The term “misconception” echoes loudly throughout the discourse on the War of Iron Swords. The premise of a “small but smart army,” reliant on technology over manpower, facing terrorist organizations that were considered non-existential threats, all crumbled on October 7th. But how about our economic landscape – have its conceptions also been shattered?
Indeed, Israel stands as a robust nation, economically speaking. Initial data reveals that Israel’s debt affords a comfortable margin – at 60% of GDP, in contrast to 130% in the United States, for instance. However, this constraint has imparted a crucial lesson: according to the forecast from the Ministry of Finance’s chief economist, the war is anticipated to curtail growth by approximately 1.4% in 2023 and 1.1% in 2024. These projections hinge on a scenario where intense combat concludes in the first quarter of 2024.
Under these circumstances, state revenues are expected to be impacted by around 24 billion shekels in 2023 and 36.4 billion shekels in 2024. Simultaneously, government expenses to fund the war are estimated at 30 billion shekels in 2023 and 85 billion shekels in 2024 (with about 15 billion shekels anticipated to be funded by dedicated American aid). Consequently, induced core growth due to the war is projected to be about 2.3% in 2023 and 4.4% in 2024, absent measures to mitigate its repercussions.
Moreover, an expenditure equivalent to about 1.1% of GDP is expected from a property tax fund for direct and indirect compensation for war damages. Consequently, the full fiscal impact of the war in the base scenario is expected to surpass 150 billion shekels over the years 2024-2023.
Anticipated continual growth in government expenditures
Additionally, as a consequence of the war, a consistent increase in government expenditures of at least 20 billion shekels is expected in the years 2025 and beyond, compared to anticipated pre-war expenditure trends. This is attributed to security expenditures, reconstruction activities, and other civilian expenditures resulting from the war, along with the rise in interest payments due to the sharp increase in the deficit and government debt. With the anticipated rise in fixed security expenditures and the necessity to increase interest payment budgets (due to the global interest rate environment and the extent of debt mobilization for war financing), redirecting future growth benefits to alleviate the tax burden on Israeli citizens while maintaining public spending size poses a challenge, as observed in the last two decades.
The extent of the economic and fiscal implications of the war necessitates a reassessment of the government’s fiscal policy. Continuous support for growing security expenditures demands a robust economy dependent on fiscal stability and the implementation of a responsible fiscal policy. To achieve this, government expenditures must be streamlined on the one hand and government revenues increased on the other. Without significant steps to address the structural deficit and a descending ratio of debt to GDP, the reliability and resilience of the Israeli economy may be compromised, leading to a prolonged decline in the standard of living for the general population in the coming years.
Opportunity for correcting imbalance in the Israeli economy
To implement these steps, minimize the fiscal damage caused by the war, and maintain the economic credibility of the Israeli economy, substantial measures are needed to significantly reduce Israel’s structural deficit in 2024. In the medium term, starting from 2025, efforts should be made to erode the deficit so that the debt-to-GDP ratio returns to a descending trend, reflecting to international bodies a fiscal policy that addresses the consequences of the war. To anchor the credibility of these steps, measures impacting both the immediate and medium term must be established.
Therefore, the Ministry of Finance has presented an economic plan aimed primarily at stabilizing the government’s fiscal situation, considering the one-time and fixed expenditures of the war, with a series of balancing measures.
This war and the economic situation resulting from it also present an opportunity to correct distortions in the Israeli economy, as proposed by the Treasury in its plan. For example, Israel lags behind in per capita output by 10% compared to the average in OECD countries, and therefore, while reduction in the public sector mechanism was a necessity even before the war, there is now public legitimacy to address it.
The Treasury proposes addressing public health and carbon emissions issues, as these measures will also generate the necessary funds for the state treasury. However, these measures were proposed earlier and rejected because there was not yet an urgency to address them. According to the plan submitted, higher taxes will be imposed on fossil fuels – coal, natural gas, and fuel oil. While this may increase the cost of industrial and electronic products, it may also enhance competition in the electricity generation sector and correct distortions that could lead to the cessation of coal-based electricity production, for example.
Where’s the money? This is how the treasury plans to bridge the deficit
- Fuel Tax: 2.5 billion shekels per year, starting from 2027.
Electric Cars: 15 agorot per kilometer starting from 2026 (according to the 2/24 index).
Gasoline Cars: A tax will be imposed, as determined in 2025. - Coal Emissions Tax: 2.7 billion shekels from 2030. A tax will be imposed on coal, natural gas, and fuel oil, excluding industrial and electricity products.
- Tobacco Products Tax: A saving of 600 million shekels, coming soon. Exemptions for returning residents (Duty-Free products) will be abolished, and all tobacco products will immediately increase by at least 5%.
- Government Companies Savings: 2.2 billion shekels, coming soon. 70 government companies will contribute dividends to the state treasury totaling 2 billion shekels. The Standards Institute will transfer accumulated funds of 200 million shekels.
- Fuel Expenditure Reduction: Savings of 70 million shekels (in 2025) and 400 million shekels (in 2026). There will be supervision of fuel expenses, ensuring that individuals and companies report fuel expenditures in close proximity to kilometers traveled.
- VAT Increase: 7.2 billion shekels, starting from 2025. VAT will be raised to 18%.
- Bank Tax: 1.4 billion shekels per year, the proportional part of it starting this year. In the coming weeks, a 17% tax will be imposed on bank salaries and a 26% tax on bank profits.