Remarks by the Governor Dr. Karnit Flug at the Cabinet meeting on the Budget Plan for 2019-2021 and meeting the fiscal restrictions for 2018

29/10/2017 |  Flug Karnit
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Fiscal Policy
The Ministry of Finance presented the  government with a report on meeting the fiscal restrictions for 2018.  An analysis of the situation of the 2018 budget is important, and shows that the deficit will be close to the ceiling that was set—a level that is higher than the level that stabilizes the debt-to-GDP ratio.  As the Bank of Israel noted when the two-year budget for 2017–18 was decided upon, this situation indicates the importance of keeping a significant reserve when preparing a budget a long time in advance, and there are needs and programs that were not forecast or planned for when the budget was prepared.  It is already clear that the government’s commitments for 2018 will use up the entire reserve that was set aside.  The situation is that even according to the revised revenue forecasts, the deficit in 2018 will be close to the ceiling set out in the law, assuming full expenditure performance. We must take into account the need to keep a significant reserve should it be decided to prepare the 2019 budget at this early stage.


The Budget Department also presented a revision of the multi-year budget program for 2019–2021.  The Ministry of Finance’s revised macroeconomic forecasts are similar to those of the Bank of Israel, and we find them acceptable.  I attributed great importance to the use of the numerator and, based on it, to the preparation of a three-year plan that enables advance planning of government activity and preparation for future developments.


The picture that emerges from the Budget Department’s analysis is that, even now, given the government’s commitments and the revised revenue forecasts, adjustments will be required both on the expenditure side and on the revenue side in order to meet the fiscal restrictions set out in the law for the coming years.  The required measures are on the order of about NIS 10 billion in 2019, in order to meet the deficit target of 2.5 percent of GDP—a deficit rate that is close to consistent with the stabilization of public debt as a share of GDP.  Other measures will be required in the following years.  These adjustments do not include the expenditures that will accrue if the programs implemented as part of the Net Family plan are extended to the coming years, the increase in benefits for the disabled, and the decline in tax revenue from dividends that are brought forward to 2017.


Given the situation of the budget, it is clear that cutting taxes at this time, which will subtract from tax revenue in the coming years, is not consistent with meeting the fiscal targets in the next few years.  Moreover, the cyclically adjusted deficit is already higher than other OECD countries, and is expected to be even higher in 2018.  This means that, if taxes are reduced, it will very likely be necessary to increase them as early as 2019.  Such volatility in the tax rates is not desirable from the point of view of the business sector, and cannot help achieve the long-term targets that tax cuts can achieve (such as encouraging and incentivizing labor).


It is important to note that there is no reason to assume in advance that there will be more pleasant surprises through one-off increases in tax revenues.  Even though revenues were higher than forecast in the past four years, there is no need to go too far back in our history to remember years in which there was a sharp decline in revenue due to global economic developments that are completely exogenous and outside of the control of policymakers in Israel.  In addition, tax cuts at this time would be pro-cyclical, meaning their contribution to expanding economic activity will be small, since the economy is already at full employment.  The pro-cyclicality will become more serious if, as a result of current tax cuts, the need to raise taxes increases if and when there is a slowdown in activity.


Moreover, reducing taxes can be expected to require the government to further reduce expenditure relative to the path permitted in the budgets for 2019–2021, where the weight of civilian expenditure is already very low by international comparison, making it difficult for the government to provide a response to the long-term challenges that will affect the economy’s long-term growth potential.


If the government wants to implement all of the important ideas recently mentioned:

       1.      Implementation of the recommendations of the Committee on Productivity and Support for Sustainable Growth

       2.      Expanding the Earned Income Tax Credit

       3.      Expanding after-school care

       4.      Increasing benefits for the disabled

       ​5.      Improvements in long-term care

then the question of where the sources will come from must be considered.


I would mention that exceeding the deficit path set out in the law will not enable a continued moderate decline in the debt-to-GDP ratio—a path that ensures a continued decline in the burden of interest payments, thereby helping to free up sources on the expenditure side.  Therefore, decisions must be made on increasing revenue, or doing without these programs.  In view of the low tax burden in Israel and the low level of civilian and overall expenditure, it is difficult to see how significant resources can be freed up by reducing expenditures.​

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