Protective Edge Cuts Government's Tax Take as Spending Grows

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Israeli Finance Minister Yair Lapid, right, inspects damage in Sderot after it was hit by rocket fired by Palestinian militants in Gaza, July 3, 2014.Credit: AP

Operation Protective Edge caused the government’s budget deficit to swell in July as officials allowed businesses in the south of the country to delay making tax payments and as war-related expenses rose, the Finance Ministry reported on Monday.

The deficit widened to 2.3 billion shekels ($720 million) during the month, as much of the south and center of Israel were pummeled by Hamas rockets, compared with 400 million shekels in the year-earlier month, the Treasury said.

The main reason was a 10.1% drop in collections of indirect taxes, mainly the value-added tax and customs, to 10.6 billion shekels. Some 400 million shekels of that decline will eventually reach the Treasury, which gave businesses in the south an extra month to make VAT and customs payments. Businesses there took the brunt of the rocket attacks.

Overall, tax collections for the month were down 3.5% to 22.4 billion shekels as direct income-tax revenue registered a 2.5% increase to 11.2 billion shekels, the Treasury said. Revenue from taxes on capital gains shot up more than 14% during July to 378 million shekels.

Meanwhile, government spending for July rose to 26.3 billion shekels, partly due to seasonal factors but also because it rushed to transfer funds to local authorities in the south.

The July fiscal report is giving policy makers a first glimpse of Protective Edge’s damage to the economy and to the government's finances. Israel went into the war in relatively good fiscal shape, with the budget deficit under target. But the Defense Ministry is seeking some 18 billion shekels in extra spending this year and next, outlays that would force the Treasury to impose tax hikes and cut spending elsewhere.

Alex Zabezhinsky, chief economist at the investment house Meitav Dash, said in a report on Sunday that Protective Edge would trim 0.5 percentage point off the increase in Israel’s gross domestic product this year. With GDP growing just 2.5%, that's about 1.2 billion shekels in lower tax revenue, he predicted.

Lower growth would come in sharp contrast to the Second Lebanon War in 2006, when Israel’s economy bounced back quickly after the month-long conflict.

Zabezhinsky said he was more pessimistic this time because economic growth was slowing even before the war, world economic growth is tepid, and neither the Bank of Israel nor the Treasury today has the tools at its disposal to spur growth through monetary or fiscal policies.

“If the war were to end now … the treasurer will need to give priority to supporting economic growth, even if it means a temporary and controlled increase in the deficit,” he said. “But if the war continues much longer, the government will need to take steps to ensure fiscal discipline.”

July marked the second month of widening deficits for the government, although its fiscal condition remains good. The budget deficit widened in July to 2.7% of GDP from 2.5% in June, but it remains below the 3% targeted for all of 2014, the Treasury said.

In the first seven months of the year, tax collections increased 5.8% after inflation from the same period in 2013, to 149.7 billion shekels, the Finance Ministry said. That represented 2.2 billion shekels more than the Treasury had been expecting so far this year.

But the trend data show that while direct tax collections have been on the rise, indirect tax revenue has been unchanged to lower, the Treasury noted. Moreover, the growth in tax revenue has been decelerating, rising 7.3% year on year in January through May and just 4.8% in January through June, it said.

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