Israel must be cautious in implementing further tax cuts, the International Monetary Fund said in its annual report on the state of the country's economy released Monday.
"It is important that the  budget abstain from any further unplanned tax cuts in order to accelerate the path of public debt reduction," the organization said following its recent mission to Israel.
Nonetheless, the IMF praised the government's "commitment to increased competition and efficiency" and its intent to continue structural reforms that have enhanced market confidence and contributed to continued economic growth.
In the context of those reforms, the Knesset in late July, approved a series of tax cuts advocated by then finance minister Binyamin Netanyahu.
Value Added Tax was reduced from 17 percent to 16.5%; corporate taxes are slated to be cut from 34% to 25% by 2010; and the maximum marginal income tax is set to drop from 49% to 44% by 2010. In addition, home purchase taxes are to be canceled on sums up to NIS 550,000, and National Insurance Institute and health taxes are to be gradually cut, according to this summer's legislation.
Assuming that domestic economic growth maintains the forecast 4% annual rate, Israel's government should try to keep fiscal deficit "well below" 3% of gross domestic product, the IMF report said, adding that "a pronounced and sustained decline in public debt ... would help lower future interest costs and thereby give greater scope to priority spending."
On the other hand, the IMF warned that some cuts to welfare spending have "contributed to social hardship," and it was therefore important that there be a safety net to protect children, the elderly, and the disabled.
Committing to a multi-year budget plan would help minimize expenditure growth, increase predictability, and favor transparency in the budget's execution, the IMF also advised.
Though the Bachar reforms and subsequent development of the capital markets were "largely positive," the group said they also created risks and induced changes that force participants in the capital market - including insurance companies, provident funds and pension funds - to learn new skills to handle a range of new instruments and evaluate credit, the mission warned.
"The regulatory authorities are aware of these risks and are taking action to address them, but more needs to be done," including allocating enough funds to the Insurance Commissioner and Israel Securities Authority to respond effectively, the report said.
The IMF also endorsed Bank of Israel Governor Stanley Fischer's proposed Bank of Israel Law, noting that such legislation - which would create both a monetary board and a management committee within the central bank - should strengthen the central bank's independence.
"There should be no ambiguity about the primary function of the BoI: It is to ensure price stability. ... Other goals, for example growth, should be considered only in so far as they do not undermine the primacy of price stability," the report said.
The IMF predicted that the central bank would "likely need to raise rates over time as the employment and output gaps close," but said high unemployment and excess capacity in housing and construction "argue against aggressive tightening over the near term."
Fischer called the report "one of the most positive" put out by the Fund.
"We were accustomed to [receiving] compliments on the monetary policy, [though] occasionally doubts were raised on budgetary policy," Fischer commented. "In this report, the Fund supports the monetary policy and also expresses full support of the ... budgetary policy, and I hope that it will continue to be so in the years to come."
Finance Minister Ehud Olmert said the report "gives faith in Israel's economic policy as it is today, and suggests that its continuation will bring very positive results to the Israeli economy."