Summary:
In 2004, the government deficit amounted to 3.9 percent of GDP which is somewhat less than the target determined during budget approval and represents a substantial reduction from its level of 5.6 percent of GDP in 2003. The deficit of the general government, which is measured according to the National Accounting rules2, declined to 5.1 percent of GDP in comparison to 5.6 percent of GDP in 2003. The decline in the deficit and rapid economic growth made it possible to also reduce the ratio of public debt to GDP, which had increased substantially during the previous three years. The reduction in the deficit was achieved through the continuing real decline in government spending, which was even lower than the amount budgeted, the more rapid than expected growth in GDP and the steep rise in the import of consumption goods. These factors enabled the government to meet the deficit target despite the implementation of significant tax reductions, some of which were approved in earlier periods while others were planned for the end of 2004 and implemented early or added during the course of the year. However, the decline in the deficit this year is primarily the result of the high level of the deficit during the first half of 2003. In comparison to the second half of 2003, the period following the implementation of the Economic Recovery Plan, the ratio of the deficit to GDP remained stable, despite rapid economic growth, reflecting moderate declines in both expenditure and revenues. During the past two years, total employment in the general government also declined, with the number of hours worked falling by 2.8 percent. This was the first time since the 1985 Stabilization Program that such a reduction continued for two consecutive years. The timing of expenditure in 2004 differed from past years and was characterized by particularly low levels from June to November and an exceptionally high level in December.
The restraint in spending made it possible to reduce tax rates in a credible manner, which is likely to contribute to sustainable economic growth. Specifically, the reduction in income tax rates on wages during the past two years brought them down to the common levels in developed countries. However, the reduction in tax rates limited the decline in the ratios of the public debt and the deficit to GDP, despite the acceleration in economic growth. In view of the high level of debt in Israel, which exceeds the common levels world wide, it is important that fiscal policy converge to a path which will enable a substantial reduction in the debt to GDP ratio in coming years and thereby contribute to reducing the risk attributed to the Israeli economy. The fiscal targets for the years 2005-2010, if met, will in fact enable such a reduction although this is conditional on the government exploiting the planned moderate increase in its spending to reduce the deficit and the debt and not only to reduce tax rates.
The trend of general government expenditure this year represents a continuation of the cycle which began at the end of 2000 when the proportion of public expenditure in GDP reached its lowest level since the mid-1990s. During the first two years of the cycle, the real rate of growth in pubic spending accelerated even beyond the rapid rates of growth which characterized the 1990s and the share of public expenditure in GDP rose by 4 percent. The increase in public expenditure during this period encompassed transfer payments, defense expenditure and civilian consumption. Following a slowdown in mid-2002, an absolute decline in public spending was recorded in 2003 and 2004 which returned its proportion of GDP to a level similar to that in 2000. Among the components of public expenditure, the proportion of GDP of transfer payments and civilian consumption (net of the one-off addition for vacation pay) returned to its level in 2000 while the proportion of defense consumption declined (though it remained higher than at the beginning of the period). Therefore, the rise of the deficit during this period is primarily explained by the decline in revenues which was due, in the beginning of the period, to the major slowdown in economic activity and later to the reduction of tax rates.
1 The general government is composed of the central government, the National Insurance Institute, the local authorities, non-profit organizations (the Sick Funds, universities, yeshivas, etc. whose primary source of income is the general government) and the National Institutions (the Jewish Agency, Keren Hakayemet and the World Zionist Organization). Its activity is measured according to the National Accounts definitions which differ from those of the government budget (see Text Box 3.1).
2 Although the calculation in Israel does not include exchange-rate valuation adjustments of the public debt.
Chapter 3: The Budget and the General Government - PDF file