Analysis

Israel's Finance Ministry Needs to Wrestle With 2016 Budget Hole of Up to $4.4b

Treasury has to contend with spendthrift coalition and concerns over raising the country's debt-to-GDP ratio.

Reuters

The proposed 2016 government budget has a gaping hole of between 15.5 billion to 16.5 billion shekels (around $4.4 billion). The Finance Ministry’s proposed solution is painful, but not hugely so.

Last month, Finance Ministry budget director Amir Levy was pushing to limit next year’s budget deficit to 2.5%. It was on that basis the budget was constructed, but ultimately the ministry settled on raising the budget deficit ceiling to 2.9% of GDP – which would provide the government significantly greater leeway in finalizing its spending plan.

It is also calling for across-the-board cuts of 3% in government ministry budgets and the transfer of a billion shekels from the coffers of the Jewish National Fund (Keren Kayemeth LeIsrael, in Hebrew) to the state. It also proposes the spending commitments contained in the coalition agreement of Prime Minister Benjamin Netanyahu’s government, which took office in May, be spread out over two years, along with the rescission or reduction of some tax exemptions. The proposed budget does not, however, call for tax increases.

At the end of last year, the Bank of Israel was projecting a smaller 8.5 billion shekel budget hole (or 3.4% of the country’s projected GDP). In November, Bank of Israel Governor Karnit Flug presented that figure to the cabinet, on the assumption the government would not exceed its spending ceilings based on the 2015 numbers. However, that does not appear to be realistic. The government is spending more due to the coalition agreements, which call for commitments of an extra 8 to 9 billion shekels.

The government is also spending more due to a defense panel headed by Gen. (res.) Yohanan Locker, which recommended that the defense budget be boosted by 4 billion shekels more than the Finance Ministry’s budget division was suggesting. That’s 12 to 13 billion shekels more than Flug had indicated and, if the budget deficit ceiling is 2.5% of GDP, would bring next year’s budget hole to 20.5 billion to 21.5 billion – meaning it would exceed the maximum deficit by these amounts.

There are a number of approaches that can be used to pare down next year’s budget. As noted, one of them is raising the deficit ceiling from 2.5% to 2.9% of GDP. Legislation passed almost two years ago called for a 2% budget deficit ceiling for next year, but the budget division was well aware that this was not realistic when it constructed the budget with a 2.5% deficit. But by raising it to 2.9% of GDP, the government would pare the hole by about 5 billion shekels, leaving it with the 15.5 billion to 16.5 billion shortfall mentioned above.

Raising the deficit ceiling has a number of negative consequences, however – among them, raising the country’s debt-to-GDP ratio, something the ratings agencies don’t look kindly on.

It should also be noted that economic forecasts for 2015 may underestimate the country’s financial performance – and if the country’s economy grows more, that also means higher government revenues. The treasury’s projection for tax collection this year is 265.4 billion shekels, but sources at the ministry and outside it have expressed optimism that the government’s actual tax take this year will be at least 5 billion shekels higher, meaning 270 to 271 billion shekels.

The tax collection projections for next year, as presented to the cabinet, forecast a tax take of 276.3 billion shekels; more optimistic observers believe the real numbers will be 282 to 285 billion shekels. However, Finance Ministry sources say they stand by their forecast, explaining that if they’re off the mark, it is by a few billion shekels. The problem with next year’s budget, they say, is not on the revenue side; it’s with the amount the government is likely to spend.

The ministry, meanwhile, says the actual budget hole is not as high as Flug projects, but instead is in the range of 4 billion to 6 billion shekels. They acknowledge a hole, but say the defense establishment will not get everything the Locker committee is recommending and instead will wind up with about 2 billion shekels more. The coalition commitments are another 8 billion.

If the deficit ceiling is raised to 2.9%, that leaves a hole of 10 billion shekels they must still wrestle with.