Analysis |

Israel Has a Bigger Problem Than Its Record 160-billion-shekel Deficit

If Israel’s credit rating is lowered, it won’t be because of the deficit, but because the government has no economic plan and never passed a budget

Sami Peretz
Sami Peretz
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Sami Peretz
Sami Peretz

At first glance, data on the government’s revenues and expenditures in 2020 seem to show that Israel got off cheaply in the coronavirus crisis. According to Finance Ministry data, the crisis cost 111.7 billion shekels ($35.1 billion) – a 43.1 billion shekel drop in revenue and a 68.6 billion rise in expenditure.

But is that really all? The answer is no. The real cost of the crisis will continue far into 2021 and even 2022, in the form of a lower gross domestic product than we could otherwise have expected.

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The deficit hit 160 billion shekels ($50.7 billion) in 2020, or 11.7 percent of GDP. That’s the sixth-highest deficit in the OECD, the league of Western-aligned, democratic countries, whose members’ average deficit was only 9 percent. Israel entered the crisis with a high structural deficit that only worsened due to the coronavirus, and that’s our weak point.

Our strong point is the relatively minor damage to the economy despite three lockdowns. Government revenues dropped by only 43 billion shekels, to 318 billion. This was due to the high-tech industry, which suffered little from the crisis; tourism’s relatively low share in the economy; a relatively high ability to adapt to the crisis through remote work, enabling businesses whose economic contribution is high to stay open; and adaptation by businesses.

For instance, revenue from direct taxes totaled 167.2 billion shekels, down a mere 0.7 percent from 2019. It would have been higher without the crisis, but under the circumstances, that’s a negligible hit.

How did this happen in a year when unemployment peaked at almost 28 percent? The answer has to do with who was unemployed: low-income workers, most of whom don’t earn enough to pay tax in any case.

Businesses like hotels, restaurants and event halls pay relatively low wages, so putting their employees out of work doesn’t affect the state’s income. Even better-paying workplaces chose relatively low earners to put on unpaid leave or fire, apparently because such workers had little seniority or contributed less to the business.

As a result, the state was paying unemployment benefits mainly to low-income workers, while its income tax revenues suffered little damage.

Indirect tax revenue fell more sharply, by 3.7 percent, to 137.3 billion shekels. That’s mainly due to long weeks when retailers were closed, resulting in a drop in value-added tax revenue, as well as a drop in fuel tax revenue because movement restrictions meant people were driving less. Fuel tax revenue fell to 16.5 billion shekels, down from 19 billion in 2019.

The decline in indirect tax revenue also apparently stems from unreported economic activity. Many service providers were forbidden to work during the lockdowns, so if they worked anyway, they didn’t report their income.

Prof. Leo Leiderman, Bank Hapoalim’s chief economist, said the deficit would remain high in 2021, but that isn’t the main problem. The real problem, he said, is the lack of a state budget and a clear economic policy.

Leiderman thinks it’s too soon to talk about tightening expenditures, since at this stage, the government’s job is to stimulate the economy. Moreover, negative real interest rates mean that borrowing to finance the deficit won’t significantly increase the state’s financing expenses. For both these reasons, he doesn’t see the deficit as a serious problem.

In any other year, the deficit ballooning to such proportions would immediately lower Israel’s credit rating. But the circumstances justify increasing the deficit, to help businesses and the unemployed and to increase investment in the health system so it can cope with the virus. In fact, international financial institutions are encouraging governments to implement expansionary fiscal policies, since that’s the only thing which can keep their economies from a deep, prolonged depression.

If Israel’s credit rating is lowered, it won’t be because of the deficit, but because the government has no economic plan and never passed a budget. Whether these problems will be solved after the country’s fourth election of the last two years remains an open question.

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