Central bank urges higher residential property tax to alleviate housing crisis

The Bank of Israel on Monday presented a list of recommendations to help the country’s new government deal with the housing crisis, including a hike in municipal taxes.

In its role as the economic adviser of the government, the central bank laid out six “strategic pillars of action” to boost economic growth. The program was presented to Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich, as well as to other government ministers.

One of the six pillars was a recommendation for policies in the housing market that are designed to make the purchase of an apartment and the cost of rent more affordable by encouraging the construction of housing, in an effort to increase supply and thereby bring down prices. The policies also include introducing new supportive financial tools.

The Bank of Israel also called on the government to increase the municipal or property tax on housing, also known as “arnona,” and to reduce the tax on property zoned for business and commerce.

“The arnona [property] tax structure creates a negative incentive for the promotion of residential construction by the local authorities,” the central bank wrote in the report. “To remove negative incentives to encourage residential construction, it is important to increase local authorities’ income from each resident.”

Currently, municipalities have the incentive to approve construction on land zoned for commerce and industry over that zoned for housing, as the business tax rates are higher than the residential rates. If the government adopts the recommendation, municipalities will be able to further boost their revenue through higher taxes on residential properties.

While such a move might be effective in the long term, it would likely be highly unpopular as at it would provide a fresh hit to the public already dealing with a cost-of-living crisis.

One of the new government’s key proposals has been a one-year freeze on raising municipal property tax rates.

Still, the bank sees cutting housing prices as a priority.

In 2022, home prices in Israel jumped by a record 20.3 percent year-on-year, while the Bank of Israel has hiked borrowing costs to 3.75% by raising interest rates since April, as it battles rising inflation. Despite the efforts, Israel’s inflation rate has remained well above 5%, breaching the central bank’s target range of 1% to 3%.

But higher interest rates also hit existing and potential mortgage borrowers hard, with the majority of home loans in Israel tied to variable rates. At the same time, the amount of equity required to purchase a home keeps rising, and with it, the affordability gap is widening, especially among young and first-time buyers.

As an additional channel for investment by the public, the Bank of Israel recommended the government start offering a bank deposit linked to the apartment price index to people who do not own apartments. The deposit would serve as an alternative financial tool for the public to invest money in real estate, separate from buying an apartment, and is intended to cool demand for housing purchases.

The deposit would be offered through the banks, which would compete in a tender for the interest rate. Another suggestion proposed by the Bank of Israel is to offer the public investment into tradable bonds linked to housing prices.

Alongside these recommendations, the Bank of Israel emphasized the importance of maintaining a high supply of housing units and considerable investment in infrastructure, in view of the rapid growth rate of the country’s population in the coming years. Infrastructure for housing includes investment in construction, transportation, and public services, as well as education, electricity, and sewage.

The annual growth rate of Israel’s population is 2%, compared to the OECD average of 0.6%, the Bank of Israel noted. Over the next 25 years, Israel’s population is expected to grow to more than 15 million people from the current 9.7 million, the central bank said in the report.