Finance Ministry Warns: Israel Heading for Greek-style Fiscal Tragedy

Study shows a yawning gap between government revenues and spending as the country’s population ages and Haredim, Arabs make up a larger part of the population.

Finance Minister Moshe Kahlon, left, and Prime Minister Benjamin Netanyahu.
Reuters

The long-term demographic projections released by the Central Bureau of Statistics two years ago have aroused a serious debate about what Israel will look like, and should look like, in the year 2059.

At the core of the CBS outlook is demography – what percentage of Israelis will be ultra-Orthodox Jews (Haredim), non-Haredi Jews, and Israeli Arabs, how many will be elderly, of working age or children. From there, the economists can paint a picture of what the country’s economy will look like in that year.

In fact, for the past 18 months that has been the work of Assaf Geva, an economist in the Finance Ministry. His conclusions aren’t encouraging.

By Geva’s reckoning, government spending will be growing by 1.2 percentage points faster than gross domestic product every year, mainly because of Israel’s aging population. Government revenues will grow 0.4 point faster than GDP, mainly because Israel will be enjoying the bounty of its natural gas reserves. But work-related tax revenues will be shrinking, because a greater percentage of Israelis will be retired.

But another reason for lagging tax revenues is because Haredim and Israeli Arabs will make up a larger share of the population than they do now, and both groups have lower labor-force participation rates than the rest of the population.

In 2059, according to the CBS projection, the non-Haredi Jewish portion of the population will have shrunk to 50.3% of the total (from 67.9% today). The Haredim share will have more than doubled to 26.6%, from 11.1% today, and the Arab share will reach 23.1%, up from 20.9%.

The gap between the growth of government spending and government revenues will be fatal for government finances. In today’s terms, that gap of 0.8 point amounts to a shortfall of about 9 billion shekels ($2.3 billion).

Meanwhile, Israel’s debt will begin to start climbing as a percentage of GDP. In recent years, debt has been falling and today equals about 67% of GDP. Greece’s, by way of comparison, is 175%, but Israel is a long way from the 60% policy makers have been targeting. But with the gap between income and expenses widening, the downward trend will come to an end sometime around 2030, and the ratio will then grow to 88% by 2059.

Geva says that to solve this problem, Israel will have to “make medium- to long-term fiscal adjustments,” which is treasury-speak meaning either budget cutting and tax hikes, or a combination of both. It could also mean making Israel’s bureaucracy more efficient, although in practice that’s now what governments choose to do.

The 0.8-point gap represents Geva’s best-case scenario. It assumes that the government will succeed in raising the retirement age for both men and women to 69, bring more Haredim and Arabs into the workforce, and improve their productivity and educational achievements.

If Israel doesn’t succeed, the future looks bleaker. Failure to raise the retirement age means the gap between income and spending will widen by 2059 to 2.4 percentage points, or 25 billion shekels annually in current terms. Israel’s debt-to-GDP ratio will swell to 135%.

If Israel fails to integrate the Haredim and Israeli Arabs into the labor force, government revenues will lag spending every year by 3.4 points, or 35 billion shekels, because tax collections from people working will have collapsed. At that point, Geva doesn’t try to predict Israel’s debt ratio, but he assumes it would reach Greek levels of 170% or more – or the level Israel had when its economy was going into a tailspin in 1985.

Thirty years ago, the government adopted the Economic Stabilization Plan, a wide-ranging program of budget cuts, price controls and structural reform. But then, Israel’s demographics were very different.

As Geva points out, the problem of the revenue gap and rising debt isn’t just the government’s. “Accepting ‘business as usual’ [by not acting] will lead to fiscal bankruptcy in the medium- and long-term, together with a decline in the GDP growth rate and rising inequality,” he concludes.

The message of Geva’s analysis is that the decision whether more Haredim and Israeli Arabs join the workforce isn’t a problem of lifting them out of poverty and ensuring more income equality. Rather, it is a problem for all Israelis.

In this context, it is worthwhile examining the coalition agreements that Prime Minister Benjamin Netanyahu signed with the ultra-Orthodox parties last month. They restore child allowances that discourage Haredim from working, they boost spending on yeshivot, and weaken the incentive for Haredi schools to teach a core curriculum – both measures that will block the way of the next generation into the labor force. The understandings that reverse the drive for more Haredim to serve in the army will have the same effect.

Just as importantly is that the coalition agreement says nothing about the problems facing Israel’s Arab minority, namely discrimination and exclusion. Netanyahu was more concerned that too many of them would vote than that they he is that they will find productive, rewarding work.