“The Israeli economy is a strong economy – high growth rates, full employment and a low debt-to-GDP ratio. The economy is strong thanks to the responsible economic policies that we have pursued over the last years as we have maintained fiscal discipline.” Those were the words of Finance Minister Moshe Kahlon at Monday’s cabinet meeting just before he asked them to approve another across-the-board cut in their ministries’ budgets.
Regarding the first half of his remarks, Kahlon spoke the truth. Today, four years after he took over the finance portfolio, the economy is still growing (even if the Bank of Israel’s Composite State of the Economy index published on Monday was a little disappointing).
The employment picture is as good as ever (even if figures also published Monday showed employment down slightly amid record low joblessness). The debt-to-GDP ratio (even if it has risen slightly recently) is a lot lower than it was a decade or two ago.
The problem with Kahlon’s boast is the second half, the part where he talks about the responsible economic policies that we have pursued over the last years. The responsible part of the Kahlon fiscal policy was in increasing civilian spending, like health and education, while restraining the defense budget.
But the policies Kahlon pursued are the ones whose path led to the spending cuts the cabinet approved on Monday. Bank of Israel Governor Amir Yaron went further, calling for a diet of spending cuts, elimination of tax benefits and higher tax rates. That will only come, however, after the election in September and the formation of a new government.
How did it come to this? The governor explained that to the ministers on Monday. One way was that the government expanded spending under the guise of temporary measures without ensuring there was a way to pay for them.
So, where will the money to extend the spending on important social programs come from? That will be the next government’s unpleasant task. You can cheat the fiscal framework set up to enforce budget discipline by tricks like calling funding for afternoon children’s programs “temporary,” but when the funding period is coming to the end, it will have little choice but to cut the programs or take painful measures, like an across-the-board budget cut, to allow them to continue.
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Kahlon’s other boast, that he kept to the government’s fiscal rules, is not exactly correct. In Israel there are two main fiscal rules, both of which are anchored in law that set the permitted level of the deficit and how quickly expenses can grow.
The deficit rule calls for its level to gradually decline, but for nearly 30 years Israeli governments have repeatedly pushed back the time frame. Kahlon did just that when he became finance minister in 2015.
Reducing the budget deficit is hard to swallow, but it’s much easier to ingest when the economy is growing quickly or tax revenues are being swelled by one-time tax windfalls. Kahlon had both luxuries for much of his four-year tenure, but he no longer does. The bigger deficits (over 2.5% of the GDP) will spell an increase in Israel’s debt-to-GDP ratio, undoing another achievement.
Regarding the second fiscal rule, successive governments have also been amended repeatedly over the years. In 2016, Kahlon requested and received permission from the cabinet to break the spending cap , and did so in the following years. Whatever Israel’s reputation may be regarding fiscal policy, in the Kahlon era no one has taken the spending ceilings seriously.
Maybe Kahlon has come to appreciate the words of warning he once got from Karnit Flug, the previous Bank of Israel governor with whom he famously sparred. Flug mobilized all her strength to prevent the finance minister from ordering another round of tax cuts in 2018 – a move that would have made the fiscal headaches he’s dealing with now even more severe.
Even after he was ultimately convinced, not due solely to Flug but also thanks to the urging of treasury officials, Kahlon hasn’t given us his mantra of “low taxes bring higher economic growth.” Maybe Flug’s successor will finally convince him.