Karnit Flug lends support to raising deficit

Karnit Flug

But the Bank of Israel is still insisting on a tax hike.

Bank of Israel, led by Governor Karnit Flug, agrees that the budget deficit for 2015 should be raised from 2.5% to 3% as a one-time measure, and is calling for a tax increase to ease the future burden on the public of a gradual reduction to 60% of the ratio of government debt to GDP by the end of the decade. The Bank is advocating a NIS 4.5 billion cut in the 2015 budget.

The Bank's position on the budget framework, published today, states, "In determining the combination of a tax increase, elimination of exemptions, and another cut in civilian spending, the fact that civilian spending in Israel is already very low by international standards should be taken into account. This makes it difficult to provide an appropriate response to socioeconomic challenges in education, health, welfare, etc. The short-term effect on growth of a tax increase is equivalent to that of a reduction in government spending."

The Bank adds, "A deviation from the schedule for reducing the debt-GDP ratio decided upon by the government in 2013 means a retreat from a previous commitment to continued debt reduction. The credibility of budgetary policy rests on meeting commitments in the long term, and constitutes an important element of the infrastructure supporting the economy's financial stability."

In the position document, Flug states that she agrees with an increase in the budget deficit target, provided it stems from one-time requirements for covering the costs of Operation Protective Edge and its results, as well as the emerging slowdown in revenue growth.

"At the same time," the Bank adds, "Increasing the deficit beyond such a one-time increase means a rise in the structural deficit, which would put Israel on the road to a higher debt-GDP ratio for the rest of the decade, and would cause an increase in the government's interest rate expenses."

The Bank of Israel based its position on the working assumption of lower growth than its June 2.9% forecast for 2014 and 3% growth in 2015. The working assumptions include scenarios of no tax increase and a NIS 2-3 billion loss in state revenue resulting from Minister of Finance Yair Lapid's 0% VAT program for apartments.

The Bank noted that the government's 2015 spending ceiling involves a 2.6% increase in real spending. "In these conditions, a 3.5% budget deficit can be expected, which is the equivalent of a structural deficit equal to 3% of VAT. This deficit does not allow a reduction in the ratio of debt to GDP," the Bank writes. Lapid has stated that the budget deficit target can be raised to 3.5%.

Published by Globes [online], Israel business news - www.globes-online.com - on August 27, 2014

© Copyright of Globes Publisher Itonut (1983) Ltd. 2014

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