Budget Will Help Netanyahu, Not the Israeli Economy

Proposed budget approved by the cabinet lacks vision and growth engines and is devoid of the necessary investment in education and R&D.

Mark Israel Salem

Last Thursday, the cabinet decided that the 2015 state budget would be 380.9 billion shekels ($100 billion) and 414.6 billion shekels for 2016. Every cabinet member supported the two-year budget except Defense Minister Moshe Ya’alon, who abstained.

Cabinet approval of the budget is the easy part of the task confronting Prime Minister Benjamin Netanyahu and his narrow coalition on the road to gaining Knesset assent. The Knesset must pass the budgets and Economic Arrangements Bill – the supplementary legislation to the budget – by November 19. With the current narrow coalition of 61 MKs facing an opposition of 59 MKs, that could be a tough challenge: Any single disgruntled coalition MK could scuttle major budget provisions that are not to his or her liking for whatever reason, and even defeat the budget as a whole.

On the eve of the final two Knesset votes on the budget, a number of powerful players – including the Histadrut labor federation, farming organizations, manufacturers and banks – will spring into action, trying to advance issues of importance to them even if they run counter to the fiscal policies of Netanyahu, Finance Minister Moshe Kahlon and the cabinet as a whole.

The major budget allocations in 2016 will go to the Defense Ministry (55.9 billion shekels); the Education Ministry (48 billion shekels); interest payments on government debt (39.6 billion shekels); transfers of funds to the National Insurance Institute (31.8 billion shekels); and the Health Ministry (29.5 billion shekels).

The 2015-2016 budget is devoid of vision and engines for growth. It lacks the required investment in research and development, or the understanding that the country’s future depends upon investment in general and funding of the universities in particular.

The budget will not spur the economy in any particular field. It contains no good tidings for the public, doesn’t narrow social disparities or address the problem of poverty. It’s not the budget of a new, hungry government taking office to change the world. It doesn’t contain major reform programs – unless anyone thinks the so-called “cornflake reform,” which will liberalize food imports, and changes in the poultry sector are major. And it doesn’t provide for structural changes that would push the Israeli economy forward.

It’s a conservative budget that fails to encourage new initiative, lest that undermines the prime minister’s position. And the conclusions of the Locker committee, the public panel that looked at defense spending, didn’t manage to get included in the budget or the Economic Arrangements Bill. The budget is that of a newly minted finance minister who is still learning his job and who, for the time being, isn’t relying on his ministry’s professional staff.

Is the economy really growing?

Contrary to what was stated at last Thursday’s cabinet meeting, the state of the Israeli economy is far from outstanding. In the first quarter of 2015, the economy grew by just 2% on an annualized basis (all of these figures are annualized). Estimates for the second quarter all point to similar results. In other words, per-capita growth in Israel is close to zero, since the population is growing by 1.9% a year. The export of goods plummeted by 16.9% in the second quarter, following major declines in prior quarters, while exports are supposed to be the economy’s major growth engine. In addition, foreign tourism is only just recovering from last summer’s war in Gaza.

Sales at the major retail food chains fell by 3.6% in the second quarter. The sector represented by industrial manufacturing, mining and stone quarrying – another major growth engine – suffered a worrying drop of 10.4% in April and May, following concerning declines in previous months. Lifting our collective foot off the pedal could lead the Israeli economy in unwanted directions.

Real growth in the government budget between 2014 and 2016, according to Finance Ministry data, is 7.2%. It is projected that the economy will grow by 3.1% this year, with per-capita growth of 1.4%. But these figure appear overly optimistic. The Finance Ministry is predicting 3.3% growth next year and per-capital growth of 1.6%.

Playing with the deficit ceiling

The budget deficit ceiling will be 2.9% of GDP this year and next. In practice, it will have to be higher. But the Finance Ministry – contrary to the opinions of Bank of Israel Governor Karnit Flug and Finance Ministry accountant general Michal Abadi-Boiangiu, and in a procedure that doesn’t appear to be legal – excluded the expenses from the budget involved in the transfer of army teleprocessing and intelligence facilities to the Negev – an estimated multiyear sum of more than 14 billion shekels – shifting the expenses to the Israel Land Authority.

By law, the deficit ceiling for 2015 (and every subsequent year until 2018) was supposed to be 2% of GDP; and from 2019 and onward, it was supposed to be 1.5%. Israeli governments, however, are accustomed to passing laws and then violating them when they find them inconvenient. The current government refused to roll up its sleeves and meet the deficit ceiling’s limitations. Instead, it raised the ceiling for each of the coming years. As a result, the deficit for this year and next was raised to 2.9%, and thereafter to 2.5% in 2017; 2.25% in 2018; 2% in 2019; 1.75% in 2020; and 1.5% in 2021.

Playing games with the deficit ceiling comes at a price. If in previous years Israel boasted about the decline in its debt-to-GDP ratio, during the current decade the decline was slow. In 2014, it dropped to 67%. This year it won’t drop at all, but will actually rise. An assessment by the Bank of Israel forecasts we will end the year with a 67.6% ratio. It will go up again next year, because with a 2.9% budget ceiling, there can be no drop in the debt-to-GDP ratio. Instead, it will rise.

The Finance Ministry boasted about data it released prior to the cabinet meeting, which shows that, unlike other developed countries, Israel’s debt-to-GPD ratio is on the decline. But that’s only half true. The international credit rating agencies attach major importance to various countries’ debt-GDP ratio, and recently the accountant general acknowledged that the average ratio among other countries to which the ratings agencies compare Israel (Slovenia, Slovakia, Poland, Spain, Estonia, the Czech Republic, Malta, South Korea and Chile) was just 46%, a lot lower than Israel’s.

The price of debt

Debts carry a steep price. At nearly 40 billion shekels, the third-largest expense in the 2016 budget after defense and education is debt service (the interest the government pays on its debt). The Organisation for Economic Co-operation and Development stated that Israel paid the equivalent of 3.1% of its GDP in debt service last year. The OECD average was just 1.7%.

The cabinet set low tax collection targets for this year and next – 266.4 billion shekels and 272.3 billion respectively. For purposes of comparison, in 2014 the government collected 254.7 billion shekels in taxes. A conservative assessment of the government’s tax collection capacity next year reflects concern over growth that could be lower than preliminary estimates. The government invested a lot of money in the Tax Authority in recent years, in an effort to substantially improve its war against undeclared capital. So far, however, the results have been disappointing.

Netanyahu believes the country needs to take little in the way of taxes and provide fewer services. In fact, public expenditure in Israel in relation to GDP is the lowest among all of the OECD countries other than South Korea. And the 2015-2016 budget makes the situation even worse.

Bank of Israel Governor Karnit Flug supports the opposite approach, which is for the government to provide better and more comprehensive services to the Israeli public than it is getting. The price, Flug says, needs to be higher taxes. The data released in advance of last Thursday’s cabinet meeting reveal that average public expenditure among OECD countries last year was 45.1% of GDP. In Israel, it was just 39.5%.

In addition, Israel’s expenditure on defense is the highest in the developed world. Civilian spending (excluding defense) and without debt service averaged 43.3% among OECD countries last year, while in Israel it was just 30.8%.