Economics: Where’s the money?

Finance Minister Yair Lapid’s greatest challenge is answering the question he himself posed in his campaign.

Finance Minister Yair Lapid (photo credit: MARC ISRAEL SELLEM/THE JERUSALEM POST)
Finance Minister Yair Lapid
There is poetic justice to the fact that Finance Minister Yair Lapid’s greatest challenge is answering the question he himself posed in his campaign: Where’s the money? Though the 2015 budget proposal and economic plan Lapid presented to the government this week has plenty of good stuff in it, from plans to partially privatize government- owned companies to pushing forward port reform, there are several major problems that are worrying.
1) Israel is losing credibility on its fiscal promises The coming year, 2015, will be the third year in a row in which the budget will have higher deficit targets than those recommended by the Bank of Israel.
The bank’s plan to bring down Israel’s debt to a sustainable 60 percent of GDP recommended deficit targets of 3% in 2013, 2.75% in 2014 and 2.5% in 2015. Lapid has set them at 4.65%, 3% and 3.4%, respectively.
In 2012, the target was set for a reasonably low 2%, but shot up to 4.2% by year’s end.
Setting a high deficit is a means of avoiding more economically sound but politically difficult options. For example, according to budget expert Momi Dahan, there are about NIS 47 billion in tax benefits, exceptions and exemptions in the tax code.
The entirety of the deficit for 2015 amounts to NIS 38b.
Some exemptions serve worthy policy goals, but eliminating just a fraction of the outdated, wasteful ones could bring in enough revenue to put the deficit back on track.
But people like their benefits, enjoy their exemptions and feel entitled the ones they have gotten used to, even if they no longer serve a policy purpose or make sense.
What they don’t care about are deficit figures, despite the fact that the deficit affects people’s lives more concretely than they think.
In 2015, Israel will pay out nearly NIS 40b. in interest payments alone. That’s 75% of the amount budgeted for defense.
Notice that this figure is not the amount we are shelling out to pay back money we borrowed in the past (which is set at a whopping NIS 101b.) – it is just the interest we are paying on that debt.
Leaving alone the fact that future generations will be forced to pay for any deficit spending, there are good arguments that directing spending the right way today could help provide future generations with a better economy from which to pay that debt.
But consider that when the deficit is higher than our economic growth, it increases our debt burden and thus, the amount of interest we have to pay. Israel still pays double the Organization for Economic Cooperation and Development average in interest payments, in part because the security situation lends uncertainty to our fiscal stability.
Finally, running a high deficit can be a good trick to help boost growth in a recession or deal with an emergency situation. Countries that have stuck to low deficit targets have more flexibility to spend when something unexpected happens.
The 3.4% deficit means that if some unanticipated shock hits Israel, it will have less room to maneuver before credit agencies reassess how risky it is for others to lend to it. Although Israel’s growth is moderating, it’s still growing, so there’s no need to run up a deficit right now – especially when we don’t know what 2015 and 2016 hold in store.
2) Spending from important ministries has already been cut for 2015 Another issue that people are not discussing is that fact that the government approved an across-the-board cut into the 2015 budget without almost anyone noticing.
At the end of the summer war, the government approved a 2% across-theboard cut for every ministry except defense. In the aftermath of the war, Israelis were sympathetic to the fact that cuts might be necessary to pay for the country’s security, and nodded their approval.
That cut, however, was automatically transferred into the 2015 budget. Each year, the outline for the new budget is based on where the previous budget left off. As a result, the 2% cut for 2014 meant that the 2015 budget’s growth was also around 2% lower than originally planned.
Though it is completely accurate to say that budgets have grown around 2.61% from 2014, it is somewhat misleading, because it refers to the reduced 2014 budget.
In comparison to the original 2014 budget, average spending for ministries will have grown 0.6% instead.
Lapid has touted plans to increase spending on education and health by NIS 1.8b and NIS 2.5b respectively in 2015. Sounds great, right? In reality, however, the increases were already worked into the 2015 budget through automatic growth and policies the government had approved ahead of time.
They also don’t take into account the 2% Protective Edge cut, in which education lost NIS 480m. The ministry lost the same amount (plus whatever boost it was supposed to get on top of it) in 2015, meaning that between the two years, there was about a billion less to go around in education spending than there otherwise would have been. The same applies for health, welfare and other civilian services, on which Israel already spends a relatively small amount relative to other OECD countries.
3) The 0% VAT policy will not work Finally, the 0% value-added tax policy is an expensive project that will not solve any problems.
The policy sounds great.
For young couples that have served in the IDF, it will chop off the 18% VAT they have to pay when they buy their first home.
So why did the Finance Ministry’s chief economist quit over it? Why did the government’s chief economic adviser Karnit Flug come out against it? Why do the professional staff at the Finance Ministry confess to going along with the policy grudgingly, on orders from Lapid? Why do economists deride the law so? The reason is that it will not help anyone.
The cost of housing in Israel is a serious problem: prices have roughly doubled since May, 2007. The problem, however, is that there are incredible amounts of roadblocks and difficulties in getting new housing units built and onto the market, so the supply simply has not kept up with the growing demand.
The 0% VAT policy adds to the already high demand.
Suddenly, a group of people will have a discount, so they will join ranks of those trying to buy a home.
Unfortunately, the number of units from which this larger pool of buyers will have to choose – the supply – will have remained the same. If more people are bidding on the same number of houses, the people selling those houses will simply raise the prices until they get the best deal they can.
The reason economists dislike the 0% VAT policy so much is they think it will push up the prices of housing for everyone. The government’s generous policy, which will cost NIS 2b-3b a year, will end up enriching the construction companies selling the homes by letting them charge higher prices, not the buyers who will have to pay them.
Yet the worst part is that the beneficiaries will still feel like they’re better off because relative to the new, higher market price, they will have a discount.
In his election campaign, Lapid said he wanted to be like a “Shas” for the middle class. That sounded great for the middle class, because Shas fought tooth and nail to benefit their constituency.
The problem is, Shas’s policies of subsidizing and redirecting funds toward their ultra-Orthodox base made everyone in the system – even its seeming beneficiaries – worse off.
With the 0% VAT policy, Lapid has successfully followed in their footsteps, just as he promised.