Israeli economy, stable during global crisis, could be disturbed by budget deficit

While the Israeli economy has managed to steadily weather the global financial crisis of recent years, a growing budget deficit now threatens to disturb the relative economic stability of the past several years.

Freshman Knesset Member and newly minted Finance Minister Yair Lapid must now attempt to raise government revenues by increasing taxes and slashing expenditures in order to close sizeable gaps in the 2013 budget.

The uncomfortable measures, and remaining budget shortfalls, leave many worrying about the state of the economy, just months before economic oracle Stanley Fischer leaves his post as longtime governor of the Bank of Israel.

“The state of the economy is good certainly as compared to other advanced economies,” Edward Offenbacher, Director of Monetary/Finance Division of the Bank of Israel’s Research Department, told JNS.org.

Offenbacher has worked at the bank for more than 30 years, following a stint at the U.S. Federal Reserve.

“We’re not growing as fast as we were in the period of 2004 to 2010,” he said. “But we’re doing as well as could be expected based on the circumstances in the world. By and large, our situation is better than in almost all comparable countries.”

According to Offenbacher, there are two major components to the Israeli government’s budget deficit. The first is that the amounts of tax revenues the government collected in 2012 were significantly lower than initially forecasted.

The second component is that the 2013 budget has significant increases in expenditures, including commitments to increase wages for teachers and doctors. Additional expenditures were made based on the recommendations of the Trachtenberg committee which attempted to ease economic burdens on young working couples, following the social protests of the summer of 2011.

“The government made a lot of commitments for expenditures which were undertaken without considering the overall budget implications. Plus, in the defense ministry there were some overruns. So the expenditures were higher than planned,” Offenbacher said.

In order to balance the budget, Lapid has started warning the public to prepare for a number of cuts that will need to be adopted. Several pundits have referred to the cuts as “austerity measures.”

Yet according to Offenbacher, the word austerity may be inappropriate as the situation in Israel is not nearly as alarming as the financial crises currently plaguing many countries in Europe.

“The magnitude of the measures needed to bring the budget back into proportion are far less than we’ve heard about in European countries, like Ireland or Greece,” Offenbacher said.

Lapid is scheduled to meet with Fischer in the coming days to discuss his plan to balance the budget. It is being reported that in addition to sweeping cuts and planned tax increases, Lapid will seek Fischer’s support to loosen the budget constraints placed on the government, by easing a “fiscal rule” that directly links government expenditures and debt to projected economic growth.

In other words, Lapid may attempt to pass a budget with a deficit that is larger than the government has previously agreed upon—a step that may make it even more difficult to close the gap in the years ahead. Carrying a larger debt burden could hurt Israel’s overall economic standing.

Offenbacher explained that this fiscal rule—adopted to curtail government debt relative to the economy—has gained Israel “tremendous credibility and admiration within the investment community.”

Violating its own budgetary policy by acting against the fiscal rule could send signals of irresponsibility to foreign investors and affect Israel’s standing with major ratings agencies.

“Israel’s central bank has a formal role as an advisor to the government on economic issues including the budget,” said Offenbacher. “But ultimately, the authority over the budget rests with the Finance Ministry.”

In addition to the budget gap, the Israeli economy is being challenged by growing income inequality—an issue that has been receiving a great deal of public attention. Salaries for members of Israel’s upper class are grossly out of proportion with those of poor, and even with the salaries of middle class families.

“There is no consensus on how income inequality affects a nation’s overall growth, or inflation,” Offenbacher said. “But there is a growing sense that in terms of economic efficiency and economic performance that income inequality doesn’t help. There is also a feeling, in my own opinion, that there is an issue of justice with the great disparity in incomes.

“The question is whether the middle class is paying too much of the burden,” he said.

One of the reported measures Lapid is now considering to balance the budget is a reduction in the per-child allowances the government pays out monthly to families. Many in Israel have come to rely on these meager but steady allowances to help pay for recurring expenses such as food and diapers. Slashing the allowance is likely to be unpopular particularly with those that need it most—the poorest sectors of Israel’s society.

“Almost every tax system makes some kind of allowance for dependents in a family,” said Offenbacher, who explained that the concept of the child allowance is somewhat similar to the personal deductions in the U.S. tax code for each dependent.

“The question is: If you are going to cut child allowances, what are you going to do instead?” he said.

Lapid may have an even more difficult time balancing the budget and dealing with the social fallout of so-called austerity measures without the guiding hand of Fischer, who is scheduled to leave his post in less than three months.

Fischer is widely credited with steering Israel safely through the global financial meltdown of 2008 and 2009, an effort that has placed Israel in relatively stable economic standing compared to other advanced economies.

According to Offenbacher, “I had the good fortune to be majorly involved, and my own personal opinion is that Stanley Fischer pulled off a masterly performance.”

While Fischer “anticipated the collapse of the global economy,” Offenbacher said, unforeseen challenges will face the next Bank of Israel governor—whose identity is yet another unknown.

“By and large, given Israel’s record in the past crisis, and given the fact that our banking system has been very well supervised, Israel has been ahead of the curve,” Offenbacher said.

“Solid management of the Israeli economy, as well as good management within Israel’s business sectors including in hi-tech has put Israel in at least as good a position as any other economy to deal with its long-term issues, and that is reflected in the good ratings that Israel has secured, and the foreign investments we have received,” he added.