After witnessing more than 14 months of political turmoil and two failures to establish a ruling coalition, Israel’s voters may finally have a new government. If so, it can add to its make-up list the time lost to policy paralysis from back-to-back elections, and put up a Post-it about the coronavirus epidemic and the growing odds it will take a major toll on the world economy.
First on the agenda is trying to keep the Israeli economy on a growth track. Despite the political standstill that took hold after the Knesset dispersed at the end of 2018 and the chill winds from the world economy, Israeli gross domestic product grew 3.5% last year, a faster pace than in previous years.
By comparison, 2020 has gotten off to a poor start. January data were strong but already last month worrying signs started to develop in light of the coronavirus’ spread. Not all sectors of the economy are vulnerable, but that could change quickly.
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The Organization for Economic Cooperation and Development said on Monday that if the virus sweeps through the Asia-Pacific region, Europe and North America, global growth could fall to just 1.5% this year, half the OECD’s previous estimate.
Even before the epidemic emerged as a threat, the Israeli government had been operating effectively with an austerity budget. That is because in lieu of the Knesset’s passage of a 2020 spending plan, the government has been spending strictly along the parameters of the 2019 budget, on a month-by-month basis. There’s no easy way to increase spending, even as Israel is being swept along by the impact of the coronavirus.
If Monday’s election fails again to produce a coalition, the budget paralysis will continue into 2021 and weigh on economic growth.
The medical impact of the virus on Israel is still unclear, and the number of confirmed cases remains small. However, it is clear that some sectors of the economy are already feeling the effect and demands for government assistance of all kinds (see story on this page).
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If a new government is indeed formed after the election, the government will seek a two-year budget, since most of 2020 will already be behind us by the time the Knesset approves it.
Only a few months ago, treasury officials were sure that the 2020 budget would bring deep cuts of about 20 billion shekels ($5.7 billion). The goal was to reduce the widening of the budget down to a reasonable level.
The uncertainty about future spending is huge. For instance, no one knows what the tab will be for the next phase of increased allowances for the disabled or for the Israel Defense Forces multiyear budget. The treasury must also find ways to fund programs for which no revenues have been identified, for instance subsidies for after-school programs.
However, the next government – assuming there is one – faces a bleaker economic environment than the treasury had been forecasting, due to the coronavirus among other things. By the time a new finance minister is named and he or she names a staff, the pace of GDP growth may well be much slower than it is now.
If so, that will reduce the Finance Ministry’s appetite for reining in the deficit because such a move would only exacerbate the slowdown.
Under the law, the maximum deficit in the 2020 budget is 2.5% of GDP and in 2021 2.25%. Economists have long assumed that the next government will raise these ceilings. Treasury officials have spoken about 2.9% and Netanyahu has said it would even reach 3.3%, but a slowing economy is likely to boost the figures more.
If the government does raise the deficit, it will be adopted as a kind of selective form of classical Keynesian economics, which says governments should increase deficit spending in times of recession and then reduce it when the economy recovers. The previous government didn’t do Part 2 of the policy.
The Bank of Israel says a deficit in excess of 2.5% has the effect of increasing public debt as a percentage of GDP, which at the end of 2019 stood at 60%. The idea of the country’s debt rising will not sit well with the international credit rating agencies.
But as Karen Vartapetov, the S&P analyst covering Israel, hinted last week, not every increase in the debt burden leads to a rating downgrade. The next government will no doubt remind him of that.
A to-do list
The next government’s economic to-do list includes a number of other key items. These are:
Coalition spending: The odds are good that whoever forms the next government will not involve a broad coalition – one in which every party has immense bargaining power and uses it to squeeze billions of shekels out of the budget for its pet causes. All things being equal, a narrower coalition should get off to a better fiscal start.
Reforms: Right now, the government is thinking defensively because of the impending coronavirus threat. But if economic growth is going to pick up again in the medium to long term, it needs to fix a host of problems.
Finance Ministry officials have had a long time to work on their next round of reforms – about two-and-a-half years since passage of the 2019 budget, to be precise. They include raising the pension age for women, congestion fees at peak traffic hours, a law enabling the establishment of a metropolitan transit network for greater Tel Aviv, and taxes on sugary drinks and maybe disposable cutlery.
Taxes: Needless to say, during Israel’s lengthy election season, not a word was uttered by politicians about raising taxes. But that will change after a new government is formed, Raising taxes is a critical part of the plan to lower the deficit, even though it will weigh on economic growth.
In the last two years, the Israel Tax Authority has been examining not only raising tax rates but reform measures it plans to recommend to the next finance minister, They include reducing tax benefits, for example to immigrants, requiring global online businesses, such as Airbnb, to report their local revenues, and perhaps ending the exemption from value-added taxes on personal imports.
Defense spending: Chief of Staff Aviv Kochavi decided last year that he had had enough. With no permanent government since December 2018, he decided to design his own five-year budget for the IDF, even though he still doesn’t know how much the army will be getting from the state budget.
Kochavi has won approval in principle from Netanyahu and the defense and finance ministers for a 1.6 billion shekel budget supplement for the next two years. The amount hasn’t actually been budgeted, but the army is spending as if it has.
If Israel had a functional government, the multiyear budget would have been formulated in line with the overall fiscal situation. But in lieu of that, Kochavi has acted on his own, including the cost-cutting elements that are a critical part of it.
Needless to say, the army is more generous with itself about that Part 2 than it would be if it had reached agreement on a multiyear budget in negotiations with the treasury. If a new government doesn’t emerge from Round 3 of elections, the defense budget may turn into a budget monster.