Israeli Leaders Take Sides as 2015 Budget War Begins

Finance Minister Yair Lapid is taking the heat because of his soft stance on next year’s deficit.

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Two camps are forming as the government seeks a way to cover the Gaza war and the shortfall expected in the 2015 budget. On the fiscal-discipline side are Prime Minister Benjamin Netanyahu and Bank of Israel Governor Karnit Flug, on the other is Finance Minister Yair Lapid.

Lapid does not want to increase taxes and aims to cover next year’s budget shortfall by raising the deficit cap to at least 3.5% of gross domestic product. Netanyahu and Flug envision a maximum deficit of 3% and seek to increase taxes instead.

The country’s economic leaders met in the Prime Minister’s Office on Tuesday to discuss the 2015 budget for the first time. But this year the talks are being carried out under the public radar.

Participants in Tuesday’s meeting included Lapid and senior Finance Ministry officials, as well as Netanyahu and members of his economics team, including PMO head Harel Locker and National Economics Council chief Eugene Kandel. Also on hand were senior central bank officials led by Flug, who’s at loggerheads with Lapid.

Netanyahu originally opposed Flug’s appointment as bank governor; she was his last choice when she took over last autumn. At the time, Flug had Lapid’s support.

Now it seems the alliances have reversed – in recent months Flug has joined other top officials, including Netanyahu, in opposing Lapid’s flagship plan for giving certain first-time home buyers an exemption on value-added tax.

Cabinet members such as Defense Minister Moshe Ya’alon are not currently part of the debate, although Ya’alon has been pushing to increase the defense budget by billions of shekels.

The official plans for 2015 call for a deficit cap equal to 2.5% of GDP, but all sides realize that this figure is no longer realistic. The question is what the new limit will be – up to 3%, 31 billion shekels ($8.7 billion), as the central bank and PMO want, or at least 3.5%, 36 billion shekels, as Lapid wants.

Meanwhile, the cabinet on Sunday is scheduled to discuss a plan for a 1.5-billion-shekel budget-wide cut to finance Operation Protective Edge. All ministries except defense would face a 2% cut, according to a proposed made at Tuesday’s meeting.

The defense budget would get an extra 1.5 billion shekels both this year and next. Defense officials estimate the Gaza operation will cost 9 billion shekels, while Finance Ministry officials say an extra 4 to 5 billion shekels will be allocated to cover costs. In total, defense officials are asking for another 11 billion shekels.

Flug and Kandel vehemently opposed Lapid’s call to raise the deficit cap beyond 3%. Lapid in response said professors Flug and Kandel lacked experience in the rough-and-tumble business world.

Budget discussions usually start earlier in the year, but the first round was postponed until Tuesday due to the Gaza fighting and the tense relations between the treasury and PMO. The next discussion is scheduled to take place among cabinet members on September 11. By law, the cabinet must present the Knesset with a budget draft by the end of October.

In a surprise move Monday, the Bank of Israel announced that interest rates would be cut to an all-time low of 0.25%. In releasing its decision for September, the central bank said the economy was in poor shape.

The decision was a strong statement regarding the central bank’s stance on next year’s budget. While Flug did not address what the Finance Ministry had done to fix the deteriorating economy, the question hung in the room. A problem is that Lapid is often at odds with his deputies.

Aside from the increased defense budget, the state’s tax take is likely to fall next year as the economy slows. Since the budget jibes with projected revenues, there will be less money to go around.