2007 BUDGET PASSES EASILY AMID GROWING SCANDALS AT

C O N F I D E N T I A L TEL AVIV 000083

SIPDIS

SIPDIS

NEA/FO FOR DANIN; NEA/IPA FOR WILLIAMS, SHAMPAINE,
BELGRADE; EB/IFD/OMA FOR GARRY;
NSC FOR ABRAMS, DORAN, WATERS;
TREASURY FOR HIRSON

E.O. 12958: DECL: 01/05/2015
TAGS: ECON PREL EFIN PGOV IS
SUBJECT: 2007 BUDGET PASSES EASILY AMID GROWING SCANDALS AT
THE MOF

REF: TEL AVIV 0036

CLASSIFIED BY: DCM GENE A. CRETZ FOR REASONS 1.4 (B) AND (D)


1. (C) SUMMARY: THE 2007 BUDGET, TOTALING NIS 283 BILLION
(USD 67 BILLION),BREEZED THROUGH THE KNESSET ON JANUARY 4,
AFTER THE PARTIES IN THE GOVERNING COALITION DROPPED THEIR
DEMANDS FOR ADDITIONAL SPENDING. THE BUDGET MAINTAINS THE
GOI POLICY OF FISCAL RESTRAINT, EVEN WITH THE LARGER THAN
EXPECTED ALLOCATION OF USD 12.5 BILLION FOR DEFENSE-RELATED
EXPENDITURES. CRITICS CLAIM, HOWEVER, THAT IT DOES NOTHING
TO NARROW THE GROWING GAP BETWEEN THE RICH AND THE POOR, AND
EVEN CUTS SOCIAL WELFARE SPENDING TO PAY FOR THE DEFENSE
EXPENDITURES. THE BUDGET PASSED ONLY HOURS BEFORE REPORTS
HIT THE PRESS ABOUT THE EMERGENCE OF A MAJOR SCANDAL
INVOLVING THE ISRAEL TAX AUTHORITY (ITA),AND ANOTHER PRESS
STORY THE NEXT DAY INDICATING THAT FINANCE MINISTER HIRCHSON
IS PERSONALLY IMPLICATED IN THE POLICE INVESTIGATION OF A
DIFFERENT SCANDAL INVOLVING EMBEZZLEMENT AND THEFT FROM THE
PERIOD BEFORE HE BECAME A GOVERNMENT MINISTER. THE PRIME
MINISTER (PM) AND FINANCE MINISTER (MINFIN) PREVAILED UPON
DEPARTING MOF DIRECTOR GENERAL YOSSI BACHAR TO TEMPORARILY
ASSUME CONTROL OF THE ITA IN ORDER TO RESTORE A SENSE OF
PROPER FUNCTIONING TO THE ORGANIZATION. HOWEVER, BACHARS
DEPARTURE AS DG, TOGETHER WITH THE SUDDEN ERUPTION OF MOF
SCANDALS POSSIBLY INVOLVING HIRCHSON AND ELEMENTS IN THE
PRIME MINISTERS OFFICE, PRESAGES INSTABILITY FOR ISRAELI
ECONOMIC POLICY IN THE IMMEDIATE FUTURE. PRESS REPORTS
ALREADY SPEAK OF A POSSIBLE LOSS OF INVESTOR CONFIDENCE IN
ISRAEL AS A RESULT OF THE SCANDALS. END SUMMARY.

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BUDGET BREEZES THROUGH THE KNESSET
--------------


