Fiscal fright

A number of negative indicators have pointed to a coming economic slowdown and the urgent need for fiscal discipline. The economy has been hit hard by Europe’s economic meltdown.

The Europeans make up Israel’s single largest export destination. And with Greece, Italy, Spain, Portugal and Ireland dragging down the more stable economies of Germany and France, it is not surprising that Israeli exports are hurting. Compounding the problem is the stagnation of the US economy and slower growth rates in China and elsewhere in the Far East.

In June, the trade deficit (adjusted for seasonal influences and not including ships or diamonds) was $1.85 billion, the largest since January. Looking at the entire first half of 2012, exports as a proportion of imports dropped to just 67.5 percent, from 76% in the same period last year and 83% in the first half of 2010. And weaker export is plaguing all economic sectors from hi-tech to low-tech to traditional industry. Hi-tech in particular, which at one point accounted for more than half of export revenues, now compromises 46%.

The sharp drop in exports is one factor contributing to the depreciation of the shekel against the dollar.

And the depreciation of the shekel will increase inflationary pressures. Unemployment will inevitably rise as well, as the global economic slowdown is felt locally.

Unsurprisingly, the Central Bureau of Statistics downgraded its GDP growth estimate for the first quarter of 2012, to an annualized 2.7% from 3%, and even this might be overly optimistic.

At a time when the economy is slowing, Prime Minister Binyamin Netanyahu’s government has instituted several major spending increases. The minimum wage was raised and public sector wage hikes were given to interns, nurses, social workers and contract workers.

The budget for higher education was increased; a security fence is being built on our border with Egypt to prevent African migrants from entering; the Trajtenberg Committee for Socioeconomic Change’s proposed cut in the defense budget was not only scrapped, the defense budget was increased in light of the unstable geopolitical situation. Under the circumstances, the government has scrambled to otherwise reduce government expenditures and to increase revenues.

On Monday, the cabinet is scheduled to vote on a number of steps include raising value-added tax from 16% to 17%; raising income tax by one percentage point for those who make more than NIS 8,881 and by two percentage points for those who earn NIS 67,000 or more; an across-the-board cut in all ministry budgets (except defense, education and social services); and raising the tax on cigarettes and beer.

The urgency of the cuts and tax hikes grew after credit rating agencies warned that Israel might be downgraded if the budget deficit for 2013 reaches 4%.

The government has already decided to increase the deficit from 1.5% of GDP to 3%, against the recommendation of Bank of Israel Gov. Stanley Fischer. And even that limit might be violated if economic growth continues to slow down.

Still, while it is important for the government to maintain fiscal discipline, one cannot help getting the impression that the recent steps proposed to reduce the budget deficit were the result of hasty decision making.

As former Bank of Israel governor David Klein pointed out, “It appears as if somebody is frightened and said that something needs to be done quickly.”

Raising VAT is, of course, the easiest way to quickly increase state revenues, but VAT is also a regressive tax that hurts the poor disproportionately. And raising income taxes for the middle class will only increase the burden on that section of society that is already struggling to make ends meet.

Unfortunately, more ambitious reforms such as increasing competition in fields such as banking, food production and insurance or increasing efficiency at our ports, the Israel Electric Corporation or the public sector have been neglected.

Admittedly, implementing such reforms would require a willingness on the part of the government to confront powerful business and labor interests. But these reforms would do more to lower costs, stimulate business activity and reduce income inequality.