Bank of Israel warns that taxes must increase in 2016

The government currently is functioning on a month-to-month basis based on the 2014 budget and the deficit for the year is actually expected to hit close to the original 2.5% target

The Bank of Israel building in Jerusalem (photo credit: REUTERS)
The Bank of Israel building in Jerusalem
(photo credit: REUTERS)
Regardless of the optimistic budgetary scenarios political parties tout in their platforms, the Bank of Israel said Wednesday that tax increases will be necessary in the coming years to hit deficit targets, even if no new spending is added.
By law, every budget must limit the amount its spending increases and try to hit a specific deficit target, which means either further reducing spending or raising new revenues. The current law lays out a deficit path that would reduce Israel’s overall debt burden to 61 percent of GDP by the end of the decade, a goal that would help save NIS 3.5 billion in interest payments alone by 2020.
Because no budget was approved for 2015 and the government is functioning on a month-to-month basis based on the 2014 budget, the deficit for the year is actually expected to hit close to the original 2.5% target instead of rising to the 3.4% that Yair Lapid proposed as finance minister.
That will give the new government sworn in after March’s elections some leeway for the year. Even with no tax increase, the deficit would be 2.6% as long as it cuts back spending according to the rule, for a total of NIS 325.8b. (about NIS 8.4b. more than 2014 plus inflation).
Cutting spending in accordance with the spending cap and leaving taxes untouched would also lead to a 2.6% deficit in 2016. That year, however, the deficit is meant to shrink to 2%, so moving forward, there will be tougher choices, according to the central bank’s analysis.
Even if the government makes the necessary cuts to hit the spending rule, it will still need to find another NIS 8b. in taxes (or further cuts) to hit the deficit target through the end of the decade, most of them in 2016. If Lapid had his way with the 2015 budget, which would have made loosened targets now in favor of tougher ones later, the government would need to find NIS 14b. in new taxes, but it could collect them later in the decade.
All this will come as a rude awakening to parties making extravagant election-time promises while pledging, like Lapid, not to raise taxes.
The Zionist Union said its program would cost nearly NIS 7b., about half of which would be added to the 2016 budget. Koolanu estimates that its plans will cost NIS 45b. over five years. Neither have discussed areas they are prepared to cut, and both argue they can find the resources for their plans through spurring higher- than-expected growth and expanding the tax base to collect unreported revenue.
The Bank of Israel was not impressed with such calculations.
“Experience shows that it is preferable to be cautious in the inclusion of estimates of increased collection in the overall revenue projection,” the report said. “In order for the budget path set out by the government to continue maintaining its reliability over time, it is important that the government continue to avoid reverting to such items as much as possible.”
Still, the Zionist Union leader Isaac Herzog blamed the apparent need for more taxes on Prime Minister Benjamin Netanyahu, even while reiterating his pledge not to raise them.
“The recommendation to increase taxes is the direct result of six years of Netanyahu’s destructive economic policy,” Herzog said.
Looking at the controversial topic of defense spending, the central bank said the extra costs of Operation Protective Edge, the summer war with Hamas, did not harm the budget frameworks for 2014 or 2015. That was due, it said, to higher-than-expected revenues and lower spending in 2014 and the automatic budget going into effect in 2015.
But figuring out how the defense budget fits into the overall framework would be necessary for future governments, the Bank of Israel said.
“If the next government chooses to adhere to the current expenditure path, its ability to increase civilian expenditure will depend on its readiness to significantly reduce defense expenditure, since interest expenses as a share of GDP are not expected to continue declining significantly,” the report said.