2. (U) IN LINE WITH FINANCE MINISTER AVRAHAM HIRCHSON'S
STATED GOAL OF SECURING THE BUDGET'S APPROVAL BY THE START OF
THE NEW YEAR, THE KNESSET PASSED THE 2007 BUDGET BILL JUST
AFTER MIDNIGHT ON THE MORNING OF JANUARY 4, REPRESENTING A
DEPARTURE FROM PAST YEARS, WHEN THE BUDGET APPROVAL PROCESS
FACED SIGNIFICANT DELAYS. MINFIN HIRCHSON WAS ADAMANT ABOUT
"MAINTAINING THE BUDGET FRAMEWORK" AND FISCAL RESTRAINT.
ALTHOUGH SOME COALITION PARTNERS HAD EARLIER DEMANDED HUGE
ADDITIONAL ALLOCATIONS RANGING UP TO NIS 6 BILLION (USD 1.4
BILLION) IN RETURN FOR THEIR SUPPORT ON THE VOTE, THEY
ULTIMATELY DROPPED THESE DEMANDS FOR FEAR OF FORCING EARLY
ELECTIONS IN WHICH MANY OF THEIR MEMBERS WOULD FACE THE
PROSPECT OF LOSING THEIR KNESSET SEATS. THE BUDGET PASSED BY
A 63 TO 31 MARGIN, WITH SIX ABSTENTIONS.


3. (U) VARIOUS PARTIES, BOTH WITHIN AND OUTSIDE THE
COALITION, WERE, HOWEVER, REWARDED FOR THEIR SUPPORT. FOR
EXAMPLE, AVIGDOR LIEBERMAN'S ISRAEL BEITENU PARTY RECEIVED
APPROXIMATELY NIS 190 MILLION (USD 45 MILLION),INCLUDING
MONEY FOR SURVIVORS OF THE HOLOCAUST, DISCHARGED SOLDIERS,
COMBATING THE DRUG TRADE, AND TAX BENEFITS FOR THE ELDERLY
AND NEW IMMIGRANTS. THE OPPOSITION UNITED TORAH JUDAISM
(UTJ) FACTION, WHICH HOLDS THE CHAIR OF THE FINANCE
COMMITTEE, WILL RECEIVE NIS 290 MILLION (USD 69 MILLION) FOR
ULTRA-ORTHODOX HAREDI SCHOOLS AS PAYMENT FOR ABSTAINING IN
THE BUDGET VOTE -- IN ADDITION TO THE NIS 290 MILLION IT
ALREADY RECEIVED FOR ABSTAINING ON THE FIRST READING OF THE
BUDGET LAW IN SEPTEMBER. MOREOVER, UTJ FINANCE COMMITTEE
CHAIR, YACKOV LINTZMAN, REPORTEDLY WORKED HARD TO FACILITATE
THE BUDGETS SMOOTH APPROVAL. AT THE JANUARY 7 CABINET
MEETING, A MAJORITY (THIRTEEN) OF MINISTERS SUPPORTED THE
PRIME MINISTER IN FURTHER CUTTING SPENDING BY NIS 870 MILLION
(USD 208 MILLION) TO SOMEWHAT OFFSET THE NIS 1.85 BILLION
(USD 443 MILLION) ADDED TO THE DEFENSE BUDGET SEVERAL WEEKS
AGO. THE SPENDING REDUCTION INVOLVES AN ACROSS-THE-BOARD CUT
IN THE ACQUISITION BUDGETS FOR MOST MINISTRIES OF ABOUT 3.5
PERCENT.

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SCANDALS ABOUND IN THE MOF
--------------


4. (C) THE DAY THAT THE BUDGET BILL PASSED WAS ALSO MARKED
BY THE EMERGENCE HOURS LATER OF ALLEGATIONS REGARDING
IMPROPRIETIES IN THE ISRAEL TAX AUTHORITY (ITA),A DIVISION
OF THE MINISTRY OF FINANCE (SEE REFTEL). POLICE ALLEGE THAT
TOP ITA AND OTHER GOVERNMENT OFFICIALS HAD EITHER RECEIVED OR
GIVEN BRIBES TO WIN TAX BREAKS FOR COMPANIES, AMONG OTHER


