CPI underestimation: State gains, citizens lose

Rental homes in Jerusalem photo: 3division
Rental homes in Jerusalem photo: 3division

An investigation by "Globes" shows that the underestimation of inflation saved the state NIS 3.5 billion in interest payments.

Retroactively revising the Consumer Price Index (CPI) from 2010 onwards is a step that will shake the Israeli economy, and therefore appears to be very unlikely, despite the recommendations by the public committee, headed by Dr. Danny Ben-Shahar, appointed to examine the method used to calculate housing prices in Israel.

The Central Bureau of Statistics yesterday published the first official statement on the matter, after "Globes" revealed the error in rent measurement. Although Central Bureau of Statistics sources yesterday predicted that the CPI would not be retroactively revised, the Central Bureau of Statistics admitted that the public committee's recommendations on income-producing housing had posed a real dilemma.

According to the recommendations in the committee's interim report, rent statistics in Israel should be retroactively corrected going back to 2010. The rent index is part of the CPI, and it is therefore unclear how the indices can be separated and the committee's recommendations implemented without changing all the inflation figures from 2010 onwards.

The CPI has never been retroactively revised, and there is no accepted methodology for doing so, in contrast to other indices published by the Central Bureau of Statistics. The reason why is simple - the CPI is a key element in the economy's price system. It directly or indirectly affects all aspects of Israel's economy and all of its citizens. Since the hyperinflation of the 1980s, the Israeli economy has been linked to the CPI. Revising the CPI can also have far-reaching legal consequences. For example, Israel's government debt totaled NIS 741 billion as of the end of 2016. 41% of this debt, NIS 300 billion, is index-linked. An increase of 1% in the CPI increases Israel's sovereign debt by NIS 3.8 billion. Retroactive revision of inflation will ostensibly require the state to pay interest rate differences to all of its bondholders.

In addition, income tax and purchase tax are graduated taxes. The state revises its tax brackets every year. The fact that the brackets were not fully revised means that the public paid more income and purchase tax that it should have. On the other hand, vehicle owners who pay for fuel and do not have a company car saved several shekels over the years due to the fact that excise tax, which is index-linked, was not fully revised.

The Israeli government is the big winner from the fact that the official indices were lower than the actual indices, both in lower interest payments and failure to adequately update CPI-linked budget spending. The state also profited from a higher tax burden, with the direct loss in this case belonging to the taxpayers. If we add the pensioners and employees whose wages are CPI-linked to the equation, it can be definitely stated that in the bottom line, the state won and the private citizen lost.

The state saved NIS 3.5 billion in interest payments

Israel saved NIS 3.5 billion in interest payments as a result of the fact that the CPI did not fully reflect actual inflation for the past decade, according to an assessment commissioned by "Globes" from Meitav Dash Investments Ltd. (TASE:MTDS) chief economist Alex Zabezhinsky.

The assessment is based on the assumption that the public committee's estimates for housing prices will be confirmed. Zabezhinsky said, "To the best of my knowledge, finding an error in the calculation of the CPI is an unprecedented event. I do not believe that the CPI will be retroactively revised, because it is impossible to recalculate all the differences in contracts and bonds. Furthermore, keep in mind that the error was in gathering the data, not in calculation."

The Bank of Israel today rejected the argument that its monetary policy had been biased because of the error in calculating rent. A Bank of Israel assessment found that the methodological error in calculating inflation had made no difference over the past two years. Most of the effect was in earlier years, i.e. starting in 2008. The effect during those years was 1-2%.

As for the future effect of the revision, economists today predicted that rents would have a greater effect on the CPI than previously if the effect is in both directions.

The Bank of Israel said in response, "The Bank of Israel is in constant contact with professional personnel at the Central Bureau of Statistics. Initial evaluations conducted by the Bank of Israel show that the effects of the difference in the measurement of inflation in the CPI were small, and certainly not large enough to affect monetary policy."

Published by Globes [online], Israel Business News - www.globes-online.com - on January 31, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

Rental homes in Jerusalem photo: 3division
Rental homes in Jerusalem photo: 3division
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