Despite fierce opposition in the Treasury, the government was close to finalizing an agreement with the Histadrut Labor Federation on Monday night, under which the budget expenditure framework would be raised to more than 3 percent per year. "There is a general consensus that the budget spending ceiling will be raised to at least 3% from last year's budget from the planned ceiling of 1.7%," said a senior Labor Party source engaged in the negotiations. The agreement on the 2009-2010 state budget, which will be presented for cabinet approval on Tuesday, was struck between Prime Minister Binyamin Netanyahu's economic adviser Ori Yegev and Histadrut chairman Ofer Eini after negotiations with the Finance Ministry reached a deadlock. Furious about the agreement, senior Finance Ministry officials were meeting with Netanyahu late Monday night to work out the details of an economic package deal. Negotiations between the Treasury and the Histadrut, which started on Thursday, broke down on Monday afternoon after the labor federation rejected the demand to postpone the planned 5% salary increase in the public sector, a move that would save the state NIS 3.5 billion a year. In exchange, the Finance Ministry would have agreed to a more modest increase in the public spending ceiling from the current 1.7% per year. Opposed to an across-the-board salary freeze for state employees, Eini agreed in principle to a partial freeze on one-off payments such as promotion bonuses and annual allowances for clothing and rehabilitation, as well as other minor benefits, which would save the state coffers only between NIS 1.5b. and NIS 2b. annually. "If the Histadrut does not agree to the demand to forgo the planned salary increase in the public sector in one form or another and the government raises the year-on-year budget spending ceiling to 3%, the deficit will balloon to a level that could endanger the economy," said a source close to the Finance Ministry. Sources close to Defense Minister Ehud Barak said on Tuesday that Netanyahu and Barak were still far from an agreement on the proposed cuts to the defense budget. They complained that the budget would not leave any room for extra expenditures during a crisis. According to the source, Netanyahu told confidants that "if he caved in on the defense budget, it would crash the economic and social system." Barak told confidants in the Knesset that he did not expect a deal to be reached until the last minute. The Treasury needs to cut NIS 14b. from the budget to keep within the current spending limit of 1.7% year-on-year and to curb the budget deficit. That deficit is already expected to surpass NIS 40b., or 6% of GDP, in 2009, and 5.5% of GDP in 2010, as a result of sharply declining tax revenues and additional commitments resulting from the coalition agreements of the current government. According to the Treasury, without the proposed NIS 3b. cut in the defense budget and without a freeze on public sector wages, which would save the state NIS 7b. over two years, and without a great part of the proposed cuts to the welfare budget, the necessary budget ceiling will have to be violated. If the government raised the annual spending ceiling to 3%, the deficit could rise to more than 6.5% of GDP, the Finance Ministry said. Opposition to larger deficits comes not only from the Treasury, but also from the Bank of Israel. Last week, the central bank's Governor Prof. Stanley Fischer warned that a higher deficit of 6.5% to 7% would be problematic for the finance sector, and that Israel could not afford a large, expansionary stimulus package. He called on the government to maintain fiscal discipline to keep public debt in check. "We are now running large deficits, and some people are asking why we are not making them even bigger, as [in] other countries," Fischer said. "The answer is simply that we have no way of financing them." Netanyahu confirmed on Sunday that the government would scrap most of the controversial cuts to welfare spending proposed by the Treasury last week if a package deal with the Histadrut were finalized. In that case, the government will cancel the proposed cuts in payments to Holocaust survivors, the elderly and the handicapped. In addition, the proposed hospitalization charge of NIS 50 per day and other items that could hurt the weak will also be canceled. In response to public criticism that the Treasury's proposals target the poor, it is considering two new taxes aimed at the wealthy. The Finance Ministry is proposing to raise the maximum salary ceiling liable for National Insurance payments from the current NIS 40,000 per month to NIS 60,000, and to raise the tax on expensive vehicles and other luxury items. Rebecca Anna Stoil and Gil Hoffman contributed to this report.