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The cabinet was expected to approve the state budget and the Economic Arrangements Bill for 2011 and 2012 sometime after press time last night. The budget will be NIS 345.1 billion next year and NIS 358.6 billion in 2012 - each amount an increase of 2.66 percent over the preceding year.

The budget assumes economic growth of 3.8 percent in 2011 and 4 percent in 2012. Both the budget and the arrangements bill will be presented to the Knesset by the end of October.

Labor chairman and Defense Minister Ehud Barak gathered the party's ministers before the cabinet meeting, which continued late into the night, and demanded they voted with him against any cuts in the defense budget.

Agriculture Minister Shalom Simhon said the disagreements among faction members would not prevent them from voting with Barak.

The Finance Ministry's budget director, Udi Nissan, and Histadrut chairman Ofer Eini reached an agreement to delete several clauses from the Economic Arrangements Bill yesterday. These include plans to privatize the postal service and Merkava tank production and to freeze child allowances and National Insurance Institute old-age pensions in 2011. They also agreed to increase the income tax exemption on these pensions, but did not determine by how much to increase it.

In addition, they decided to set up a joint committee, with representatives of the Histadrut, the employers and the government, to supervise the pension funds' investments.

People age 75 or older will receive a 15 percent discount when buying medicines, instead of the present 10 percent reduction. Public-sector workers will get an increase in vacation pay in 2011, and a fund will be set up for factories in financial difficulties.

Prime Minister Benjamin Netanyahu warned the ministers at the opening of yesterday's meeting that he would not allow the deficit to be increased beyond the level stipulated in the budget bill.

"The success story of Israel's economy in the past decade stems from our control over expenditures, from our reforms and other steps to increase revenues and competitiveness," he said. "We must continue this tradition."

Barak, defending the sizable defense budget, termed it "an insurance policy, and very similar to health: You realize it's missing only when you need it. A wise, correct investment in defense will prevent confrontations, and if we are forced into one, then a correct investment will shorten it."

"All these things have a huge economic impact," he continued. "One day of fighting costs $1.5 billion. If instead of three wars per generation, there were only two, or if we could postpone a confrontation or a war by 10 years, that would be a huge advantage for the economy."

Barak warned of "irresponsible cuts in the defense budget that would lead to situations we've known in the past, as in 1973 or 2006, when we weren't prepared, financially or otherwise, and certainly didn't foresee an immediate war."

"Any budget cut would harm our readiness," he concluded.

Israel Defense Forces Chief of Staff Gabi Ashkenazi said he was ready for a NIS 1.8 billion cut over the next two years, but adamantly rejected the NIS 4.2 billion cut the treasury sought.

Bank of Israel Governor Stanley Fischer, in his role as the cabinet's economic advisor, sided with those who favored increasing the education budget at the expense of defense.

"The new two-year budget is very good, in fact it's excellent," Fischer said. "It was prepared with full cooperation between the treasury and the Bank of Israel."

"If we don't invest in education, we'll pay a very high price in the long run," he continued. "The education and higher education systems are constantly deteriorating. It is evident in OECD surveys. As an economist, I say we can't go on like this - we must invest money in education. Reforms are not enough. We can't put off investing in education year after year. That's our responsibility to the state's future, [which depends] not only on defense, but on education and health."

Fischer estimated that another five to six years will pass before the American economy gets back on its feet. This means Israel will not receive assistance from the United States, he said.

Following the global crisis, everyone is beginning to understand that Israel is conducting a responsible, conservative macroeconomic policy, he added. If Israel continues this way, it will fare well by comparison to other Western economies.

Public Security Minister Yitzhak Aharonovitch demanded a NIS 2 billion budget increase for his ministry for the next two years. He said the treasury's budget proposal weakens the fight against crime and traffic accidents and will undermine people's sense of security, as well as the service they receive from the state.

Social Affairs Minister Isaac Herzog voiced strong opposition to the proposed freeze in old-age pensions and income support. He urged ministers who care about social causes to join his struggle.

"These allocations are for the weakest members of society," he said. "They must not be cut."

Herzog also demanded an increase in funds to help tens of thousands of single-parent families.