Economists Warn Yair Lapid's Budget Will Slow Israel's Economic Growth

But say finance minister had no other choice; bond marked reacts indifferently; Yacimovich harshly criticizes spending package.

Finance Minister Yair Lapid’s 2013-14 budget, with its tax hikes and spending cuts, is likely to lead to dampen growth next year, economists warned Tuesday. But, while Labor Party leader Shelly Yacimovich leveled harsh criticism on the spending package, the economists said Lapid had no other choice and the bond market reacted indifferently.

“The treasury’s policies are policies that will depress economic growth, but I don’t think the finance minister had a lot of options,” said Yaniv Hevron, chief economist at Excellence Investment House. “Missing the deficit target for a fourth year in a row would have likely caused Israel’s credit rating to fall.”

The Finance Ministry Tuesday released the 290-page budget, whose most onerous items include a 1.5 percent increase in income tax rates and a NIS 7 billion cut in government spending in the remaining months of 2013, and another NIS 18 billion next year. Children’s allowances will be cut to NIS 140 a month per child. Companies enjoying tax breaks under the Law for Encouraging Investment will be paying higher income tax rates as well as a five percentage point hike in the dividend tax to 20%.

Ori Greenfeld of Psagot Investment House said Tuesday that the budget is likely to shave half a percentage point off next year’s economic growth, which he had been forecasting would reach 3.4%, including gas from the Tamar field and 2.7% without it. His views were echoed by Rafael Gozlan, chief economist at IBI Israel Brokerage & Investments, citing the one percentage point increase in the value-added tax to 18%.

“This will strike another blow to [demand, which in any case is weak, so we can expect a significant slowdown next year,” said Gozlan.

Right now he is forecasting gross domestic product growing between 3.4% without Tamar’s contribution and 4% with it. “There is no problem in principle with raising taxes in order to preserve fiscal discipline, but there was no public discussion about it and the utility of the higher spending that now requires higher taxes,” he said. “In the end 2014 is going to be a hard year for the economy.”

Lapid inherited a budget in disarray. Prime Minister Benjamin Netanyahu’s previous government had undertaken spending commitments for the years ahead without the means to pay for them, causing the deficit to balloon last year and saddling Lapid the task of trying to restore order.

Greenfeld said he doubted that even if the treasury was able to implement all the reforms it is planning in the 2013-14 budget, the government will have trouble reducing the budget deficit to 3% of GDP next year. The budget calls for the deficit to peak at 4.65% this year. “The situation right now is that, taking into account the tax rises and budget cuts, there will be a structural deficit in the years ahead,” he said.

Nevertheless, on the Tel Aviv Stock Exchange prices for government bonds rose Tuesday. The 10-year shekel bonds, which are not linked to inflation, rose 0.3% to a record low yield of 3.59%.

Yacimovich, who is the opposition leader, said Lapid had betrayed the public. “It’s a program for depression and pain, not a plan for growth,” she said. “The budget we’re in was created because no one dared to collect taxes from the biggest source of all − big capital − and because economic decrees, the rising cost of living and wage erosion hurt the middle class and poor, who stopped consuming.”

Lapid is pursuing the same policies as his predecessors, “only more brutally and with no shame.”

Lapid himself did nothing to try to diminish the edistress the budget is likely to cause. “Yes − it’s hard. We knew it would be hard, but it’s not the same thing as when it finally arrives. It’s hard and people are angry, but this is exactly what it means to take responsibility: To do what’s difficult, knowing that it will make people mad at you,” Lapid wrote on his Facebook page.

But the alternative was a “collapse of the economy, nothing less,” he wrote, hinting that Israel could find itself in the same straits as Europe’s most indebted countries. “Every time you see on television streets filled with smoke in a country that is crumbling, know that behind it stood spendthrift politicians who couldn’t stand up to pressure. That won’t happen on my watch.”  

Oren Nachshon