Netanyahu Warns of Tax Increases as Cabinet Clears Controversial Deficit

Promises Bank of Israel's Fischer he will maintain responsible fiscal policy.

Ignoring warnings by the Bank of Israel and the Finance Ministry's budget division, the cabinet on Sunday has agreed to widen the 2013 budget deficit to 3% of Israel's gross domestic product.

Prime Minister Benjamin Netanyahu warned, however, that keeping the deficit at 3%, not more, will require stern measures.

"We will need to take steps, in the area of taxes as well, to meet this target," he said. "But I don't want to increase the tax burden excessively. I think this is the message."

Only two ministers opposed the plan, which was formulated in private last week by Netanyahu and Finance Minister Yuval Steinitz without consulting the treasury's senior staff. Vice Prime Minister Shaul Mofaz exited the meeting, leaving his "no" vote on paper and no explanation, while Deputy Prime Minister Dan Meridor, a former finance minister, also voted against the measure.

Apart from doubling the projected deficit from the 1.5% of GDP originally targeted, the cabinet also approved Netanyahu and Steinitz's longer-term deficit reduction plan, which calls for a gradual reduction on the deficit to 1.5%.

During the meeting, Netanyahu turned to Bank of Israel Governor Stanley Fischer, who publicly criticized the wider target last week, and signaled that the deficit increase was a one-time event.

"I am going to use your words against raising the deficit to 3% over and over - both at the cabinet table and outside as well," the prime minster said. "I say to those who say that we can squander, 'Listen to what the governor said.' We will act responsibly as we have acted so far and will continue to in the future."

While widening the deficit may save the prime minster the political headaches of draconian spending cuts and higher taxes, the financial markets are especially sensitive to government overspending at a time when Europe is grappling with massive debt and bank bailouts.

Nevertheless, Netanyahu said that given the circumstances, he had little choice but to increase the overspending for 2013. The government is trapped between growing demands for spending and commitments already made - among them free preschool education starting this September - and declining tax revenues as the economy slows.

"I didn't want to increase the tax burden excessively, not in 2003 when I was finance minister and not now," he said. "When you increase the tax burden, you depress growth, and when you depress growth, you do two tings - increase unemployment and in the end also cause the deficit to grow."

He said the new deficit target is the same level fixed by the European Union. "Germany is perhaps the only country in Europe that is under this target level. Most countries, maybe even all of them, have even higher [deficit] targets," he said.

On top of raising "certain taxes" that he did not specify, the prime minster said the government would also have to cut costs in order not to exceed its separate target for spending growth next year.

"The decision [to raise the deficit level] doesn't require a change in the spending target," he stressed. "In the final analysis, the government has control over spending targets and this is where we will act with the greatest stringency."

Deficit opposition

The increase of the deficit was opposed by Gal Hershkowitz, head of the Finance Ministry's budget division, and by the ministry's accountant general, Michal Abadi-Boiangiu. In shekel terms, it will boost the deficit in next year's budget from NIS 14.3 billion to NIS 28.5 billion.

Steinitz, however, defended the cabinet decision in defiance of his own senior staff.

"The structure of the new deficit that has been approved preserves the fiscal responsibility we have acted with to date," the finance minster said after the cabinet vote. "It is in line with world economic conditions on the one hand, and enables us to continue on the route to cutting the debt-to-GDP ratio to 60% by the end of the decade."

The debt-to-GDP ratio, along with the targets for annual deficit and spending growth, is another cornerstone of the government's fiscal policy.

At the Finance Ministry, the official statement sounded a note of resignation. It noted that the deficit target, which is fixed by law, is a multiyear goal. "On occasion there are changing conditions and economic parameters that have a budgetary impact that is not in line with the path fixed in the law," the ministry said. "Therefore, the Finance Ministry will formulate a package of measures needed to match the trajectory of expenses and the trajectory of the deficit according to the law, as well as factoring in economic forecasts, tax policy and the extent of [budgetary] commitments."

A senior treasury official warned on Sunday that if the government does not act on spending, the deficit will in fact reach 4.3% to 4.5% of GDP, according to the ministry's projections. The 3% target can't be met unless there are deep cuts in spending and tax hikes, a view echoed by Manuel Trajtenberg (see story below ).

"The debate with the Bank of Israel on a deficit of 2.5% or 2% is no longer relevant," said the official, who spoke on condition of anonymity. "The problem is much bigger."

Opposition leader Shelly Yacimovich accused Netanyahu of belatedly adopting the social-economic agenda of her Labor Party after years of fighting against it. But, she said, his government was doing little to reduce income inequality or reduce the power of business groups and the wealthy.

"Resources and capital continue to be accumulated by small groups while the burden falls on the middle class and poor," she said.