%.
According to sources familiar with Sunday’s meeting, Netanyahu accepted Smotrich’s demand to limit the 2026 defense budget increase to under 35 billion shekels ($10.7 billion) and instructed defense officials to urgently finalize terms with the Treasury.
The decision sets the stage for a high-stakes, marathon cabinet session later this week to approve the long-delayed 2026 budget, with fiscal discipline and security spending locked in a delicate balancing act.