The Lapid Israeli Budget                                                                                        12.05.13

by

Howard Adelman

I have so much to write about and just too little time. Major topics include: (1) Syria; (2) Tzipi Livni, John Kerry and the Peace Process, and (3) Lapid and the Budget. There are also a number of minor topics from Women at the Wall to Stephen Hawking. However, Yair Lapid tabled his budget this past week when I was otherwise preoccupied. The implications are important so I will write on the budget first.

In my blog on February 4th, I asked, “in a budget of NIS 350 billion largely locked into a third for interest payments on debt, another third for salaries and the other third with little room for flexibility, how can any finance minister come up with NIS 15 billion in cuts and additional revenues of about NIS 30 billion? I also wrote that Lapid’s stated priorities were to:

1. Reduce the cost of living by every means at its disposal (part of the coalition agreement);

2. Enhance free market competition and reduce the concentration of power;

3. Reduce economic disparities and launch a fight against poverty.

Finally, I also wrote that Israeli direct income taxes and indirect value added taxes now offer few incentives for any increase. Yet, as we shall see, these became the main sources for extra revenues. More importantly, there are more than sufficient revenues available by simply closing what in North America are called loopholes and in Israel are called incentives; very few of these were att. In preparing for this budget, I only managed to examine seven of twelve areas of the economy in order to understand the possibilities for the Israeli economy. The five areas still not covered include those with the largest expenditures: health, education, housing, defense and the support for the Haredi sector.

The total budget was NIS 296 billion for 2013 and in 2014 it will grow to about 304 billion shekels. Instead of the proposed cuts of NIS 15 billion and additional revenues of NIS 30 billion, the ratio of cuts to expenditures has been reversed. Planned cuts are NIS 30 billion (roughly 1/3rd for 2013 and 2/3rds for 2014. Planned new revenues are NIS 12-14 billion. Because the budgeted cuts run from July 2013 to the end of 2014, 18 months instead of 12 months, the cuts are only about 25% greater than anticipated. The real change is in the revenues which are much less than had been expected. Based on current committed expenditures projected forward, the deficit would have reached 5.5% of GDP by the end of 2014, up from 4.2%. Given the increases in revenues projected as well as the cuts in expenditures, the deficit will still actually increase as a percentage of GDP, up to 4.65 % this year and only reach the targeted 3% by the end of 2014.  

Last year, Israel spent $US15.5 for defense (NIS 55.5 billion), almost 7% of its GDP, but that budget excluded US$3.1 in US aid. The largest single cut was expected to come from the defense budget – NIS 4 billion, but this was, in fact, a smaller cut than expected and smaller than cuts elsewhere. A cut of NIS 4 billion from a budget of NIS 55.5 billion is a cut of 7.2%. Part of the spanner thrown into the defense budget was sequestration in the United States which has meant an automatic US$300 million cut or one-quarter of the Israeli cut. Excluding the US cut, the actual cut is only about NIS 3 billion. Further, the American portion of the cut could come from the Dome and Arrow defense missile system (total value $US 429 million) that seems to be increasingly necessary given the build up of rockets by Hamas and especially Hezbollah, but President Obama seems to have gone out of his way to earmark that part of the US$3.1 billion allocated to Israel. Today, Israel’s security cabinet will discuss those proposed cuts to defence. Given the visible threats from Syria, Hezbollah, Gaza and Iran, do not expect those cuts to stay firm.

As far as I have been able to make out, the cuts will be as follws – please offer corrections. Infrastructure and transportation support will be cut by NIS 2.75 billion in this year alone and 5 billion next year. There is no costs included for the additional number of accidents due to bad roads.  Education will be cut by NIS1 billion. The amount of the cuts from welfare and health was not known but is expected to be another NIS 2 billion. But a separate cut of a staggering NIS 3 billion shekels was scheduled to come from child allowances and support for day care programs. At the same time, child benefits will be cut from NIS 175 shekels per month to NIS 140 shekels per month, an enormous almost 17.5% cut. These cuts, if they hold, will be expected to total NIS 2.75 billion in 2013 and an additional NIS 3 billion in 2014. Cuts to settlers and haredim are expected to total NIS 2 billion. The wage freeze plus NIS 2 billion cut in public sector wages is on hold until Treasury negotiates a deal with Histradut.

