• The state budget for 2021 and 2022 strikes a balance between the wish to avoid a fiscal contraction that may slow the economy’s recovery from the coronavirus crisis and the need to avoid an increase in the structural deficit that would burden the management of fiscal policy in the future.
  • The expected deficit in 2021 is much smaller than had been expected only a few months ago, due to a rapid increase in tax receipts, mirroring the auspicious macroeconomic picture, the minor economic effect of the fourth wave of COVID-19 morbidity, and anomalous increases in investments in the high-tech sector, consumer goods imports, and home sales.
  • Government expenditure on the COVID-19 crisis—NIS 69 billion in 2020—has contracted considerably and now centers on the healthcare system instead of financial support to households and businesses.
  • The freezing of public-sector wage accords, as part of the macroeconomic package deal, made it easier to construct the budget for 2021–22. It is important to base future years’ wage agreements on the trust that the parties to the deal established in order to promote reforms that will improve the efficiency of government services, particularly by integrating digital processes into them.
  • When the 2022 budget is compared with that of 2019—the last year that had an approved budget and the year preceding the effects of the pandemic—two changes in spending stand out: a decrease in the defense budget as a share of GDP pursuant to the multiyear trend, and a major upturn in the infrastructure investment budget due to the maturation of programs that were advanced in recent years.
  • The economic plan approved along with the budget includes important reforms that will support sustainable economic growth, higher productivity, and responses to several structural issues in government activity and budget structure that will enhance the efficiency of government activity and save on budget costs in the long term.
  • The five-year plan for Arab society includes a large allocation of resources for the advancement of human capital, employment, infrastructure, and other matters in Arab society. It also contains mechanisms that will help to surmount barriers that impeded similar moves—albeit smaller—in the past.
  • The budgeting plan of the Greater Tel Aviv Metro is an important step toward the advancement of this critical infrastructure project. However, the enshrinement in law of the division of funding for this project between the general state budget and dedicated receipts, of which there is acute uncertainty as to their size and the timing of their arrival, may impede the advancement of the project and the its resulting expected utility.
  • The raising of women’s retirement age will reduce National Insurance outlays and abet an increase in older women’s employment in the long run. The approved path of aid goes further than previous proposals in alleviating the arrangement's influence on many of the weak groups that the arrangement will adversely impact.
  • The replacement of earmarked bonds with a guaranteed-yield mechanism for the pension funds is likely to generate considerable budget saving in the long run but also comes with considerable financial risks. It is important to manage these risks cautiously because their nature and magnitude are different from those in the other components of the budget.
  • There is a considerable gap between the estimated cost of the government’s existing liabilities and the level of expenditure that is allowed by the expenditure rule after 2022. In the past, as in this year, such gaps made it necessary to raise the expenditure ceiling.
  • Ahead of the next budget, it is important to examine the contribution of the expenditure ceiling, its level, and its structure in view of the need to promote the permanent investments in infrastructure and human capital that are essential for the elimination of productivity gaps between Israel and the other advanced economies, and in view of the importance of maintaining fiscal space.
  •   A revision of the historical National Accounts data yielded a more optimistic estimate of the economy’s potential growth rate later in this decade and created a wider margin for the shaping of budget policy. Nevertheless, due to the large structural deficit, a major increase in investment while maintaining a stable debt to GDP ratio, and a fortiori a declining one, still requires both restraint of the growth of other spending and a tax increase.

 

On November 16, 2021, the Bank of Israel published a survey of the state budget and the economic plan for 2021 and 2022 approved by the Knesset; the fiscal picture for the current year; and the picture foreseen in the next two years and the rest of the decade.

The budget framework and its composition reflect several important macroeconomic considerations. (1) First, the state of the economy must be borne in mind: The budget must not restrain activity before the economy recovers from the coronavirus crisis; at the same time, it should not increase the structural deficit, which was high even before the crisis, because such an increase might raise the debt to GDP ratio excessively and leave fewer sources available in future budgets to fund the government investments that are needed to improve labor productivity and cope with future crises. (2) The budget needs to address structural matters of importance for long-term growth that were not dealt with under the interim budget. (3) It should restore operational stability to the government ministries’ work, which was disrupted by prolonged government activity on the basis of interim budgets and, particularly, activity based on the 2019 budget, which was approved early in 2018 and therefore underwent only limited adjustments for subsequent changes in needs.