IMPROPRIETIES. SHULA ZAKEN, PRIME MINISTER OLMERT'S PERSONAL
SECRETARY, AND ABOUT 30 OTHERS, INCLUDING SENIOR OFFICIALS,

SIPDIS
ARE BEING INVESTIGATED AS PART OF THE CASE, INCLUDING JACKY
MATZA, THE HEAD OF THE ITA, AND HIS IMMEDIATE PREDECESSOR IN
THE JOB, EITAN RUB. BOTH PM OLMERT AND MINFIN HIRCHSON MAY
BE QUESTIONED BY THE POLICE IN CONNECTION WITH THE CASE. THE
SCANDAL HAS SPARKED OUTRAGE WITHIN ISRAELI SOCIETY AND
EXACERBATED THE PUBLIC'S DISTRUST OF GOVERNMENT THAT HAS
GROWN SINCE THE SUMMER'S INCONCLUSIVE WAR IN LEBANON AND A
RASH OF OTHER SCANDALS INVOLVING ISRAELI POLITICAL FIGURES.
BOTH PM OLMERT AND MINFIN HIRCHSON CONVINCED OUTGOING AND
WELL-RESPECTED MOF DG YOSSI BACHAR TO ASSUME THE HELM OF THE
ITA TEMPORARILY TO RESTORE ORDER AND CONFIDENCE TO THAT
ORGANIZATION, AND TO MAINTAIN BACHAR'S CALMING PRESENCE AT
THE MOF. FURTHER DAMAGING THE MOF HAVE BEEN REPORTS,
INITIALLY PUBLICIZED THE MORNING AFTER THE BUDGET'S APPROVAL,
THAT MINFIN HIRCHSON HIMSELF IS SUSPECTED OF FRAUD, MONEY
LAUNDERING, AND INVOLVEMENT IN THE THEFT OF MORE THAN NIS 5
MILLION (USD 1.2 MILLION) FROM THE NATIONAL WORKERS UNION (A
PART OF THE HISTADRUT FEDERATION OF TRADE UNIONS),WHICH HE
HEADED PRIOR TO BECOMING A GOVERNMENT MINISTER. IN THE DAYS
SINCE THE SMOOTH APPROVAL OF THE BUDGET, HIRCHSON HAS TRIED
TO PROJECT A "BUSINESS AS USUAL" ATTITUDE, DESPITE THE
SCANDALS.

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SNAPSHOT OF THE 2007 BUDGET
--------------


5. (U) ISRAEL'S 2007 STATE BUDGET TOTALS APPROXIMATELY NIS
283 BILLION (USD 67 BILLION) AND REPRESENTS YEAR-ON-YEAR REAL
EXPENDITURE GROWTH OF ABOUT 3.3 PERCENT OVER 2006, CONSISTING
OF THE 1.7 PERCENT SPENDING INCREASE ALLOWED FOR IN THE
COALITION AGREEMENTS, PLUS A ONE-TIME ADDITIONAL 1.6 PERCENT
(NIS 3.5 BILLION OR USD 830 MILLION) INCREASE EARMARKED FOR
FINANCING EXPENSES RELATED TO THE LEBANON CONFLICT. IN
ADDITION, THE GOVERNMENT PLANS AN ADDITIONAL 0.5 PERCENT (NIS
1.1 BILLION OR USD 26 MILLION) OFF-BUDGET SPENDING INCREASE
TO FUND CONTINUING DISENGAGEMENT-RELATED EXPENSES. THE
DEFICIT TARGET WILL BE 2.9 PERCENT OF GDP, OR NIS 18.7
BILLION (USD 4.4 BILLION). TAX REVENUES ARE FORECASTED TO BE
LOWER THAN IN 2006, DURING WHICH THERE WERE ONE-TIME RECEIPTS
TOTALING APPROXIMATELY NIS 6 BILLION (USD 1.4 BILLION) -- USD
1 BILLION OF WHICH ALONE RESULTED FROM WARREN BUFFETS
PURCHASE OF 80 PERCENT OF THE ISRAELI COMPANY ISCAR FOR USD 4
BILLION IN CASH. THE NEXT PHASE OF THE INCOME AND CORPORATE
TAX REDUCTIONS RESULTING FROM THE GOVERNMENT'S TAX-REFORM
PROGRAM WILL GO INTO EFFECT IN JANUARY 2007, AND WILL LIKELY
REDUCE TAX REVENUES IN THE FUTURE.

