There Is no Alternative to Raising Taxes, Says Israel’s Chief Economist

Israel's budget deficit has risen steadily over the years, reaching much higher levels than the OECD average, with the finance ministry projecting it will reach 3.8% in 2020. To reduce the deficit, the next finance minister will have to cut down on inefficient expenses, Greenberg said.

Chief economist Shira Greenberg. Photo: Alex Kolomvisky

How did the finance ministry over-exceed the budget by such a high amount for the second time in a decade? According to Greenberg, this is mostly a matter of lower private consumption. "While the average growth stood at 3.5% over the past decade, our forecasts show that growth will fall to 3.1% for 2019 and 3.2% for 2020," she explained. "Low interest rates, low inflation and high employment rates that have led to wage increases in the private sector, and steps the government took to reduce living costs—all have turned private consumption into a growth engine. All these elements still exist, but not at the same level, which is the main reason private consumption has slowed."

In recent weeks, much of the economic debate in Israel has centered around a ministerial plan to revoke certain tax exemptions awarded under Israeli law. "Tax benefits offered for savings routes in Israel are greater than those offered in OECD countries, which justifies a reexamination of the matter," Greenberg said. Her division is looking into many types of exemptions and benefits and will recommend changes according to their findings, she said. "Our job is to come up with a wide range of possible steps that the finance minister and the government will be able to choose from according to their policy," she said.

While the government could take cost-cutting measures that will reduce the need for taxation changes, it will be very hard to deal with the current deficit without canceling tax exemptions or raising taxes at all, Greenberg said.

One of the reasons for the reduced government income is that Israel's main growth engine—its tech sector—underperformed recently, falling short of the finance ministry's forecasted revenues. "One of the factors that influenced Israel’s income is direct income from exits," Greenberg said. "While the wave of exits has continued during the past two years, Israel's direct income was much lower than before. This is partly due to the percentage of foreign ownership in the companies acquired."

Currently, not many Israeli institutional investors are bankrolling the Israeli tech industry, and credit lines are extended only to companies that already generate revenues, Greenberg said. The industry's funding processes do not necessarily encourage Israeli ownership, she added. "We are examining this issue, looking to bolster the growth of Israeli tech companies by the future addition of functions that could turn low-productivity employees into high-productivity ones. This, in turn, will increase direct taxes from future exits."

The matter of high versus low productivity is something the government will need to focus on in the future, both in terms of preserving the high productivity of the tech sector and of boosting the productivity of the rest of the Israeli industry, Greenberg said. "Tech makes up 12% of the private sector's product, while the rest of the industry contributes the other 88%," she explained.

While Israel's employment market is strong, there are warning signs, such as the decrease seen in the percentage of work-age people participating in the Israeli job market, Greenberg said. According to her, that decrease is mostly the result of changes in the composition of the Israeli population, such as a lower number of working ultra-Orthodox Jewish men.

A second warning sign is a lower increase in the number of available jobs in the private market compared to past years, a growth rate that now stands at 1% compared to 3%-4% in the public sector, according to Greenberg. "The government needs to incentivize people to seek employment, and to incentivize the private sector to create more jobs," she said, adding that changes also need to be made to ensure minority populations receive better education and life skills that will, in turn, enable them to find high-paying jobs.