The newly approved budget responds to these matters well. The deficit target was set at a level similar to the structural deficit that predated the coronavirus crisis, avoiding fiscal restraint in 2022 and postponing such consolidation until the economy rebounds from the coronavirus crisis. Concurrently, by not raising the structural deficit, the budget stabilyses the debt ratio and facilitates preparations for longer-term fiscal investments in the following budgets. The economic plan that accompanies the budget includes important reforms that will abet faster and sustainable economic growth and treatment of acute social issues, and its frameworks systematize many necessary adjustments of ministries’ budgets since the last budget was approved. Thus, the budget creates a  foundation for the advancement of another stage in the reforms that are needed for the advancement of the economy in the budgets for 2023 and subsequent years.[1]

As the budget details were being debated, the expected deficit in 2021 contracted considerably, largely due to a rapid increase in tax receipts, and is now projected at 5–5.5 percent of GDP as against the 6.8 percent target that was set when the budget was approved by the government. The increase in tax revenues reflects the auspicious macroeconomic picture and the minor impact of the fourth wave of COVID-19 morbidity on the economy due to the small amount of government restrictions on economic activity and the adjustments that the business sector made in view of the lessons of the previous waves. The strong growth also reflected exceptional increases in investments in the high-tech sector, imports of consumer goods, and home sales. All of these manifested in an upturn of 1.5–2.0 percentage points in the share of tax receipts in GDP relative to the level in the pre-pandemic years despite the lack of increases in tax rates during that time. Even though tax receipts have remained strong in the past few months, such upturns in receipts tend to ease off; accordingly, the government adopted a moderate revenue forecast for 2022. The Bank of Israel’s forecast for 2022 reflects similar moderacy.

Alongside the strong revenues, government spending in 2021 has increased gently thus far, reflecting the restraints on activity that apply under an interim budget. In the time remaining between the approval of the budget and the end of the year, the ministries’ budget performance is expected to accelerate considerably, but there is doubt whether all of the approved budget expenditure can be spent by the end of the year. The larger the remaining surpluses are, the more the actual budget deficit will decrease further. In addition, the earmarked expenditure for matters related to the coronavirus crisis, which summed up to NIS 69 billion in 2020, contracted this year and is expected to fall short of the sum budgeted at the beginning of the year. Another measure that contributed to the restraint of government expenditure was the freezing of public-sector wage agreements as part of the macroeconomic package deal. Along with the stability and budgetary savings that this arrangement brought about, it is important to base future wage agreements on the trust that was created among the partners to the arrangement in order to promote reforms that will enhance the efficiency of government services, particularly by integrating digital processes into their work.

Examination of the composition of the budget for 2022 (excluding coronavirus expenditure) in comparison with the 2019 budget—the last approved budget and the last pre-pandemic budget—indicates that the share in GDP of most main expenditure items such as healthcare, education, and transfers to the National Insurance Institute did not change substantially. The two most noticeable changes in the composition of the budget are a decrease in the defense budget by more than half a percent of GDP and a sizable 0.6 percent of GDP increase in the infrastructure investment budget, due to the maturation of programs that were advanced in recent years. The increase of investment in the public-transport infrastructure, insofar as it comes to pass and continues in coming years, is an important key to raising labor productivity, expanding and elasticizing housing supply, and improving the quality and standard of living.

Along with the budget, the Knesset approved an extensive economic plan that has the potential of contributing meaningfully to economic growth, raising labor productivity, and narrowing disparities among different population groups. Important parts of the program are consistent with the recommendations that the Bank of Israel presented to the government when it was established.

There is considerable benefit in promoting such reforms in regular legislation in the course of the year, but the difficulty of advancing structural economic moves in recent years has caused a cumulative gap to build up. Therefore, it is important to have approved the economic program at this time as a work plan for the current government and a roadmap for the Israeli economy. Concurrently, the discussion of additional reforms, deferred thus far, should be launched presently, and not postponed until the next budget.

