Israel's fiscal Pandora's boxes

Amiram Barkat

The government's parallel spending trick, known as "boxes",imperils Israel's hard-won credit rating and economic good name.

The economic crisis is at its height, but a state budget is still not in sight. The Ministry of Finance is trying to crack the formula for assisting the economy without violating the principles that shape the state budget. Thus the "non-budget box" came into our lives. For example, the Ministry of Finance is currently working on a NIS 30 billion "box" for infrastructure initiatives, following several previous boxes already approved.

The term "box", which was hardly known outside the walls of the Ministry of Finance, has become an important element of the economy in recent days. For government ministries, large projects in waiting, and thousands of unemployed people, the box is a lifeline. On the other hand, there are warnings that this is an extreme measure liable to endanger the stability of the economy.

To understand how the boxes method was born, you have to go back to 2005. Ariel Sharon's government is about to carry out the disengagement from the Gaza Strip. The minister of finance at the time, Benjamin Netanyahu, is threatening to resign if the plan is approved by the government. On the desk of the budgets commissioner in the Ministry of Finance, Kobi Haber, is a long list of budget demands. The main one is a compensation package for every Israeli resident of Gush Katif in the Gaza Strip who will be evicted from their home. Among other expenses are the cost of training thousands soldiers and other security forces to evacuate the residents, and the cost of the operation itself. The total price tag for all these items, some immediate and some spread over several years, comes to NIS 7 billion.

Haber has no source for financing these expenses, with the economy just starting to recover from the second intifada. What concerns Haber most is the "expenditure rule", the new budget limit set by Netanyahu just two years previously. This stipulates that the state budget can grow by no more than 1% annually. The international rating agencies, the International Monetary Fund, and other international bodies, like this rule, which ensures that Israel's debt to GDP ratio will gradually fall.

What to do? Haber realizes that he has no choice. He will have to open the budget, but he doesn't want to breach the new spending rule, and he thinks up the following solution: a special budget for the disengagement, to be separate from the state budget. This is a budget that undergoes a full legislative procedure in the Knesset, just like the state budget bill, with one significant difference - the government doesn't fall and the Knesset is not dissolved if the bill fails to pass within an allotted time.

This budget (the name "box" would come later) is not caught by the spending rule, even though it requires expansion of the fiscal deficit. Thus Israel can continue to claim that it is committed to the spending limit. Such an exercise can only work if it is a matter of one-time expenditure.

Haber's idea won the backing of the Bank of Israel (then headed by Stanley Fischer) and survived the searching eye of the credit rating agencies. As far as they were concerned, Israel's commitment to maintaining fiscal responsibility in the long term was more important than a short-term bluff.

The trick worked so well that it was repeated a year after the disengagement, in 2006. This time, the prime minister is Ehud Olmert, and once again a large one-time project is on the agenda: replenishing the IDF's stock of munitions, which has been depleted in the Second Lebanon War. Prime Minister's Office director general Raanan Dinur gives the spending supplement the whitewashing name "box". Some of the extra resource was diverted to strengthening ministerial budgets. The war spending actually came out a property tax fund.

Crisis safety nets

The boxes method came back into our lives this year, in the wake of an almost impossible reality. On the one hand, the coronavirus crisis obliges the state to pour money into the economy and provide a safety net for people laid off, for the self-employed, and for owners of collapsing businesses. On the other hand, the government is being run without an approved state budget, and so it may not expend more money than in the last approved budget (the 2019 budget, which the Knesset passed in 2018 and which was planned in 2017). The only way out of this fiscal and political impasse is to put the coronavirus plans in boxes.

The first box was prepared for the first rescue plan, amounting to NIS 80 billion, which got underway in April. The state's participation in the first plan was NIS 34 billion, and the legal basis for spending this sum was created through an amendment to The Basic Law: The State Economy, by a majority of 61 members of Knesset. This allowed the Ministry of Finance to expand spending by 8.5% over the limit.

In early June, the government aid program was expanded to NIS 105 billion, and another box, amounting to NIS 15.5 billion, was created.

The third box, amounting to NIS 25 billion, anchors the government's participation in the Israel Katz's extension of the safety net (to June 2021), and a fourth box, amounting to NIS 6.7 billion, is for financing Netanyahu's handouts to every Israeli.

A fifth box landed on the government's table this week: NIS 4.12 billion for education, and after its approval the legally mandated spending ceiling has been exceeded. But that is by no means the end.

This last box, for the education budget, represents further erosion of the box rules. This is not a matter of a one-time event, but of a budget for a particular ministry. If it can be done for education, why not for defense, or for health?

Kosher, but it doesn't smell too good

The boxes method has proven a kosher (if rotten smelling) option for running the country without an approved state budget. It Is not clear, however, whether it will be possible to continue with it if an election is called and the Knesset is dissolved. A transitional government does not on the face of it have the authority to introduce fiscal legislation, but then many things that seemed impossible last year have become possible thanks to the excuse of an emergency and a once-in-a-century health crisis.

The upshot is that as the prospect of approval of the 2020 budget (with or without 2021) recedes, and as the prospect of dissolution of the Knesset and an election looms, pressure grows on the Ministry of Finance to produce more and more boxes, before it's too late.

The hottest box on the agenda is a supplement to the defense budget. The prime minster and the minister of finance have already promised the chief of staff another NIS 3.3 billion this year. Further down the track, sources inform "Globes", a huge box is being put together for infrastructure. In this case, it's a question of something desired both by the minister and by ministry officials.

So what's wrong with this method? If it's a matter of a transparent budget requiring a full legislative procedure, why not continue with boxes ad infinitum? The main fear is that every bluff has a limit and every bubble must burst sooner or later.

The credit rating agencies will not be able to overlook this double budgeting: one orderly budget set in advance, and a parallel budget not subject to the spending rules that grows every time in accordance with this or that need.

At some point, they will pull out a yellow card, in the form of a downgrade of Israel's rating outlook, or even, heaven forbid, a downgrade of the rating itself. If that happens, Israel will pay a high price. The direct damage will be a higher cost of raising the huge debt that the state needs in these times. The indirect damage will be a severe blow to the successful image that has been built up for the Israeli economy over nearly twenty years.

Published by Globes, Israel business news - - on August 3, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

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