Yuval Steinitz - Tomer Appelbaum
Yuval Steinitz. Photo by Tomer Appelbaum
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The government needs to avoid any pressures to increase the budget - and the deficit - in the wake of the social protests, stated the OECD in its first-ever comprehensive report on the Israeli economy, released on Monday.

The international economic organization publishes detailed reports on member states every two years. Israel has been a member for a year and a half.

The report was prepared by OECD representatives Peter Jarrett and Philip Hemmings, who presented it on Monday to Finance Minister Yuval Steinitz and Bank of Israel Governor Stanley Fischer.

Jarrett said Israel's economy was strong, while Hemmings said the bright side of the report was that real estate prices were dropping. This is a good thing so long as they don't drop too quickly, he said. It was the central bank's low interest rates over the past few years that caused housing prices to shoot upward, the report states.

The report covers a lot of ground, from the subprime crisis to the Trajtenberg recommendations and the euro debt crisis.

"The absence of bailouts of financial institutions, the relatively mild downturn in economic activity in 2008-09 and the speedy recovery thereafter have helped Israel avoid the challenging fiscal situation facing a number of other OECD economies," it states.

The OECD calls on Israel to continue working to reduce its debt-to-GDP ratio to 60% by 2020, as it has planned.

It also rejects any calls to increase the budget, and therefore the deficit, in the wake of the social protests. "Despite pressures arising from the tent protests, there are welcome indications that the authorities intend to maintain the [deficit] ceiling and are, for instance, investigating channels for economies in the defense budget to create room for additional spending in the social sphere," it states.

It praises the Trajtenberg committee's call not to cut VAT or corporate tax rates. "Turning to VAT, the tent protests have generated calls to widen exemptions (or introduce preferential rates ) for some goods and services," it notes. "Addressing social concerns in this way is expensive because all households benefit, including those on high incomes."

"Contrary to what many may believe, in several respects an increase in the VAT rate is potentially the least economically damaging way of ensuring revenues adequately meet deficit and spending goals in the wake of the Trajtenberg Committee recommendations," it adds.

However, it rejects the committee's calls to increase taxes on higher wage-earners.

"High rates of personal-income tax (or employee social contributions ) on top earners can be problematic because they can prompt tax evasion and elicit little in the way of additional revenues," it states.

The report calls for reducing tax breaks for homeowners and real estate investors, which it says often go to the well-heeled. It praises the government's methods to cool down the housing market, but warns that trouble may still be ahead.

"There is still a risk that a soft landing may not be achieved and house prices ... may reach 'bubble' proportions, heightening the risk of a sharp and damaging correction," it says. This may call for more government intervention, but on the other hand, "the early signs of weakness may presage an imminent sharper-than-desired decline in prices, which would call for measures in the opposite direction," it states.

Regarding the country's natural gas finds, the report praises the government's decision to adopt the Sheshinski committee's recommendations calling for the state to increase its take from gas sales.

While Israel has improved its GDP per capita and labor productivity since 2003, it has done little to reduce its poverty rate, the report states. Arabs and ultra-Orthodox account for 60% of the country's poor, even though Arabs are only 20% of the overall population and ultra-Orthodox make up 10%.

On other matters, the report recommends a thorough housecleaning at the Israel Electric Corporation, correlating taxes on vehicle use to environmental factors, and expanding public transportation.

At the ceremony Monday, Steinitz remarked with a smile that he would be sending a copy of the report to Defense Minister Ehud Barak, who has called for expanding the 2012 budget by NIS 8.7 billion.

Fischer for his part noted that the OECD backed his decisions to cut interest rates twice recently, but did not support the central bank's policy of buying dollars. "That's the OECD's ideology," he noted.