The interest rate blow that David Klein dealt to the economy, raising rates 4.5 percent in one month, appears to have put the brakes on the rush to the dollar. But it's not likely to last. Interest rates alone, no matter how high, don't have the power to change basic processes in the economy, so the real work is still left to the finance minister: To take an entirely different approach to the whole budgetary policy, to restore faith in the economic leadership and to prevent a financial crisis.
Up until three weeks ago Silvan Shalom believed he had finished his work for 2002 and 2003. That was after the plan to reduce the deficit by NIS 12 billion passed the Knesset, and Shalom believed he had a reasonable budget for the coming 18 months, so he deserved a little rest. But the NIS 12 billion plan isn't a cuts program, not by a long shot. Some NIS 4.5 billion of it is increasing the deficit from 3 percent to 3.9 percent and another NIS 4 billion in increased taxes, including employer entitlements. The real cut is NIS 3.5 billion, but only NIS 2 billion of that are actual cuts, while another NIS 1.5 billion are to be found in reduced allotments.
But the economic emergency package is also based on a serious economic mistake. Increasing the cost of labor, both by reducing employer benefits by 1 percent and by eliminating the ceiling on marginal taxation in the form of health and National Insurance Institute payments for both employers and their workers. There's nothing as absurd as increasing the cost of labor when you want to fight unemployment. Moreover, the treasury won't even see all the cash it plans to collect, because the self-employed will become limited companies and wage earners will try to lower their tax burden by consulting with tax advisers, the only growing sector of the economy.
No wonder the financial markets reacted to the economic emergency package with blatant mistrust. The dollar continued rising and bonds continued to drop. The prime minister understood that if the shekel hits the five to the dollar mark, Israel could face a Latin America-type rapid deterioration into financial crisis. That's why Ariel Sharon was so pressured two weeks ago. Immediately upon his return from Washington, he met with Shalom and Klein, demanding implementation of a plan that would calm the dollar and stop the financial volatility. Only then did the penny drop with the finance minister. Only then did Shalom realize he wasn't done with the work on the budget for 2002 and 2003.
As a first step Shalom declared a unilateral cease-fire with Klein. No more public accusations about the central bank's interest rate policies, but the contrary. Shalom showed broad support for raising interest rates, including the 2-percent hike this week. But the other, much more difficult, step Shalom has yet to take. A significant cut in the 2003 budget, to reduce the deficit to 3 percent of the gross domestic product, as well as a restructuring of the budget with less spending on operations and more for infrastructure.
This time, when he brings a plan for cutbacks to the public and the government, it better be based on very conservative assumptions. It would be best if the treasury assumes 0-percent growth for next year. That would win the confidence of the public, and prevent a new run on the dollar. Such a conservative budget won't need to be endlessly corrected and cut - and since anyway next year is an election year, any cutback will face stiff opposition from all the parties. A 0-percent growth rate is also based on the assumption that the war in the territories and the terror attacks inside Israel won't end soon. Clearly, that assumption means the predictions about tax revenues should estimate low, so more than the NIS 5 billion now under discussion in the treasury, needs to be cut.
And another change is necessary: No more taxes, but real cuts in government expenditures, redundant operations, unification of activities, privatization of state-owned enterprises, closing unnecessary departments, shutting down redundant foreign legations and reducing allotments to everyone of working age.
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