Lapid, Flug spar on 2015 budget, espouse differing understanding of deficits

Though they agreed the deficit could increase from the planned 2.5% to 3%, Lapid argued that higher deficits were preferable to further cuts and to tax increases.

Karnit Flug
With nine days to go before the 2015 state budget is presented to the government, the country’s economic policy- makers are at odds over how increasing deficits will affect the economy.
Finance Minister Yair Lapid described low deficits as a means to give the government wiggle room for emergencies.
“Low deficits are not an ends in and of themselves. A low deficit is intended to provide a security buffer in the event that something out of the ordinary happens. Something like a hurricane, or a global crisis, or a military campaign,” Lapid said at the National Calcalist Conference in Tel Aviv on Tuesday.
The fact that the 2014 budget was well below its deficit target before Operation Protective Edge helped finance the costs of the war.
Lapid noted that the four rounds of fighting since 2006 had cost the government a combined NIS 16 billion in cash, plus tens of billions more in indirect costs.
The steps taken to lower the deficit in 2013 and 2014 were put in place for just an eventuality such as Operation Protective Edge, which not only took budgetary funds but also slowed an already moderating economy.
“The last thing the Israeli economy needs right now is more taxes and more cuts,” said Lapid, who already snuck a cut into 2015 by slashing 2 percent off the current year’s budget, which serves as the basis for future spending.
“We need to expand the deficit,” he concluded, citing the need to continue spending on defense and social services.
While Bank of Israel Gov. Karnit Flug agreed that the 2015 deficit target could rise from 2.5% to 3%, she said that further increases could backfire.
For Flug, the issue of high deficits was not about short-term flexibility, but the costs imposed in the long-run.
The higher Israel’s deficits, the greater its debt burden will be. The greater the debt burden, the more the government must spend each year to pay it off, including higher risk premiums.
Raising the deficit too much “will lead to a future increase in interest payments in the economy, which last year, for example, reached NIS 38b.,” she said. For comparison, that amounts to nearly two-thirds of defense spending.
She differentiated between structural deficits, which result from the differences between ongoing policies for expenditures and revenue collection, and cyclical deficits, which result from temporary changes from the business cycle or external shocks.
Speaking right after Lapid at the conference, she explained that Israel’s structural deficit was already higher than most of its peers in the OECD.
Though the overall deficit target for 2015 was set to fall to 2.5% of GDP, the structural deficit alone would already amount to 3%.
In a jab at Lapid’s policies, Flug attributed the increase in the structural deficit to his decisions to push forward his 0% VAT housing policy, which has been criticized as both ineffective and expensive, and to cancel planned tax increases that had been planned for 2014.
Raising the overall deficit to 3% to deal with the consequences of the war was acceptable, Flug argued, but without tackling structural problems, the deficit would undoubtedly rise even more, leaving the underlying policies that will lead to high deficits in the future intact.
“I wish I could tell you that it’s possible to add all these worthy expenses to the budget without any of us paying for it – not us, and not our children – and that despite the fact that we don’t raise taxes and eliminate exemptions, that we can protect the economy from shocks,” she said. “But it’s clear to you that thinking we can do all that, and now, is an illusion.”
Throwing his hat into the mix, Economy Minister Naftali Bennett, a former businessman, framed the question of deficits in terms of investments.
“It depends what you plan to do with this deficit,” he said. “Is the money for growth or to put off uncomfortable decisions?” “A deficit is taxes in the future,” he continued. If deficits are loans that must be paid back, he reasoned, the question is whether it will be used to make more money (e.g. encourage economic growth). If so, it’s worth taking because there will be plenty to pay it back with.
Bennett compared the government to an out-of-kilter motor releasing black smoke, saying that instead of pouring in more gasoline, it would be necessary to fix the motor and make sure it burns the fuel efficiently.
The idea of increasing the deficit to some extent received support from Bank Leumi CEO Rakefet Russak-Aminoach and Histadrut labor federation chairman Avi Nissankoren, though they did not specify how much.
At the conference, Finance Ministry budget director Amir Levy gave some insight into precisely what was being considered for 2015. Eliminating a slew of tax benefits and exemptions, a favorite target of economists and analysts when it comes to seeking more revenues, was not on the table for 2015. The most well-known examples include VAT exemptions for Eilat and fruits and vegetables.
Defense spending could not rise by NIS 11b., as the defense ministry is demanding, he added, but said that some big ticket projects, such as the Tel Aviv Light Rail, were moving forward.
When asked about Lapid’s 0% VAT policy, which would become another NIS 2b. to NIS 3b. liability if it passed, Levy wryly reminded the audience that the Finance Ministry’s professional staff had opposed the policy, but had gotten on board in compliance with Lapid’s wishes.