Governor Flug Speech: The budgetary and deficit aggregates
The current budget is the first budget of a new government that was elected for a 4-year period. Therefore, the current budget constitutes an important signal of the extent of the government’s commitment to budgetary discipline,
To Presentation (Hebrew)
I would like to present to you my main position regarding the budgetary aggregates before you get down into the details of the budget, and before each of you focuses on the budget of your respective ministries. It is important to ensure that the government has an overall picture of the significance of the budget aggregates with both a macroeconomic view, and with a view of the ramifications for the economy and its stability. In order to formulate an overall view, it is important to see Israel’s budgetary aggregates in general, and also by international comparison.
It is important to mention now, at the beginning of my remarks, that the current budget is the first budget of a new government that was elected for a 4-year period. Therefore, the current budget constitutes an important signal of the extent of the government’s commitment to budgetary discipline, the main expression of which is reducing the weight of public debt out of GDP.
· Following the large deficit in 2012 (4 percent), which required a sharp correction, the deficit stood at about 3 percent in the following two years, and is expected to be slightly lower this year when the budget was managed according to the 1/12 rule (if expenditures do not increase at the end of the year), with a deficit target of 2.5 percent of GDP. According to the law, the deficit is supposed to decline to 2 percent of GDP in 2016 (about NIS 23 billion), which seems at the current time to be quite an ambitious target.
· Following the continued decline of debt as a share of GDP, it has been relatively stable since 2013, at about 67 percent of GDP.
· Even though the debt to GDP ratio is not high by international comparison in view of the crises that some of the advanced economies have experienced, interest payments on the debt constitute about 3 percent of GDP, or about NIS 30 billion, compared with an average of 1.7 percent among the advanced economies.
· In order to reduce debt servicing expenditure, and in order to ensure that the government will be able to deal with external or internal shocks that may hit the economy, it is important that we continue to reduce debt as a share of GDP, even if only moderately. The development of public debt is also the most important variable that the ratings companies look out when evaluating the financial state of the economy.
· As a rule, the deficit in the budget is financed through debt. Therefore, the deficit of today is added to the existing debt and raises its level in all future years.
· It is important to emphasize that the current deficit is a structural deficit, a deficit that is derived from a basic gap between total government expenditure and the sources of government financing, and not from temporary factors.
· Even if we compare our deficit with those of other countries, it is important to look at the deficit in parallel definitions and adjusted to the business cycle. (Contrary to what is common, we do not include indexation differentials on government debt in the deficit.) The picture that emerges from this comparison is that our deficit level is high by international standards.
· In view of all the above, we think it is very important that the deficit in the coming year not exceed 2.5 percent of GDP, which is the deficit level that maintains the debt to GDP ratio. The farther we get from the level of 2.5 percent of GDP, the more it will be considered as a lack of commitment to fiscal responsibility on the part of the government, and the more it will lead to an increase in the debt to GDP ratio.
· In order to reduce the deficit to 2.5 percent of GDP—the maximum that ensures that there won’t be an increase in the debt to GDP ratio in 2016 over what it was in 2014—an adjustment of about NIS 15 billion is required, according to the Bank of Israel’s estimates. This includes the cost of coalition agreements totaling NIS 8 billion.
· Under the current conditions, with a high level of economic activity, low unemployment, and no extraneous temporary defense expenditures, it is not reasonable to increase the debt to GDP ratio, and certainly not the deficit. Against this background, the International Monetary Fund recommended that we take advantage of this period to more aggressively reduce the deficit—in accordance with the targets set out in the law. Given the state of the global economy, this is a very ambitious target, but it shows how the deficit is viewed outside of Israel.
· In view of the fact that the deficit is structural, and in view of the fact that its current level does not make it possible to reduce the debt to GDP ratio, it is important that the measures taken to reduce it be extended in nature.
· Transparency in recording government expenditure is an important asset in maintaining confidence in budgetary policy. It is therefore important to adhere to recording according to the accepted rules. For instance, there are proposals to record the cost of housing programs outside the budget. These programs involve the clearing of land at IDF bases in the center of the country, some of the blanket agreements, and the Dweller Price program. It is important that the cost of such programs be recorded properly. If necessary, a temporary increase of the deficit in order to record these expenditures is preferable to nonstandard recording in the budget’s financing items.
· One of the reasons that the government is now dealing with a deficit that is much larger than the targets set in the law is that budgetary decisions made in recent years—including when forming the current government—ignored the fiscal rules. These decisions often bind not just the budget in the year in which they are made, but also in following years, ignoring the multi-year rules. When the time comes to act on the decisions, the government is forced to choose between breaking the rules and breaching the budgetary commitments it has taken upon itself.
· In order to strengthen the credibility of the commitment to the fiscal targets, and the credibility of government promises, it is desirable that the government change its work methods and internalize the data system developed by the Budget Department with the help of international experts (the “numerator”) in order to require decisions that have multi-year costs to be consistent with multi-year targets.
And a few words on the government expenditure and revenue:
· A comparison of overall government expenditure to those common in other advanced economies shows that we are in 24th place out of 32 countries, or five percentage points of GDP less than the average in the OECD countries.
· Focusing on civilian expenditures (excluding interest payments), we are in next-to-last place, with 30.8 percent of GDP, compared with an average of 43 percent of GDP in the OECD. This means that a further adjustment on the civilian expenditure side will distance us even further from the accepted standards in public services, and may also have a negative impact on the growth engines (such as investment in infrastructure, R&D expenditures, and the financing of higher education).
· To complete the picture, tax revenues in Israel are 31 percent of GDP. We are in 24th place out of 35 countries in the level of tax revenue, and with a gap of 3 percentage points of GDP from the OECD average (meaning, if we were to collect taxes like the average country, tax revenue would be about NIS 35 billion higher than what we collect today). Is it reasonable for a country with high defense expenditures such as we have to collect less taxes than most of the advanced economies? Is it unreasonable for the extra defense expenditures to be financing by an increase in revenues?
· The conclusion from all this is that it is preferable for the burden of the adjustment of the budgetary aggregates not to fall entirely on civilian expenditure, but that there also be some increase on the revenue side. In other words, it is preferable that balancing the budget not be done only through cuts in the civilian budgets, but also through the cancellation of tax exemptions that have no economic or social justification. If at this stage it is not possible to reduce exemptions, there is room for some increase in the tax rates in order not to increase the burden of debt that we and our children will pay in the future.