The Ministry of Finance and the Bank of Israel published a joint statement this afternoon saying, "In a meeting today, Minister of Finance Yair Lapid and Governor of the Bank of Israel Karnit Flug discussed several issues, including the 2015 budget framework. The minister and the governor emphasized the importance of continuous and good working relations between them, and between the Finance Ministry and the Bank of Israel, and agreed to continue a regular dialogue on all matters on the agenda at both the ministerial and professional echelons."
This laconic statement in effect summarizes the Lapid-Flug "summit," which did not arouse many expectations from the two parties. Following the prolonged cabinet meeting, Lapid and Flug kept their meeting short.
Unbridgeable differences?
The personal tension between Lapid and Flug did not dissipate even after Lapid's alleged telephone apology to Flug two days ago. The points of dispute concerning the state budget - the deficit target, tax increases, and the socioeconomic initiatives of Lapid and his cronies - appear unbridgeable without the prime minister's intervention.
Flug enjoyed a rare moment of satisfaction, after being the butt of a series of especially crude remarks by the Finance Minister and his entourage in recent days. Her intimates specifically noted three remarks: Lapid's statement in a meeting with the prime minister that Flug and National Economic Council chairman Prof. Eugene Kandel "lacked experience in the business world," and that their slant on the state budget was therefore "academic;" the report in "Globes" that a "senior economic source" said that Flug had been "hysterical" in her recent interest rate cut; and the interview granted by Uri Shani to journalist Yehuda Sharoni, in which he called Flug "a clerk."
Shani published an announcement on his Twitter account expressing regret about the effect of his remarks about Flug, but he did not retract his statement. Where Lapid is concerned, in response to questions, the Bank of Israel did not deny that Lapid had apologized to Flug for his hurtful remarks. The Finance Minister's office declined to comment on the matter.
Each side behind its red lines
With respect to the professional disputes on the state budget, it appears that the Bank of Israel and the Finance Ministry are each digging in around the red lines that they have set. The Bank of Israel appeared determined not to permit an additional increase in the deficit target, while the Finance Ministry continues to oppose tax increases, both direct and indirect, for the purpose of paying for the budget gap created by Operation Protective Edge.
The Finance Ministry is already talking about raising the deficit target for 2015 from 2.5% to "a little over 3%" of GDP. The Bank of Israel is refusing to raise the target above 3%, fearing a blow to credibility that is liable to affect Israel's medium and long-term credit rating. The Finance Ministry believes that the threat of a lower credit rating should not be a decisive consideration. The Finance Ministry is also saying that only a target is involved, based on tax revenue forecasts, which have often been wrong in the past, among other things as a result of favorable one-time events, such as the sale of a controlling share in Iscar Ltd. and the huge exit by Waze.
The Bank of Israel took in its stride the severe criticism of Flug by Federation of Israeli Chambers of Commerce Uriel Lynn because of her demand for a tax increase, despite concern about its harmful impact on growth. Against the assertion that the burden of indirect taxation in Israel is already among the highest in the world, the Bank of Israel says that tax benefits, such as the VAT exemption for Eilat, the exemption for advanced training funds, and the VAT exemption for fruits and vegetables could be eliminated instead. The Bank believes that the fact that these measures were tried in the past, and failed, due to strong political opposition, should not deter the Finance Ministry from trying them again.
On the way to a compromise?
The Finance Ministry and the Bank agree that without tax increases and without a major increase to 4% in the deficit target, the government has only one possibility: cutting spending, but such a cut has few supporters at either the Bank of Israel or the Finance Ministry.
The Bank says that government spending in Israel is already among the lowest in the Western world, and that the effect on growth of raising taxes by one shekel is the same as the effect of cutting the budget by one shekel. Before cutting spending, Jerusalem economists say, suspending, reducing, and postponing initiatives that will impose a further burden on the state budget should be considered.
This is obviously aimed at the Finance Minister's planned VAT exemption for apartment purchasers, which will cost the state NIS 3 billion a year in revenue, but also refers to implementation of the recommendations of the German Committee for reform in the health system and the Allalouf Committee on Reducing Poverty. The economists say that Lapid's VAT exemption is not a one-time expense (such as the costs of Operation Protective Edge, for example); it is a permanent cost that enlarges the structural element in the budget deficit.
As of now, it appears that the two sides are angling for a compromise in which each of them will concede a little, and the budget gap will be closed through a combination of measures that will probably include a concession on the VAT exemption by the Finance Minister.
Published by Globes [online], Israel business news - www.globes-online.com - on August 31, 2014
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