Total Cuts                                           Year                NIS in billions

Defense                                               2013-14           3

Transportation and infrastructure       2013                2.75                                                                                                                 2014                5

Education                                            2013-2014       1

Child Welfare                                     2013                2.75

                                                            2014                3

Health                                                 2013-2014       3

Haredi and settler support                  2013-2014       2

Bureaucratic Fat                                  2013-2014       3.5

Technology Sector                              2013-2014         .6

Sundry            incl. wage cuts                                               3.4

Total                                                                            30

If NIS 2+ billion more came from cuts in a 12 month budget, NIS 10 billion less came from revenues, NIS 20 billion instead of NIS 30 billion. Since revenues were also calculated over 18 months instead of 12 months, though some come into effect only in 2014, the target is less than half of the amount anticipated. So the distribution between expenditure cuts and revenues is made much more even and the target for revenues is lowered effectively by one-third. The total anticipated increase in revenue by the end of 2014 is expected to be NIS 4 billion in 2013 and NIS 14 billion in 2014.

The Value Added Tax (VAT) is increased from 17 to 18% expected to yield about NIS 20 billion over 18 months. Additional VAT income is expected to come from a number of exclusions, especially in the tourist industry that will significantly affect the incentives for going to Eilat. Israel already enjoys a single-rate VAT with very few exemptions and this step will reduce them further. Another source of revenue is to come from tax increases set to come into effect in January 2014, an increase of 1.5% for those earning NIS 5000 shekels a month. That means not only that that everyone with a gross income of more than US$15,000 per annum will be paying an  increased tax of 1.5% but that the greatest percentage increase, from 14% to 15.5%, will fall on middle income earners paying taxes. Their increased tax burden goes up by 7%. Since half of Israelis earn under NIS 5,812 a month and half of those earn less than NIS 3,451 per month. On the other hand, health taxes will only be increased for those in the highest income bracket, over NIS 40,000 a month, or an upper middle income tax bracket. The increase will be .5%. Increased revenues will also come from pleasure taxes, namely tobacco and alcohol. Further, a new 25% land betterment tax, or speculative residential property tax will be levied on those who own second apartments with a minimum monthly revenue. The tax will be 25% of the profits, and profits are not discounted for inflation. There will also be a tax of 35% on pension income of over 15,000 shekels per month.    

The distribution of those cuts is even more interesting. Consider the technology sector first, the growth engine for a start-up nation and a knowledge economy. Netanyahu cut the technology sector support budget 10 years ago and Lapid cut it again. As a result of the ten year old cuts, the hi-tech sector stagnated, employment in the hi-tech sector also stagnated both in the sense of failing to grow at or above the rate of the Israeli economy in general. Further, the enrolment in hi-tech university programs has also not increased. In 2001, the hi-tech budget was NIS2.3 billion. In 2007 it was NIS 1.4 billion. Last year it was up again to NIS1.57 billion but Lapid cut the hi-tech budget by just over a third to only NIS1 billion.

Revenue could have been obtained by increasing the corporate tax rate by more than 1% but this would have run counter to the shelved plans to reduce corporate tax rates from 24% to 18%. Similarly, plans to reduce the top rate of income tax from 45% to 39% have also been shelved (the Trajtenberg Commission). The surcharge on incomes over NIS 1 million has been retained but not increased. It is not clear how efforts to enhance Arab women and Haredi participation in the work force are calculated in the budget in terms of enhanced revenues as well as reduced expenditures. I also do not know how the increased taxes on second apartments are factored into the budget.

Israel has also been unique in having a two year budget cycle since 2009 instead of a one year budget presumably allowing better planning but accomplished only through greater rigidities and less flexibility. This 18 month budget may create more benefits and put less emphasis on rigidities, but we will have to see. However, I consider this a disastrous budget for the poor and almost as bad for the lower middle classes totally contradicting the goal of reducing economic disparities and launching a fight against poverty. VAT increasingly weighs heaviest against the lower income groups in society; it is a regressive tax. The next target is the lowest tax bracket of earners. These are the income earners who will suffer most. When one adds the significant tax cuts planned to child benefits and to support for day care, as well as other cuts not so much in the public eye, such as cuts to paying for dental treatment, then it is clear who is hit worst. In contrast, corporations only have to bear an additional 1% in corporate taxes and the option of closing the vast majority of loopholes has been lost.

Note, unlike Canada, this is a proposed budget – other Ministers will jockey for changes. Expect changes before a final proposal goes for debate before the Knesset. My own suspicion is that the 18 month cycle is meant to make it harder to calculate comparisons rather than for either planning or flexibility considerations. Nevertheless, whatever changes are made, there is no indication that the budget will reduce the cost of living, enhance free market competition or reduce economic disparities in the fight against poverty.

Tomorrow morning I will be in the hospital to have a stent put in a coronary artery so my next blog may have to wait until Tuesday.