Don’t Break Out the Fiscal Champagne Yet

The treasury’s latest figures on tax collections, spending and the deficit has a lot more to with revised national accounting and happy coincidences than anything else

The sky seemed to have fallen in on the state budget in early 2013 as the deficit relentlessly continued to climb. Stressed by the deteriorating situation, newly minted Finance Minister Yair Lapid considered raising the year's deficit target to 5% of gross domestic product. It was only due to intervention by Stanley Fischer, then governor of the Bank of Israel, that agreement was finally reached to target a more moderate 4.65%.

How quickly things seem to have changed. On Sunday the Finance Ministry revealed that at the end of August the deficit for the last 12 months amounted to just 3.3% of GDP. This doesn't necessarily reflect the final deficit for 2013 and things could still go wrong in the remaining months, but the picture clearly looks much brighter in the half year that has gone by.

What could possibly have happened in such a short space of time?

1. Following a global trend in the way economists measure economic output, the Central Bureau of Statistics has changed the way it calculates GDP to include investment in intellectual property. The move strongly benefited countries with an outsized high-tech industry that boast large measures of intellectual property. U.S. GDP, for instance, increased 3.5% as a result of the revised method of calculation. When it adopted the new method, Israel, the startup nation, saw its GDP grow by around 7%. As a result, the deficit as a percentage of GDP was reduced by 0.3 points — not because the overspending was lower but because the economy was bigger.

2. The year has seen a number of pleasant surprises in the realm of tax collection, although mostly due to one-time factors. A big tax bill was paid on the sale of the remaining shares held by the Wertheimer family in machine-tool maker Iscar to U.S. investor Warren Buffett. There were several other similar transactions on which taxes were belatedly paid this year, so that tax revenues this year are NIS 4.4 billion above forecast.

The increase in tax revenues is a welcome surprise, but it should probably be viewed as a one-time lift ascribed to nothing but a happy set of coincidences: The tax revenue figures do not attest to the beginning of a recovery in business activity. In any case, these coincidences contributed another 0.5 percentage point reduction in the deficit-to-GDP ratio.

3. The government isn't spending as quickly as budgeted. According to the budget, government spending should have been running 8.8% higher than the same time last year but has actually been only 4.8% higher. The treasury doesn’t expect that four percentage point shortfall to be closed by the end of the year. It isn't yet clear why government spending has lagged behind projections, but it might be due to restraints imposed by the Finance Ministry accountant-general or within the various ministries themselves. August was the first month in which government spending was aligned with budget projections.

At this stage it isn't clear if the shortfall in spending is a blessing or a curse. If spending lags behind projections, it means that the huge 2013-2014 budget cutbacks are in effect deeper than planned, with the ministries spending less than they were permitted. This is an unplanned cutback and could have an unwelcome effect on the economy as a major source of domestic demand is constrained. On the other hand, with the deficit weighing heavily on the economy and the unplanned cuts barely making an impact so far, perhaps the reduction comes at a propitious time.

Whatever the case, the unplanned fiscal restraint has contributed another 0.5 to 0.6 percentage points toward reducing the deficit in the 12 months through August to 3.3% of GDP. It’s not a deficit to be proud of, but certainly not too dreadful either.

Satisfaction is being felt in the Finance Ministry at this point from the decline in the deficit and from forecasted tax revenues which, unlike last year, are holding firm. But the treasury is still refraining from drawing conclusions about the budget. The 2013-2014 budget ran the Knesset gauntlet only a month-and-a-half ago, and officials are none too thrilled at the prospect of opening it up for discussion again just because of a change to the way GDP is calculated and several one-time tax revenue windfalls. But the situation, less stressful now, could influence decision making for the 2015 budget when the time comes in another nine months at least.

Ofer Vaknin