A GENERAL BREAKDOWN OF THE MAJOR BUDGET CATEGORIES FOLLOWS:

-- 18.6 PERCENT (USD 12.5 BILLION) FOR DEFENSE EXPENDITURES;
-- 29.9 PERCENT (USD 20 BILLION) FOR DEBT REPAYMENT;
-- 29.4 PERCENT (USD 19.7 BILLION) FOR TRANSFER PAYMENTS AND
SUPPORT;
-- 4.1 PERCENT (USD 2.7 BILLION) FOR INVESTMENT AND CREDIT;
-- 17.1 PERCENT (USD 11.5 BILLION) FOR OTHER CIVILIAN
EXPENDITURES.


6. (U) AMONG THE GOI MINISTRIES, THE DEFENSE MINISTRY
RECEIVED NIS 47.8 BILLION (JUST OVER USD 11 BILLION) -- THE
LARGEST SLICE OF THE BUDGET -- WHILE THE SHARE FOR THE
EDUCATION AND HEALTH MINISTRIES AMOUNTED TO NIS 25.9 BILLION
(USD 6.2 BILLION) AND NIS 16.1 BILLION (USD 3.8 BILLION),
RESPECTIVELY. JUST ONE YEAR AGO, THE ECONOMIC CAMPAIGN
PROPOSALS PUT FORTH BY THE LABOR PARTY IN THE RUN UP TO THE
NATIONAL ELECTION CALLED FOR REDUCING DEFENSE SPENDING IN
FAVOR OF SOCIAL WELFARE SPENDING. IN THE WAKE OF THE WAR IN
LEBANON, THE COMPETITION BETWEEN THE DEFENSE ESTABLISHMENT
AND SOCIAL NEEDS CONTINUES, WITH DEFENSE EMERGING AS THE
CLEAR WINNER. IN THE 2007 BUDGET, NATIONAL INSURANCE
BENEFITS ARE TO BE CUT BY FOUR PERCENT, THE THIRD STAGE IN
THE INCREASE IN THE MINIMUM WAGE IS TO BE DELAYED, AND THE
AGE AT WHICH PEOPLE ARE ENTITLED TO CLAIM UNEMPLOYMENT
COMPENSATION WILL REMAIN 28, DESPITE EFFORTS TO HAVE IT
REDUCED TO 25.


7. (U) DR. MICHAEL SORREL, HEAD OF THE ECONOMICS AND
RESEARCH DIVISION OF HAREL INSURANCE AND FINANCE, AND FORMER
HEAD OF RESEARCH AT THE FINANCE MINISTRY, NOTED IN A
MACRO-ECONOMIC REPORT DATED JANUARY 4 THAT THE BUDGET
BROADCASTS THE MESSAGE OF CONTINUED FISCAL STABILITY. HE


ADDED THAT EVEN WITH THE INCREASE IN DEFENSE EXPENDITURES AND
OTHER SPECIAL SPENDING IN LIGHT OF THE WAR IN LEBANON, THERE
WOULD BE A DECLINE IN GOVERNMENT EXPENDITURES AS A PERCENTAGE
OF GDP IN 2007 IF GROWTH CONTINUES AT A REASONABLE RATE -- AS
HE EXPECTS.

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COMMENT
--------------


8. (C) ISRAEL IS IN THE PECULIAR SITUATION OF EXPERIENCING
ECONOMIC PROSPERITY UNPARALLELED IN ITS SHORT HISTORY, WHILE
AT THE SAME TIME FACING A SEVERE LOSS OF PUBLIC CONFIDENCE IN
THE FUNCTIONING OF ITS GOVERNMENT, SPARKED BY THE LACKLUSTER
PERFORMANCE IN THE LEBANON WAR AND EXACERBATED BY THE
UNFOLDING SCANDALS INVOLVING HIGH OFFICIALS IN THE MOF AND
THE PRIME MINISTER'S OFFICE -- AS WELL AS THE SCANDALS
ENVELOPING THE PRESIDENT AND THE FORMER MINISTERS OF JUSTICE
AND PUBLIC SECURITY. THERE HAVE EVEN BEEN RUMBLINGS IN THE
PRESS ABOUT THE POSSIBLE LOSS OF CONFIDENCE BY INVESTORS IN
THE ISRAELI ECONOMY. SOME ISRAELI OFFICIALS HAVE TOLD
REPORTERS THAT THE SCANDALS MAY BLACKEN ISRAEL'S IMAGE ENOUGH
TO DISCOURAGE BOOMING FOREIGN DIRECT INVESTMENT, WHICH
TOTALED USD 13.2 BILLION IN 2006 VERSUS 5.6 BILLION IN 2005
AND 1.7 BILLION IN 2004.