The large-scale reforms that were approved along with the budget include activating a plan for the construction of the Greater Tel Aviv Metro, a five-year plan for Arab society, eliminating import barriers, improving government regulation, and measures to expand the use of digital media in government services. Even if some of these reforms will have to be adjusted over time, the steps adopted now are likely to promote investments and greater efficiency in the business sector, accelerate the economy’s rebound from the coronavirus crisis, and improve the standard of living sustainably. Despite these important structural programs, gaps in human capital investment remain and the current program gives them limited attention. It is important to deal with these matters within the framework of future budgets because they concern long-term processes that offer much benefit for long-term growth in Israel.

One of the most important programs promoted by means of the budget is the NIS 30 billion five-year plan for Arab society. The sizable budget resources that the plan allocates focus on the enhancement of human capital, employment, and infrastructure in Arab society, all of which suffer from cumulative disparities that impede Israeli Arabs’ integration into the economy and impair their quality of life. Beyond the large budgets, the program contains mechanisms that will help to surmount the barriers that restrained the fulfillment of similar moves in the past. The success of the program is important not only for Arab society but also for the fulfillment and amplification of the economic potential of this society, which accounts for a sizable share of the working-age population.

An important strategic measure for the enhancement of productivity is the construction of the Greater Tel Aviv Metro, part of a systemic solution to the problem of congestion and mobility in the metropolitan area. In the Economic Arrangements Law, a framework for the budgeting of the Metro - an important step toward progress in creating this critical infrastructure - was approved, along with several specific measures that will raise earmarked revenue for the funding of the project. In one of its components, however, the law establishes a permanent division of funding between the government and the earmarked receipts. Since there is much uncertainty about the extent and the timing of arrival of these receipts, the creation of a permanent structure of funding may impede the performance of the project and the realization of its benefits. Therefore, it should be determined in supplemental legislation that the government will fund the expenditures that are needed to promote the project each year at such an extent as shall be needed to complement the receipts from the earmarked revenues as determined—while keeping the total costs in balance and using the adjustment and updating mechanism that the law provides.

The Economic Arrangements Law includes two economic measures that may create considerable budget savings in the long term:

1.     Raising women’s retirement age to 65 by year 2032—this measure, which is also expected to help increase the employment of older women, was been elayed for many years and has now been approved. This became possible due to an increase in aid for many weaker groups that may be adversely impacted by the arrangement, relative to previous proposals;

2.     Replacing earmarked bonds with a guaranteed-yield mechanism for the pension funds. This is expected to generate considerable budget saving in the long run, but also comes with considerable financial risks due to the magnitude of the sums insured and the potential shocks to the capital market. It is important to manage these risks cautiously because their nature and size are markedly different from those in the other components of the budget.

The survey analyzes the expected trajectory of the fiscal aggregates—particularly the deficit and the debt to GDP ratio—in the medium and long terms and under various policy scenarios. With the revision of the historical National Accounts data in August 2021 in the background, a more optimistic picture surfaces of the potential growth rate of the economy as the decade continues, reflected in a wider fiscal space for the shaping of budget policy. Even with this optimistic picture, however, it is found that, due to the large structural deficit, a major increase in investment while maintaining a stable debt to GDP ratio, and a fortiori a declining one, will still require both restraint of the growth of other spending and a tax increase.

The survey presents another analysis, according to which, a rather large gap emerges between the estimated cost of the government’s existing liabilities and the level of expenditure that is allowed by the expenditure rule after 2022. In the past, as in this year, such gaps made it necessary to raise the expenditure ceiling. Ahead of the next budget, it is important to examine the contribution of the expenditure ceiling, its level, and its structure in view of the need to promote the permanent investments in infrastructure and human capital that are essential for eliminating the productivity gaps between Israel and the other advanced economies, and in view of the importance of maintaining fiscal space.

 


[1] For a discussion of the multiyear reforms that the government can promote in order to support an upturn in productivity, see “Four Recommended Pillars of Strategic Government Action to Accelerate Economic Growth and a Fiscal Framework for Financing Them,” Bank of Israel, June 2021.

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