The Bank of Israel’s comment on the government’s decision on the update of the expenditure rule

29/12/2013

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  •  The economic program adopted by the government when it approved the budget for 2013–14 reduced the deficit significantly, rehabilitated public trust and market trust in the government’s commitment to the deficit targets it set, and contributed to a decline in the risk premium of the Israeli economy and to a decline in the interest rate on the public debt.

  •  It is important that the government continue adhering to the deficit path that it adopted—by which the deficit is to decline to 2.5 percent of GDP in 2015 and 2 percent in 2016—in order to enable a consistent decline in the debt to GDP ratio and to maintain the markets’ trust that has been achieved with significant effort.

  • As part of the process to ensure meeting the multiyear deficit targets, and in order to avoid a marked increase in the tax burden, the Bank of Israel supports updating the expenditure rule to slow the rate of growth of public expenditure. This is in view of the assessment that the growth potential of the economy in the next few years, against the background of demographic changes, is expected to be lower than it was in the past decade.

  •  As the Bank of Israel has previously noted, the cost of the programs that the government has adopted requires significant adjustments in the 2015 budget in order to meet the deficit target. The rule proposed by the government and the moderate expenditure growth rate derived from it bring into clearer focus the challenge in setting budgetary priorities. Since the budget reserve has been reduced from the 2014 budget onward with the reduction in the expenditure ceiling that accompanied the decision to cancel the tax increase, and given the limited flexibility in reducing defense expenditures, it will be necessary to cancel some of the plans that the government has adopted. Should the reduction include plans that deal with areas that are important to long-term growth—such as improving the level of education, and particularly for population groups whose integration into the labor market is limited, growth-supporting infrastructure, and encouraging growth engines such as support for R&D—the ability to support long-term economic growth will be reduced.

  •  The State budget is also a main tool for dealing with inequality and poverty. It is important to make sure that the lower expenditure path set by the new rule will enable the government, inter alia, to support the successful integration into employment of population groups whose level of employment and earning power are low, and to reduce poverty among workers, also through an expansion of the Earned Income Tax Credit grant (negative income tax) program.
 
In summation, it is desirable that the continued adjustment of budget aggregates to the required deficit level achieve a balance between adjustment on the expenditure side and adjustment on the revenue side. In other words, it is desirable that the adjustment also come from an increase in tax revenues, in particular by way of cancelling exemptions, in view of the fact that total public expenditure in Israel is already not high, and the share of primary civilian expenditure in GDP is lower in Israel than in almost all of the other OECD countries, alongside a low tax burden compared to other advanced economies.