Bank of Israel Governor Stanley Fischer has challenged Finance Minister Yuval Steinitz on next year’s budget, declaring the need for more tax hikes to reduce the deficit.

Speaking at a Bank of Israel conference in Jerusalem on Wednesday, he said in an ideal world the government would meet the deficit target and reign in expenditure. But if it is necessary to increase expenditure, Fischer said, he would prefer it be accompanied by a tax increase to bring the deficit below 3 percent.

If the government is forced to choose, it should raise the spending limit instead of increasing the deficit, he said. The law limiting the yearly increase in government spending can be amended, and this is better than raising the deficit next year, he added.

The Bank of Israel expects the Israeli economy to grow 3.8% in 2013, taking into account the impact of natural- gas production from the Tamar offshore field, which is expected to go online in the second quarter. Should tax rates remain at current levels, the central bank estimates the deficit will stand at 3.5% next year – above the 3% target rate.

Fischer emphasized the urgency of dealing with the deficit, saying it will be even more difficult to deal with it later on if the economy slides into an unexpected recession.

“It is advisable not to delay such a decision,” he said. “Tensions within the government only increase when decisions are postponed, and it would be preferable for the next government to make these decisions at the beginning of its term.”

Finance Minister Steinitz on Wednesday told Army Radio it is unlikely a Likud-led government would impose fresh tax hikes next year, saying that “as it appears now, we have already imposed enough taxes.”

Fischer, despite his urgent tone, praised the current government for maintaining a commitment to reducing the rate of expenditure to GDP.

The commitment was introduced in 2003, when Prime Minister Binyamin Netanyahu was responsible for the Treasury, he said.

Fischer said that the government has made commitments for next year that amount to a 10% increase in spending, double the increase permitted under the current fiscal rule.

Israel’s security situation has worsened considerably, and this also needs to be taken into account, he said.

“To convince people in a democracy to get less than they want to get isn’t easy,” he said. “This is the work of politicians, and it isn’t work that I would consider pleasant, but someone has to do it, and they volunteered.”

The defense budget now stands at just 6.5% of GDP, a dramatic fall from the days after the Yom Kippur War in 1973, when it stood at 35%, and even lower than the US defense budget at the time of the Korean War in 1950- 53, Fischer said.

Bloomberg contributed to this report.

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