Paying for the war

The across-the-board budget cuts just decided upon – as well as others to come – are the wrong medicine for stagnation.

By
September 3, 2014 22:52
3 minute read.
money

Shekel money bills. (photo credit: REUTERS)

 
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Bad blood makes good headlines and the much-hyped acrimony between Bank of Israel Gov. Karnit Flug and Finance Minister Yair Lapid scores high on the ratings scale. This is all the more so because they are at loggerheads over our money, which makes their confrontation meaningful to every household.

On the face of it, Lapid and Flug disagree about how to cover the budget shortfall created by the recent battles with Hamas. But the seeds of disagreement were sewn well before the first shots were traded with Gaza.

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Lapid’s plan not to charge young first-home buyers value-added tax (on condition they buy directly from the contractor for no more than NIS 1.6 million) aroused Flug’s stern opposition and she expressed her opinions bluntly, all but calling it harmful populism. The quarrel over VAT on real estate is ongoing and is a microcosm of the battle royale over how to pay for Operation Protective Edge.

From the outset, Flug pointed out that the VAT exemption would cost the state a whopping NIS 3 billion. Since it would not be covered by alternative revenue, it would mean printing money, i.e. inflation.

Lapid in turn vowed dramatically not to hike taxes.

He still does, though now – in addition to his generosity to home-buyers – he needs to figure out how to pay for the massive, unexpected military expenses.

In the background of this dispute lurks an economic slowdown whose approach was already seen before the summertime hostilities in the south.

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The across-the-board budget cuts just decided upon – as well as others to come – are the wrong medicine for stagnation. The best way to revitalize a stagnant economy is to pour funds into it, not tighten the belt.

The higher taxes Flug pushes for to safeguard the shekel may foot the short-term bill but in the long run starve the economy of cash, a course that can only deepen recession. Higher taxes are not to be levied during economic slumps. Quite the contrary, tax cuts are recommended to revive a lethargic marketplace.

Risking inflation and inviting recession are both ill-advised. In both cases the cure can be worse than the disease. But there is a third way.

The one sure-fire remedy for recession is growth, and growth demands an infusion of capital.

Perhaps the solution can be identified by recalling how Israel paid for most of its wars – from the War of Independence to the First Lebanon War. In the past the Treasury levied compulsory loans on the public.

This may sound like a tax-by-another-name, but it isn’t. It is a bond issue and historically loans were paid back with interest and cost-of-living adjustments.

No one lost money and, if anything, they ended up profiting. In any case, there need not be compulsory loans. Voluntary investment can be made attractive for institutional investors and thereby net the state substantial funds.

Bond issues should be introduced and populist projects scrapped, including the first-flat VAT exemption (which the majority of economists fear will raise housing prices and further pump up the already-engorged real-estate bubble rather than drive costs down). Other, already extant, VAT exemptions are also populist luxuries that we can ill-afford.

A combination of such moves can prevent irresponsible deficit-spending or harmful tax increases.

It is time to get back to basics and remember what must be avoided during an economic downturn.

Israel enjoys a comparatively low ratio of state debt to gross national product, and floating even a large bond issue will barely alter this wholesome quotient.

The bonds, moreover, can be sold locally where there would plenty of takers.

Israel has an outstanding credit rating. Its sovereign debt has a sterling reputation and this may be an excellent opportunity to capitalize on our good record.

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