Bank of Israel Takes Issue With Key Elements of 2017-18 Budget

Report warns tax cuts, spending rises could put government in precarious fiscal position.

 Finance Minister Moshe Kahlon, in October 2015.
Michal Fattal

The Bank of Israel took issue with the main thrust of the treasury’s 2017-18 budget, saying plans to cut taxes and raise the fiscal deficit could leave the government in a difficult financial position in the event of an economic downturn.

The bank warned that Finance Minister Moshe Kahlon’s plans to lower personal and corporate incomes taxes, mainly in 2018, would probably boomerang. Kahlon has said he feels comfortable reducing taxes because collections have been running ahead of forecasts for some time.

But the Bank of Israel noted in its report Monday that, compared with most other developed economies, tax collections in Israel are already low relative to the size of the economy. The proposed tax cuts risk putting the government in a position where it will have to raise taxes and/or cut back spending when economic growth weakens and the economy could use the stimulus of tax cuts and spending increases.

The bank also warned against relying too heavily on a surge of tax revenues.

“Past experience in Israel and worldwide indicates that strong tax revenues based on developments in specific markets may dissipate rapidly and lead to a rapid increase in the deficit,” the central bank said. “The risks due to the current permanent increase in spending together with the reduction in the revenue base are significant.”

The Bank of Israel critique comes as the treasury is putting the finishing touches on a two-year budget for 2017-18, which is due to go to the cabinet later this month and to the Knesset when it reconvenes for its winter session.

The report also took issue with the treasury’s plan to widen the budget deficit to 2.9% of gross domestic product in 2017 and 2018. A deficit of that size means the government won’t be able to reduce Israel’s relatively high debt-to-GDP ratio over the next two years, although Bank of Israel economists said the increase in the ratio would be relatively small.

The central bank, however, lauded reforms contained in the budget it said would help Israel improve its lagging productivity growth, increase its international competitiveness and reduce income inequality. The reforms include plans to increase competition in communications and home-gas delivery, reduce regulations and make funding for education and local authorities more fair.

But the bank said the budget didn’t increase spending enough for education or infrastructure, which it described as two long-term barriers to economic growth. The strategy of shifting infrastructure-development costs on to the private sector is likely to lead to delays because of the time it takes to award licenses and contracts.

But, in general, the central bank expressed worry about the government’s spending trends. It said the increases in the spending ceiling in recent years, alongside the increasing use of accounting adjustments, one-off transfers from extra-budgetary entities, the switching of revenues from one year to the next and spreading out costs all pointed to the government’s failure to keep to its own spending ceiling.

Spending in 2017-18 will exceed the official ceiling significantly as it did in 2015 and 2016 because the government routinely approves multi-year spending items without examining their fiscal impact.