Asked in an interview on Galei Tzahal (Army Radio) what should be done about the budget deficit, Prime Minister Benjamin Netanyahu answered, "The way I handle the budget deficit is first of all by cutting spending, not by raising taxes, because what happens when you raise taxes? I get less tax revenue and increase the deficit, so I won't raise taxes. Government ministries have quite a bit of waste. There are still layers of fat there that haven't been addressed, although less than there were before."
How will the next government cope with the budget deficit that it will inherit? Based on talks with former senior officials of the Ministry of Finance budget department who were in charge of preparation and approval of the state budget, we have constructed the most likely scenario for the action that the next government will take.
This path, we will already reveal, is composed mainly of increases in three taxes: VAT, income tax, and corporate tax. All other possible measures, including elimination of tax distortions and exemptions, across-the-board cuts, and cuts in budget for a specific sector, will be affected by the composition of the next government, but are of secondary importance from a fiscal standpoint.
For this reason, at least in the opinion of those with experience in this aspect, the question of what government will eventually be formed is of little importance. A coalition composed of rightwing and haredi (Jewish ultra-Orthodox) parties, a unity government of center-right parties, or any other government will all eventually be forced to increase the same taxes. How will the politicians explain their u-turn?
Politicians talk and economists count
Netanyahu's remarks about his plans for handling the deficit come as no surprise. Furthermore, they do not differ from what his main political rivals, the leaders of the Blue and White Party, are saying. Even Yair Lapid, the party's leading figure in charge of its statements on economic issues, said that he would opposed tax hikes and under pressure would choose to cut excessive government spending.
Actually, we have heard general opposition to tax hikes from all of the parties running for the 22nd Knesset. Only one party, the Labor Party, proposes increasing the surtax on high incomes. On the other hand, the Labor Party also proposes a large increase in state spending, so the deficit itself will not be decreased. Incidentally, current Minister of Finance Moshe Kahlon has announced that he opposes a cut in government spending, explaining that the correct way of dealing with the deficit problem is "a change in priorities."
While the politicians are busy making pre-election statements, the Ministry of Finance is preparing a plan for the 2020 budget and the presentations accompanying it for the next minister of finance, and later for the prime minister and the cabinet. The projected state budget deficit is NIS 50 billion, 4% of GDP. The Ministry of Finance professionals staff intends to recommend that the government set a deficit target of 2.5% of GDP for 2020, which will require a cut of at least NIS 22.6 billion.
The Ministry of Finance's professional staff, which spent a long time working on the 2020 budget, has also prepared a long list of possible cutbacks for presentation to the next minister of finance. These include elimination of the VAT exemption for personal imports, reported yesterday by "Globes;" partial or full elimination of the tax exemption for rental income; a "health environmental" tax on sugary drinks and disposable cutlery; taxes on digital services (applets); lowering the tax exemption ceiling on deposits in study funds; a congestion tax; changes in the Law for the Encouragement of Capital Investment; and many more.
What measures will be adopted and how they will be marketed
The advantage of all of these measures is that they should not detract from economic growth, because they are designed to correct distortions in the tax system. These measures, however, all share two disadvantages. First of all, each of them increases the state's revenue by a relatively small amount, and many such measures are therefore needed in order to reduce the deficit to the required extent. Secondly, it is very difficult to push them along the exhausting path to Knesset approval of the budget on its third reading. Each such measure harms the economic interests of one pressure group or another.
What will happen when the economic logic of the Ministry of Finance professional staff meets the government's political logic? For this, we consulted previous budget directors who worked on previous budgets, and this is what they predict.
First of all, they say, it is likely that the budget deficit target will be raised to almost 3%, the red line of all recent Israeli governments. This will reduce the required budget cut to NIS 7-8 billion. The easiest way of bolstering state revenues is to raise VAT, income tax, and corporate tax by 1%, which will increase state revenues by a total of NIS 11 billion. The Ministry of Finance veterans believe that all of the other measures listed above that the Ministry of Finance wants to implement will yield NIS 1 billion or NIS 2 billion, once they have been through the grinder of the cabinet and the Knesset.
What about government spending? Economists believe that in contrast to what the politicians say, there is not much fat to cut. The only real fat that the Ministry of Finance has managed to push through in recent years is an across-the-board cut - a "stupid" cut. Approval of the 2019 budget, however, already included a future 2.5% across-the-board cut in the 2020 budget and a 7% cut in the 2021 budget.
The Ministry of Finance's problem in this case will be a deviation from the spending ceiling, but it can be overcome in a very simple way that has become very common in recent years - raising the spending ceiling by changing the law.
How will the next prime minister and minister of finance explain the fact that they raised taxes, after having stated that they would do exactly the opposite? "They will tell the public that the tax hike is temporary - for one year, or for two at the most," a former budget director told us. "They will promise that taxes will go back down as soon as the problem is solved.
"They will also make some kind of concession and make it stand out. For example, they could decide that a 1% income tax hike will not apply to the first tax bracket, and then they'll tell us that the middle class won't be affected by the tax hike. At the same time, they'll tell the public that the social budgets have been greatly increased, which is a half-truth, because these budgets should increase anyway because of the population increase and old commitments. That won't keep the politicians from claiming that there is a change in priorities, though."
Unity government versus narrow rightwing government
Here we come to a question of interest to the voter - how the state budget will be affected by the composition of the next government. After we said that the big measures would take place regardless of the election results, here are nonetheless several relevant distinctions. First of all, it can be said that a narrow government will make it very difficult for the Ministry of Finance to push through unpopular measures, especially those having a negative impact on pressure groups with representation and influence in the coalition. It is likely that agreement will be reached on a reduction and limitation in the number of ministers in a broad center-right government, which will pave the way for reducing the number of government ministries. This measure can save the state NIS 50-150 million a year. In a narrow government, however, the number of ministers will remain high, given the greater bargaining power of each member faction in the coalition.
A government without haredi parties is likely to cut special budgets for this sector, notably support for yeshiva students, which amounts to NIS 1.3 billion a year, and other measures taken during the Netanyahu-Lapid government. Such a government is much more likely to raise taxes on sugary drinks and disposable cutlery - measures that will be unpopular in a narrow government of rightwing and haredi parties. In a narrow government on this format, there is little likelihood of enacting any spending cuts beyond the usual across-the-board cut. At the same time, opposition to tax hikes by the coalition partners is likely to be weaker, especially corporate taxes and taxes that affect high income earners. The main opposition to these meaures will come from the prime minister.
Published by Globes, Israel business news - en.globes.co.il - on September 16, 2019
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