Prime Minister Benjamin Netanyahu met last night with Finance Ministry officials until the wee hours, hoping to iron out their differences ahead of today's meeting on the budget for this year and 2010.

Meanwhile, Labor Party representatives will meet this morning ahead of the cabinet meeting, to decide on how to vote on the budget proposal. Many issues remain in dispute, most notably the defense budget.

Last night, Labor Party leader and Defense Minister Ehud Barak met with Chief of Staff Gabi Ashkenazi and other top army officers before meeting with Netanyahu. Barak insists he won't back down on the defense establishment's demands, while the treasury - which is responsible for the budget proposal - is equally firm that the budget needs to be cut.

Barak and Netanyahu met several times in the last few days, but the talks led nowhere. "The gaps remain wide," Barak envoys said last night, and warn of a coalition crisis unless the defense cuts are abandoned.

If indeed Netanyahu capitulates to the defense establishment and unions (over civil service pay), Israel stands to run an even bigger deficit than economists have been predicting.

Netanyahu has had difficulty pushing through the spending cuts needed to keep the increase in the 2009 budget in line with the limit the government set just last week, which was just 1.7% more than the 2008 budget. Instead, the budget this year will apparently be 3.2% more than the 2008 budget.

A top treasury official told TheMarker yesterday that the ministry intends to cut the defense budget by at least NIS 3 billion, which Barak intimates could lead to a coalition crisis.

Capitulation to the Defense Ministry will create a hole in the budget that can't be covered even by steep cuts to health, education and welfare budgets, say treasury chiefs.

Given the dug-in heels at the Defense Ministry and the Histadrut labor federation, today's budget meeting can be expected to be tense. Also, the ministers of education, health and welfare are likely to bare their teeth in defense of their portfolios, arguing that the allocations for this year and next are inadequate.

Treasury officials plan to counter that the world is in crisis and Israel hasn't been spared. Israel's financial sources have shriveled up in the last year, mainly because of the steep drop in tax revenues.

The cabinet members are expected to vote on the budget proposals toward midnight tonight.

Netanyahu and Finance Minister Yuval Steinitz are expected to suggest new ways for the government to keep a lid on spending this year and next. One possibility is a blanket cut in all ministerial budgets, including education and defense, by as much as 5%. Another is to increase value added tax from 15.5% to 16% or more. Raising income tax for the top 20% of earners isn't on the table, given Netanyahu's opposition.

Yesterday the Knesset Education Committee held an emergency session to discuss the treasury's intention of cutting the education budget by NIS 750 million a year. Education Minister Gideon Sa'ar attacked the budget cut in a speech, though he avoided criticizing Netanyahu, saying the prime minister "wants to help on education." If anything, at times like these Israel should invest in education, Sa'ar argued, adding that if the budget cuts are implemented as proposed, teachers would be fired.

Shlomo Bohbot, chairman of the Union of Local Authorities in Israel, urged teachers to hold a two-hour walkout to protest the situation.

Avigdor Lieberman, the foreign minister and leader of Yisrael Beiteinu, doesn't want to bring down the coalition over the budget, but his party members are up in arms.

However, Public Security Minister Yitzhak Aharonovitch, and other cabinet members from Yisrael Beiteinu may vote against the budget proposal, which would cut NIS 1.4 billion from the police and Public Security Ministry. Aharonovitch claimed yesterday that treasury officials had lied about public security being spared from cuts.

That said, Lieberman appointed Tourism Minister Stas Misezhnikov to handle negotiations with the Finance Ministry on behalf of Yisrael Beiteinu.

The four Shas ministers also oppose the budget, unless the treasury reverses on cuts of child allowances.

Yuval Azoulay and Meirav Arlosoroff contributed to this article.