Analysis

Israeli Budget Looks Grim on Both Sides of the Ledger

Spending is increasing far faster than budgeted, tax income is rising less than forecast, and the government’s hands are tied

Finance Minister Moshe Kahlon, April 8, 2019.
Moti Milrod

Two fiscal events happened last Thursday. The first is that the treasury released its latest figures showing a continued widening of the budget deficit. The second is that the State Comptroller’s Office presented a draft of its report on how treasury officials are alleged to have manipulated the budget to make Finance Minister Moshe Kahlon look good ahead of last April’s general election.

As to the first event, the increase in the deficit for the 12 months through June to 3.9% of gross domestic product comes as no surprise. The deficit has been swelling for a year, despite promises by the Finance Ministry that the situation was under control.

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A year ago, the 12-month deficit through June was just 1.8%. It rose to 2% in July, 3.3% in September and 3.8% in April 2019 – figures well above the 2.9% target called for in this year’s budget. In shekel terms, overspending amounted to 53 billion shekels ($14.8 billion), a third more than targeted for all of 2019.

Treasury officials say the deficit will shrink further into the year, but the bigger problem is the structural deficit: The government has committed to spending for which there are no revenues to cover it. That will be a problem that only the next government can deal with – and that team is unlikely to be up and running until the final weeks of the year.

As to the second event, the comptroller delivered a confidential version of its draft report for Finance Ministry officials to read and comment on over the next two weeks before the final version is released.

Sources said the report heavily criticizes the ministry in particular in connection with the budget hole that developed over 2018. It says treasury officials worked to push off expenses from the 2018 budget into 2019 and pushed forward 2019 revenues into 2018, all with the aim of making the deficit look smaller and Kahlon look good as Israel went into election mode at the end of last year.

The report also examines allegations made last year that Shai Babad, Kahlon’s director general, was behind the numbers game – and that was the source of the fighting that reached the headlines between Babad and Shaul Meridor, the head of the treasury’s budget division.

Two weeks ago, the cabinet started addressing the growing fiscal problem – or at least gave the impression it was doing that. Bank of Israel Governor Amir Yaron told ministers that using “realistic assumptions” and assuming that no measures were taken to close the gap, the deficit would reach a stunning 4.5% of GDP.

In fact, Yaron’s estimate was generous because it didn’t take into account the risk of slowing economic growth, much less a global economic downturn or an Israeli security crisis.

At the meeting two weeks ago, the cabinet approved 1.2 billion shekels in across-the-board spending cuts and a few small revenue-enhancing measures for 2019. But the 1.2 billion will do nothing to narrow the deficit this year, though it will cover extra spending that didn’t appear in the original 2019 budget such as extending subsidies for afternoon child care.

It wasn’t a lot, but in defense of Prime Minister Benjamin Netanyahu’s government, it has limited authority to act. As a caretaker government between elections it isn’t legally entitled to make sweeping decisions. Politically, ministers have little appetite for inflicting fiscal pain less than three months before they face the voters.

On the spending side, ministries have been spending far more than the 2019 budget allocated them. In the original budget, approved by the Knesset in March 2018, spending was supposed to grow 5.1% this year, a figure that was adjusted later to 6.6% to make up for the changing reality. But in the first half of the year, spending grew 10.4% from the same time in 2018.

If you take into account all government spending – a figure that includes interest payments on debt, for example – spending growth was a somewhat more modest 9.1% in the first six months of the year.

Thus the treasury’s main challenge is to rein in spending by the ministries the rest of the year if it hopes to make a dent in the growing deficit. But that’s only half the problem. The budget numbers released Thursday also show a big shortfall on the income side.

In the first half of the year, revenue from taxes and fees fell 3.5 billion shekels short of projections. Most of the shortfall was in indirect taxes (for example, the value-added tax), which officials explain is due in part to a slowdown in the car market.

As it is, the tax-revenue projections had already been revised down once from the numbers in the 2019 budget by 3.7 billion shekels, so the actual shortfall is more than 7 billion shekels.

Beyond that, the government’s other income is also lagging. Those revenues include things like dividends from state-owned companies and royalties, and were supposed to reach 30 billion shekels this year, or 10% of total revenues. But as of June 30 they were short of projections by 2 billion shekels.

Given the revenue shortfalls, it seems inevitable that a main part of the next government’s measures to correct the budget imbalance will be higher taxes. The most likely course will be to raise VAT to 18% from 17%, which would put an extra 5 billion shekels or so into the government’s pockets.

In fact, tax receipts in the first half were up 1.2%, but this is hardly cause for celebration. The economy is expected to grow this year by 3%, and treasury planners had expected real revenues to grow faster than that.

That was the case from 2013 to 2017, when annual revenues grew 6% on average. That started to change at the beginning of 2018, coincidently when Eran Yaacov took over at the Israel Tax Authority. The revenue change had nothing to do with Yaacov but rather with a change in the components of economic growth – away from a big increase in consumer spending (which generates a lot of tax revenue) and more toward investment in fixed assets. Another factor was an increase in tax refunds.