Preliminary estimates ahead of the 2015 budget, and fiscal trends for the remainder of the decade
An excerpt from the upcoming "Recent Economic Developments (137)" that will soon be published: Preliminary estimates ahead of the 2015 budget, and fiscal trends for the remainder of the decade.
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- The fiscal adjustment in the 2013–14 budget led to a reversal of the increase in the deficit, restored the credibility of the government’s commitment to the declining deficit path, and contributed to a decline in interest rate spreads between Israel and other advanced economies.
- There is great importance to continuing the reduction of the deficit in accordance with the legislated path, because, given the economy’s cyclical position, the current level of the deficit remains high in international comparison, and does not allow an extended decline in the debt to GDP ratio.
- In order to meet the deficit target for 2015, a total of about NIS 18 billion in fiscal measures—reducing expenditures as well as steps to increase revenues—will be required.
- The level of the expenditure ceiling for 2015 will be affected to a large extent—more than NIS 4.5 billion—by the legal determination of whether a price adjustment is required, in respect of the gap between the development of prices in the past two years and the 2013–14 budget forecast.
- The expected government expenditures based on programs already approved are markedly higher than the expenditure ceiling—if a price adjustment is carried out the gap is about NIS 12 billion, and if not, the gap is about NIS 7 billion.
- Increasing expenditures in line with the ceiling will require policy actions to raise revenues—by about NIS 6 billion if a price adjustment is carried out, and about NIS 11 billion if not.
The success of the fiscal consolidation program which the government implemented alongside the approval of the 2013-14 budget restored the credibility of the government’s commitment to the declining deficit path set in 2009, which is expected to reduce the debt to GDP ratio to about 60 percent by the end of the decade. The strengthened credibility also contributed to the notable decline in the same period in the yield spreads between Israel and other advanced economies and thus to a decline in the interest payment burden in the coming years. With that, since a significant portion of the revenues which contributed to reducing the deficit were one-off revenues, and since based on most estimations the current output gap in Israel is low (the economy is near full employment), the level of the structural deficit remains too high to allow an extended decline in the debt to GDP ratio, and it is also high relative to most other advanced economies.
Assuming that the budget is fully spent, and based on updated macroeconomic projections, the expected deficit for 2014 is close to the target set by the government, 3 percent of GDP, and the ratio of public debt to GDP is not expected to change significantly this year. Tax revenues are expected to rise by about 5.5–6.0 percent in real terms, compared with 2013, due to a large extent to the increase in tax rates in the middle of 2013. With that, the many changes that have been made since the middle of 2012 in tax rates and tax regulations, and the unusually low global interest rate environment which encourages financial transactions, some of which generate considerable tax revenues, increase the volatility of tax revenues and the uncertainty regarding their short-term development.
Based on the new fiscal rule, the permitted real increase in the 2015 budget is 2.6 percent, which means an addition of NIS 8 billion. However, the real rate of increase in the government budget is adjusted each year for the gap between the price forecast used in preparing the previous budget and actual prices. The significance of this adjustment, if implemented, is that the real increase in the 2015 budget will be only 1.1 percent, or NIS 3.3 billion, and this is after the budget base was already reduced by NIS 3.75 billion in 2014. With that, this year there is a legal question of whether a price adjustment is required, since the government switched to a new expenditure rule and therefore it is not a routine update of the budget based on an existing rule. The decision on this issue will have a significant effect on the composition of the adjustment required to meet the deficit and expenditure targets in the 2015 budget.
The expected level of expenditure in the 2015 budget—based on existing activities, demographic trends, and the cost of programs approved by the government—is markedly higher than the expenditure ceiling set by the fiscal rule. This is despite the assumption that budget demands that have not yet been approved in defense, education, welfare, and health will not be approved without a parallel cut in other budget items. The gap between expected expenditure and the ceiling is about NIS 12 billion if a price adjustment is made (which will reduce permitted expenditure), or about NIS 7 billion if the legal determination is that a price adjustment is not required this year. This difference is smaller than what the government faced ahead of the 2013–14 budget, but is higher than in most previous years. Moreover, even after the adjustments there will be an additional gap of NIS 6 billion between expected expenditure and the ceiling for 2016, and a further gap in 2017 as well. Part of the gap is caused by the change in the expenditure rule last year to a more contractionary rule, but a lack of systematic monitoring of the gap between the cost of programs which the government approves and the expenditure ceiling set by the fiscal rule also contributes to the creation of the gap. To avoid a repeat of the process which led to the current problem, it is important that the government soon adopt an effective system to control the framework of its expenditures in the coming years, which will monitor its expenditure commitments and require an immediate reaction to the development of deviations from the expenditure ceiling for coming years.
The deficit ceiling set by law for 2015 is 2.5 percent of GDP. Based on estimates derived from the Bank of Israel Research Department’s tax model, if a price adjustment is made, and the expenditure increase will moderate by NIS 12 billion compared with the present estimation, the deficit is expected to be 3.0 percent of GDP, and the additional revenues that will be required in order not to deviate from the deficit ceiling will be about NIS 6 billion. If a price adjustment is not made, and the increase in expenditure is only moderated by NIS 7.3 billion, the deficit is expected to increase to 3.4 percent of GDP, and the additional revenues required will reach more than NIS 10.5 billion. These estimates include revenue losses of about NIS 2.5 billion related to the government decision to set a VAT rate of 0 percent on most first-time homebuyers, which is expected to be implemented by the beginning of 2015. The combination of required adjustments to both revenues and expenditures in order not to deviate from the deficit ceiling is thus about NIS 18 billion, which is 1.6 percent of GDP.
Meeting the deficit targets will allow the government to gradually reduce the debt to GDP ratio to about 60 percent in 2020 (the green line in Figure 1). However, meeting the expenditure ceiling without measures to increase revenues (including in 2015) will keep the debt to GDP ratio in coming years at its current level, in particular in a case in which no price adjustment is made in 2015 (the red line in Figure 1).
Paths of the debt to GDP ratio under various policy scenarios, 2014–20