Analysis / A Golden Chance to Make Amends

After 10 days of vacation in Caesarea, Finance Minister Benjamin Netanyahu will return today (with fresh vigor?) to wage the battle over the budget.

After 10 days of vacation in Caesarea, Finance Minister Benjamin Netanyahu will return today (with fresh vigor?) to wage the battle over the budget. It is hardly an easy battle at any time; but this year, it is particularly difficult because it comes on the heels of a long series of cuts over the past two years, against the backdrop of the socio-economic crisis, the cuts in allowances, the drop in the standard of living and growing unemployment.

The Finance Ministry assesses that this year will end with an approximate 1-percent growth rate, while next year's growth will increase to 2.5 percent. One can quite easily argue with this obvious optimism; but, in any event, even then the treasury admits that NIS 15 billion must be cut from the state budget in order to reach a 3 percent deficit in 2004 - the level that Israel promised to the Americans as a condition for the granting of the loan guarantees.

In order to soften the blow, some officials at the treasury (and elsewhere) believe that it would be possible to make do with a 4 percent deficit next year, since the economy is in a deep recession and under such circumstances, the very cuts cause it to deepen. But this is a position that suits an economy with a normal cycle. In an economic upswing, the deficit should be brought down almost to zero, while in a downswing it can be increased. This is true of a normal country like the United States: When there was a downswing like this year, the deficit there went up to 3.8 percent of the GDP. But everyone knows that next year, when the U.S. economy recovers, the deficit will return to zero and may even turn into a surplus.

Here, our situation is completely different. We do not have a cyclical problem, but are suffering instead as the result of a series of blows that we have been forced to take in the aftermath of the intifada. This is an "external shock" that started in October 2000 with the crash in tourism and continued with the cessation of investments and a drop in private consumption. This is why we must not employ the wrong medicine now, but rather adapt the economy to the shock - namely, adjust government spending to a new and lower level in order to prevent a serious financial crisis.

We must not forget that as recently as June 2002, we were on the brink of such a crisis. A large deficit, for the second consecutive year, could cause a crash, a loss of faith in the finance minister, a loss of the relative financial stability in which we now live, a drop in Israel's credit rating and a renewed rush to the dollar. In such a case, the governor of the Bank of Israel will not bring down the short-term interest rate and the long-term rates will go up, so that the private sector will bear the brunt and be forced to tighten its belt even further - and the recession will deepen.

We must not forget that public spending in Israel (55 percent of GDP) is much higher than the accepted rate in the U.S., or other Western countries, while the government debt (102 percent of GDP) is much bigger and more threatening.

Treasury officials are currently mulling over different and strange ideas of new taxes. But new taxes are in contradiction to Netanyahu's weltanschauung. He talks about "supply-side economics", meaning the lessening of the tax burden, so how can he justify an increase in taxes? It is clear that new taxes in a country that already has one of the highest taxation rates in the world will chase away investors and deepen the recession. This is exactly the opposite of what is needed now.

A peek inside the treasury reveals that the budgets division has great plans to cut NIS 15 billion and the only question is the extent of political bravado on the part of Netanyahu and Sharon, and their ability to withstand pressure. This is why the correct economic program for our present situation must include only three components - a deep slash into the defense budget in the wake of the change in the strategic threat on the Eastern front, cuts in the other government offices, and the correction of economic distortions.

It is expressly this time of crisis that provides a golden opportunity to correct the distortions of years, such as geographic exemptions from taxes, exaggerated grants to encourage capital investment, or VAT exemptions on fruit and vegetables. The crisis is also a golden opportunity for structural changes in the large monopolies - the Israel Electric Corporation, Mekorot, Oil Refineries and Tnuva, and for privatizing the banks.