9. (C) COMMENT CONTINUED: THE MORALE OF THE FINANCE MINISTRY
HAS BEEN DEVASTATED, WHICH DOES NOT BODE WELL FOR THE
MAINTENANCE OF FISCAL DISCIPLINE IN THE LONG RUN. WITH THE
MINISTER PERSONALLY IMPLICATED IN CORRUPTION ALLEGATIONS, THE
RESPECTED BACHAR LEAVING HIS POST AS DG, AND A NEWCOMER
TAKING OVER AS DG (AS OF JANUARY 7),THE MINISTRY APPEARS TO
BE RUDDERLESS. THE SCANDALS OVERSHADOWED ANY CREDIT HIRCHSON
GAINED FROM HIS STARTLING SUCCESS IN SECURING QUICK APPROVAL
OF THE BUDGET. HE IS ATTEMPTING TO PROJECT A "BUSINESS AS
USUAL" APPROACH, BUT MUCH DEPENDS ON THE ABILITY OF THE NEW
DG YAROM ARIAV TO TAKE QUICK CONTROL AND RESTORE CONFIDENCE
AMONG THE MINISTRY'S WORKERS. YOSSI BACHAR'S TAKING OVER THE
ITA TEMPORARILY (AS OF JANUARY 7) WILL SERVE AS A CALMING
INFLUENCE.


10. (C) COMMENT CONTINUED: THE OLMERT GOVERNMENT IS VERY
WEAK, BUT IRONICALLY, THIS MAY BE ITS ONLY ADVANTAGE AT THE
MOMENT IN ITS ABILITY TO ENFORCE ITS ECONOMIC POLICY. MANY
OF THE MKS IN THE RULING COALITION REALIZE THAT THEY STAND TO
LOSE THEIR SEATS SHOULD THERE BE EARLY ELECTIONS, HENCE THEIR
AGREEMENT TO DROP THEIR TRADITIONAL EXORBITANT SPENDING
DEMANDS IN ADVANCE OF THE BUDGET VOTE. HOWEVER, IF THE LABOR
PARTY DOES DECIDE TO QUIT THE GOVERNMENT, IT WILL LEAVE
OLMERT WITH 59 SEATS IN THE 120-SEAT KNESSET. THIS INCREASES
THE LIKELIHOOD THAT HE WILL INVITE UNITED TORAH JUDAISM INTO
THE COALITION AND MIGHT HAVE TO REINSTATE THE BUDGET-BUSTING
LARGE FAMILY BONUSES TO SECURE THEIR SUPPORT. SINCE THE
INITIATION OF THE ECONOMIC REFORM PROGRAM IN 2003, IT HAS
BEEN THE LEADERSHIP AND THE PROFESSIONAL STAFF OF THE
MINISTRY OQFINANCE THAT HAS STOOD FIRM AGAINST PREVIOUS
ATTEMPTS TO INCREASE SPENDING RECKLESSLY. THE PRESENT RASH
OF SCANDALS LEAVES THEM IN A POSITION THAT LIMITS THEIR
INFLUENCE ON FISCAL POLICY. EVEN AT THE HEIGHT OF THE MOF'S
INFLUENCE, IT WOULD NOT HAVE BEEN ABLE TO COMPLETELY PREVENT
EXCESSIVE SPENDING RESULTING FROM A COALITION CRISIS. SHOULD
UTJ ENTER THE GOVERNMENT AT A TIME WHEN THE MOF IS TOTALLY
WITHOUT INFLUENCE, IT IS QUITE LIKELY THAT THE PRICE WOULD BE
A BUSTING OF THE BUDGETARY FRAMEWORK THAT HAS HELD SINCE 2003
AND WAS RESPONSIBLE FOR ISRAELS TREMENDOUS ECONOMIC
RECOVERY. END COMMENT.

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