The Bank of Israel’s reaction to the proposed State Budget for 2015
The Bank of Israel’s reaction to the proposed State Budget for 2015.
The challenge facing the Ministry of Finance in preparing the budget for 2015 was particularly large in view of the heightened security needs following the events of the past summer. Nevertheless, the proposed budget for 2015 contains risks that are detailed below.
The deficit target in the budget proposal presented to the government today reaches 3.4 percent of GDP, above the existing target of 2.5 percent of GDP, which does not allow for the continued reduction of the debt to GDP ratio.
The Bank of Israel’s own estimate of the deficit implied by the budget proposal for 2015 is higher, and is expected to reach 3.6 percent of GDP—with the difference derived from an overestimate of tax revenues by the Finance Ministry.
In addition, the Bank of Israel believes that the realization of some of the measures suggested to meet the proposed deficit is quite uncertain.. Moreover, some of these measures do not fully reflect the effect of the government’s future commitments.
The Bank of Israel is of the opinion that some of the measures recommended to reach the deficit target in 2015 postpone the problem of a greater structural deficit. Therefore, the government will be required to take sharp measures on both the expenditures side and the revenues side in order to meet the commitment of a deficit at 2.75 percent of GDP in 2016.
According to the Bank of Israel’s estimates, the deficit implied in the proposed Budget for 2015 is expected to reach about 3.6 percent of GDP. This projection is based on the assumption that the expenditure ceiling of NIS 328 billion (including the ostensibly one-time supplement - of NIS 4.3 billion to the Defense Ministry) will be maintained, and that all of the measures accompanying the proposed Budget will be implemented. The gap in the forecast deficit derives from the fact that the Bank of Israel’s projection of State revenues for 2015 is about NIS 2.5 billion lower than the Ministry of Finance’s projection as a result of lower estimates of tax receipts from enhanced tax collection, and higher estimates of the foregone revenues due to the zero percent VAT on new homes in 2015.
In addition, there is uncertainty regarding the actual realization of some of the measures needed to ensure meeting the deficit target, while some of the measures proposed to achieve the proposed deficit target are in fact a categorization of expenses or revenues in a way that does not fully reflect the effect of the government’s future commitments. For instance, financing the expenditure item for developing Israel Railways infrastructure by an issuance of bonds by Israel Railways Ltd., which is not a profitable company and is supported by government subsidies, creates a government commitment even though it presumably reduces the government deficit. Moreover, the financing cost of these bonds will be higher than that of the Government debt. On the revenues side, the likelihood of receiving dividends in the current budget year from government companies following the issue of minority shares is low, in view of the prolonged nature of these processes, particularly regarding some of the proposed companies where agreements with the workers must be reached. Furthermore, some of the measures bring forward revenues from following years, or delay expenditures, which essentially defers the burden of adjustment to the years 2016 and 2017.
The underlying growth forecast is not unduly weak, so the expected increase in the debt to GDP ratio is not the result of the macroeconomic situation, but rather reflects an increase in the government’s structural deficit. Any deviation from the target will increase the debt ratio even more.
In view of the frequent changes to the deficit path to which the government committed—including the increase in the ceiling in the proposed budget, an overestimation of expected revenues, the character of the proposed measures, the risk in not realizing some of the measures and the risks reflected in the domestic and global economic uncertainty that may lead to a further deviation from the deficit target—there is concern that exceeding the target may negatively impact the credibility of the government’s commitment to its fiscal targets. This could have ramifications on the cost of financing the debt and on the maneuvering room available for fiscal policy to deal with unexpected shocks.
Trends becoming evident in the 2016 budget
The Bank of Israel views positively the intention to reduce the deficit in 2016 to 2.75 percent of GDP, and to return the deficit path to levels that will make it possible to reduce the share of public debt in GDP later in the current decade. In this context, the fact that the proposed Budget presents an expenditure framework, which is based on a new and detailed database, should be commended. The regular publication of this framework will permit informed public discussion on the long-term ramifications of budgetary decisions.
Assuming that the government abides by the expenditure rule in 2016, , and based on the existing tax rates, the Bank of Israel expects the 2016 deficit to stand at 3.4 percent of GDP. This implies a gap of about NIS 8.5 billion in 2014 prices from the deficit ceiling proposed for 2016, which, according to the Bank of Israel’s estimation, will require the cancellation of exemptions and/or an increase in taxes in the 2016 budget.
In addition, the Bank of Israel’s assessment is that, based on the decisions already made, the government will be required to reduce its expenditure plans by NIS 3.5 billion—beyond the reductions already made to the transportation infrastructure budgets compared to previous plans—assuming that the government does not decide on any additional expenditures between now and the end of 2016, and assuming that the defense budget will be reduced by NIS 1.3 billion in 2016, in accordance with existing decisions.