Remarks by Bank of Israel Governor Dr. Karnit Flug at the cabinet meeting on the 2019 state budget
The current budget was formulated under very good conditions in terms of the macroeconomic environment: the economy at full employment and stable growth; significantly improved terms of trade that increased national income even further and strengthen the state of Israeli corporations; the recovering global economy; increasing wages; and a stable financial system. These conditions helped the government respond to various social needs, while also lowering the debt to GDP ratio. Even in the defense area, there were not significant confrontations that interrupted economic activity or required large-scale exceptional expenditures. These assumptions also form the basis for the forecasts for 2018 and 2019. Yet despite this, the government must raise the deficit target that it set for itself to a high level.
The Bank of Israel’s forecast of tax revenue is similar to that of the Ministry of Finance. Nontax revenue includes one-off revenue items such as dividends from various state companies, the payment of royalties from the Airports Authority and from the Local Authorities’ Environmental Sanitation Fund, and encouraging government offices to file law suits—and we must be cautious when basing revenue forecasts on these measures. Measures such as these have proven to be difficult to realize in previous years, and have made budgetary adjustments necessary during the fiscal year.
The budget framework:
The need to increase the deficit target is due to the dissipation of the effect of one-off factors that increased revenue in 2017, alongside government decisions to expand important services and to assist weak population groups, as well as expenditures due to coalition agreements and other issues. The additional increase in the expenditure framework reflects the government’s difficulty in dealing with important issues within the framework derived from the expenditure rule, given that civilian expenditure as a share of GDP is very low. Therefore, the planned government expenditure for 2020–2022 is already higher than the ceiling permitted under the rule. This makes it even more necessary to consider a framework that is in line with the fiscal rules, in view of the fact that in recent years, the expenditure rule has frequently been disregarded, indicating that it does not reflect the priorities of policymakers (the government) regarding the volume of expenditure. This also shows how necessary it is to leave a significant reserve in the budget for 2019, since in the long time that remains until it comes into effect, it is reasonable to assume that additional budgetary needs will come up, as they did in the year since the previous budget was passed.
In the current state of the economy, which is apparently at the peak of the business cycle—with low unemployment and a tight labor market—it is not wise to raise the deficit target to a rate that will lead over time to an increase in the debt to GDP ratio. The target of 2.5 percent that is set in the law as of now would stabilize the debt to GDP ratio, and it would be desired to maintain it, certainly while the economy is at full employment.
It is important to remember that in recent years, the debt to GDP ratio declined while actual deficits averaged around 2 percent of GDP, even if the targets set at the start of the period were higher. The assumption that the actual deficit will be lower than the target in the coming year as well, because it will turn out that the tax revenue forecast is too low, relies on the experience of the past three years. But in the not-too-distant past, there were also large deviations in the other direction, in Israel as well as in many other countries. If we look at slightly longer periods, we find that there is no systematic deviation in any one direction in the estimates of tax revenue. Recent experience from other countries —as well as our own from the beginning of the previous decade—shows that a debt to GDP ratio that is too low may jump rapidly during a crisis. Our experience from 2012 and 2013 shows that deficits that seem reasonable during periods of economic peak increase rapidly when the economic environment changes, which then calls for budgetary restraint precisely when the economy is in a slowdown.
Obviously, increasing the target to levels even higher than proposed, under the current macroeconomic conditions, will constitute a negative signal to the markets. Market players are aware of the reality in which accommodative policies are implemented during economic peaks and their results are exposed during downturns. While it is likely that the results of the deficit increase proposed today will only be seen at the next change in the business cycle, it would be a shame for the Israeli economy to limit its ability to use an anti-cyclical fiscal policy to deal with the next crisis—which will come at some point.
Among the many issues included in the budget proposal, I would like to relate specifically to one, which is very important:
The budget proposal includes an expansion of long-term care provided by the National Insurance Institute. The government’s readiness to deal with the issue of long-term care for the elderly is of top importance due to the social necessity to ensure proper living conditions for the home-bound elderly, and the significant potential cost of the aging of the population. The measure included in the budget proposal provide an initial and immediate response to some of the needs. It is important to advance the discussion of a comprehensive long-term solution—while providing a response to the need to allocate budgetary sources—to the issue of long-term care in Israel. For this purpose, the Bank of Israel again calls for the establishment of a comprehensive team of all entities working in the field to present a multidimensional program for dealing with the expected increase in the population that will need these services, and the difficulty of parts of the public in meeting its costs.
While the budget proposal and the economic plan include important socioeconomic steps, and most of the increase in expenditure in recent years has been channeled to this area, it lacks a comprehensive discussion of dealing with the low productivity in the Israeli economy. Closing the continuing gap in productivity between Israel and the other advanced economies will require significant investments, mainly in infrastructure development—not all of which can be financed by the business sector (through PPP)—and in education. While it is important that the government act in parallel to improve efficiency in the use of resources in these areas, our low level of expenditure will not be sufficient to support closing the large and continuing productivity gaps between us and the other advanced economies. Even if the government doesn’t have a prepared plan of action right now, it is important to formulate such a plan soon, and to ensure that it will be possible to allocate the budgetary sources for its implementation. Increasing productivity in the economy is the key to long-term, sustainable and inclusive growth, and to increasing the standard of living of all layers of the population over time.