Analysis of the 2011 and 2012 Draft Budget in View of Budget Targets and from a Long-Term Perspective

Analysis of the 2011 and 2012 Draft Budget in View of Budget Targets and from a Long-Term Perspective
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  If the measures included in the draft budget for 2011 and 2012 are approved, the Government will probably stay within the newly adopted deficit and expenditure ceilings and the debt/GDP ratio will fall by 3 percentage points by the end of 2012.
  The decision to lower direct- and indirect-tax rates in 2013–2016 may require a deceleration of expenditure growth relative to the path permitted by the expenditure rule, or a hike of other taxes, in order to keep the deficit below its ceiling and lower the debt/GDP ratio after 2012.
  The expected level of expenditure in 2013, based on specific medium-term programs already adopted by the government, is above the expenditure ceiling allowed by the new fiscal rule; this makes it less likely that the Government will contain expenditure growth below the ceiling in order to observe the deficit ceiling.
  The composition of primary civilian expenditure is rigid; this impedes the Government’s ability to reallocate resources to areas that it has declared high-priority.
The Bank of Israel Research Department analyzed the draft budget for 2011 and 2012 in accordance with the Government's expenditure and deficit ceilings, and examined the expected trajectory of the public debt/GDP ratio in view of the policy measures adopted by the Government. The analysis shows that if the Knesset approves the draft budget and its accompanying measures, the Government will broadly meet the targets that it has set for 2011 and 2012 (see attached table), thereby making it possible to lower the debt/GDP ratio by 3 percentage points by end-2012. This will be an important achievement for Israel’s fiscal policy in an international environment of rising debt/GDP ratios in most developed countries. Compliance with the deficit ceiling in the next two years is expected due to the Government decision to postpone some of the planned tax cuts and to raise other taxes—a decision that buttresses the credibility of the Government’s commitment to lowering the deficit and the debt/GDP ratio in view of its multiannual program to lower direct-tax rates.
In contrast to the expected outcome in the next two years, however, the projected deficit after 2012—estimated on the basis of the expenditure rule and the legislated tax-cutting trajectory, and assuming the GDP per-capita will rise at its average rate in the past decades —is significantly above the ceiling set for these years. Instead of falling to 1 percent of GDP in 2014 as the course of the ceiling would have it, the deficit is expected to rise between 2012 and 2015 and the debt/GDP ratio will hardly change in the coming decade (see attached figure). The analysis shows that at the said growth rate even if the planned tax cuts are rescinded—or offset by raising other tax rates—the deficit ceiling will be overshot, making it necessary to raise tax rates by more than 1 percent of GDP. It was also found that even high growth rates as those achieved during 2004–09 will not suffice to meet the deficit target after 2012, but such growth will allow a substantial decrease of the debt to GDP ratio. Furthermore, the expenditure path that is expected for 2013–15, on the basis of the Government’s multiannual programs and the upward trend of budget items, is already higher by NIS 3.5 billion from the maximum permitted under the fiscal rule that was approved this year. Although this is a small disparity relative to the gaps estimated in recent years, its existence makes it harder for the Government to correct the expected overshooting of the deficit by slowing the increase in its spending to a sub-ceiling level. This difficulty is amplified by the rigidity of the composition of primary civilian expenditure; the analysis found that the share of each expenditure category changed by only a fractions of percent between 2004 and 2012. Increased flexibility of the government's expenditure composition will significantly assist in carrying out many of its more important programs by changing budgetary priorities without deviating from the expenditure and deficit ceilings.