Analysis of the Proposed Budget for 2017 and 2018 and Expected Developments over the Remainder of the Decade

Excerpt from the Fiscal Survey and collection of research issues:

·     The expected deficit in the State budget in 2016 is less than 2.5 percent of GDP, markedly lower than the deficit target set for this year and slightly higher than the actual deficit in 2015. The deficit is lower than the target due to tax revenues that are markedly higher than were forecast when the budget was being compiled. This is due to more rapid than expected growth in consumer goods imports and in wages, and the continued high volume of real estate transactions.
·     The proposed budget for 2017 and 2018 raises the deficit target to 2.9 percent of GDP in each of those years, well above the present targets of 2.5 percent in 2017 and 2.25 percent in 2018.
·     In light of the increase in the deficit target, and based on current macroeconomic forecasts, it appears that implementing the measures incorporated in the proposed budget will essentially lead to meeting the government’s new deficit targets in 2017 and 2018.
·     Increasing the deficit target for 2017 and 2018 despite the strength in tax revenues primarily reflects a marked increase in the expenditure ceiling—by about NIS 12 billion in 2017 and by about NIS 16 billion in 2018 (including about NIS 8 billion in respect of non-adjustment of prices)—further to the increase in the ceiling in the 2015 and 2016 budget.
·     The increases in the expenditure ceiling in recent years—alongside the increasing use of accounting adjustments, use of one-off transfers from extrabudgetary entities, switching of revenues between years, and spreading expenses—indicate the difficulty in achieving the government’s objectives in the defense, welfare, and social services areas within the framework of the budget determined by the ceiling, and that the expenditure rule has exhausted its ability to serve as a barrier to procyclical policy.
·     The price adjustments lead to marked fluctuations in the expenditure ceiling, resulting from the gap between the price level forecast when preparing the previous budget and actual inflation. To prevent such fluctuation, there should be a switch to nominal budgeting based on the midpoint of the inflation target.
·     The government plans to reduce corporate tax rates and personal income tax rates. The reduction will lower revenues mainly beginning in 2018, as in 2017 most of it will be offset by an increase in taxes on employers’ allocations to severance pay funds for high wage employees, on owners of three or more homes, and on members of a kibbutz.
·     Given that the economy is close to full employment, and in light of the decision to approve a two-year budget, it is important that the budget focus on measures to increase productivity—particularly an upgrading of human capital and of physical infrastructures—alongside improvement in the regulatory environment.
·     At the planned deficit level, the debt to GDP ratio is expected to increase moderately in coming years. Against the background of the employment environment and high tax revenues, policy should lead to a decline, or at least stabilization, of the debt to GDP ratio, in order to allow fiscal policy to contribute to the economy’s dealing with periods in which macroeconomic conditions will be less positive.
·     In accordance with the amendment to the Foundations of the Budget Law from November 2015 (the “Numerator”), the government is required to correct, when approving the current budget, expected deviations from targets in the 2019 budget as well. Given the proposed measures in the budget, expected expenditures in 2019 are about NIS 8 billion higher than the increased expenditure ceiling proposed in the budget. Without adjusting this deviation, the deficit in 2019 is expected to be 3.5 percent of GDP. It is imperative that the government carry out the required adjustment to halt the increase in the deficit and to maintain the reliability of this important amendment to the law.
·     The experience of the recent past in Israel and worldwide indicates that strength in tax revenues that is based on developments in specific markets may dissipate rapidly and lead to a rapid increase in the deficit. Therefore, the risks incorporated in the current permanent increase in expenditure together with the reduction in the revenue base, are significant.
 
This survey examines the two-year proposed budget for 2017 and 2018 submitted to the government, and focuses on budget aggregates—the deficit, total expenditures, tax revenues, and the debt to GDP ratio—and on their expected development in coming years. Based on the proposed budget, the deficit in the next two years will increase to 2.9 percent of GDP, compared with an expected deficit of less than 2.5 percent of GDP in 2016. The increase in the deficit reflects marked growth in the expenditure ceiling compared with the level set in the current law, and it is also expected to lead to a moderate but prolonged increase in the debt to GDP ratio. This survey does not deal with the specific details of the budget proposal and the related proposed reforms. These include a number of measures that can contribute somewhat to increasing productivity in the economy in the short and long terms, to increasing competition and raising the welfare of consumers and to reducing inequality. These processes include, among other things, the expansion of competition in the communication and trade industries and in the residential gas market, the reduction and increased efficiency of regulation, the steps to increase equality in post-primary and complementary education and to expand the teaching of core skills in poorer localities beyond school hours, increasing the equality in distribution of municipal tax receipts from government entities, the process to increase investment in communication infrastructure, correcting the disparities in the National Insurance Institute’s approach to the self-employed, regulation of employee and employer rights regarding sums allocated for severance pay and the plan to expand the use of natural gas in trucks and buses. Although it is likely that there will be disagreements about specific components of the proposed plans, the adoption of many of these steps can contribute to Israel’s economy and society. As noted, the current survey does not deal with these steps, whose fiscal cost is small, but rather with budget aggregates and their expected development.