2009-2010 GOI BUDGET APPROVED

UNCLAS TEL AVIV 001615

SENSITIVE
SIPDIS

TREASURY FOR BRYAN BALIN

E.O. 12958: N/A
TAGS: ECON EFIN IS
SUBJECT: 2009-2010 GOI BUDGET APPROVED

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Summary:
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1. (U) Three and a half months after being introduced, the
2009-2010 GOI budget was approved by a majority of 58 Members
of Knesset (MK)--versus 36 MKs against--in final readings in
the Knesset on July 15. The budget framework includes
deficit ceilings of six percent of GDP in 2009 and 5.5
percent of GDP in 2010, and a one-time expenditure increase
of 1.35 percent above the 1.7 percent expenditure ceiling
which has been anchored in legislation since 2007. The Prime
Minister paved the path to final budget approval by
withdrawing a proposal to levy VAT on previously un-taxed
fruits and vegetables--one of the most controversial items of
the budget process. A number of economists and economic
commentators view the budget favorably given the economic
slowdown, and find the increase in the deficit acceptable.
However, others believe that a deficit of 5.5-6.0 percent is
too high for Israel, and are concerned about the ability of
the government to return to the stringent declining deficit
path that it had previously set. Although the final budget
is viewed as better than the original budget proposal--which
included contentious cuts in benefits to the elderly,
children, and Holocaust survivors-- there is no shortage of
criticism among economists on how the budget process was
handled, and concerns about what this means for the ability
of the Finance Ministry to function effectively in the
future. END SUMMARY.

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THE FISCAL FRAMEWORK*BOTH GOOD AND BAD
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2. (U) The main components of the budget include: 31.5
percent for debt repayment; 29.8 percent for transfer
payments in 2009 (27.8 percent in 2010); 17.9 percent for
civilian expenditures; and, 16.2 percent for defense
expenditures in 2009 (17.2 percent in 2010). The largest
ministry budgets include: Defense - NIS 48 billion (USD 12.3
billion); Education -- NIS 30.3 billion in 2009 (USD 7.8
billion) and NIS 32.4 billion in 2010; and the Ministry of
Health -- NIS 19.2 billion in 2009(USD 5 billion),and NIS
21.4 billion in 2010. There has been an increase in the
education budget of about NIS 2.8 billion since 2008 in order
to implement a multi-year education reform plan, as well as
to improve teachers, wages. These increases also reflect a
coalition agreement to augment budgets for religious schools.



3. (U) The budget framework includes deficit targets of six
percent of GDP in 2009 and 5.5 percent in 2010. Several
economists view the deficit ceiling of six percent as
reasonable given the economic situation, and in line with
automatic stabilizers during times of economic slowdown. The
general assessment is that provided that there will not be a
collapse in tax revenues, the government will be able to meet
its target. Depending on the extent of economic recovery,
the deficit could even fall below the target in 2010. The
Bank of ISRAEL predicts the 2009 deficit to be in the 5.0-5.5
percent range. Echoing other commentators, Dr. Michael
Sarel, Chief Economist at Harel Finance, believes the deficit
ceilings of six percent and 5.5 percent are too high and are
unjustified. He believes that such levels could work in the
U.S. where they might reduce the impact of the recession, but
are not appropriate for Israel. He is also concerned about
whether the government will be able to return to fiscal
restraint in 2011 and how the GOI will meet the declining
deficit path that it set for itself after the current period.
(NOTE: This former framework included a gradual decline from
three percent in 2011 to one percent in 2014. END NOTE).


4. (U) The current government expenditures-to-GDP ratio of
approximately 43.4 percent in 2008 is close to the OECD
country average of 42.6 percent. Thanks to strong economic
growth over the past five years, Israel's expenditures-to-GDP
ratio has declined from the 52 percent level of 2003. Bank
of ISRAEL economists view the current level of
expenditures-to-GDP as sustainable and do not see a need to
reduce it further. Significant amounts of spending are
locked in for defense and debt servicing, so further cuts
would make it difficult for the government to maintain
adequate health, education and welfare services.


5. (U) The arrangements bill--Israel's budget policy
document--also included increases in child allowances and
elderly allowances, in order to somewhat offset the negative
implications of the economic slowdown; additional supplements
for companies and employers in financial distress; increased
National Insurance Institute payments for individuals earning
between NIS 35,000 ) NIS 70,000 a month (USD 7,700 to USD
18,000 a month); more generous unemployment benefits;
increased funds for R& D and the Chief Scientist; assistance
for small and medium companies; and export and credit
assistance. Attempts to expand the Israeli version of the
Wisconsin Plan nationwide, as well as negative income tax
have been delayed, due to some political disagreements over
implementation of the Wisconsin Plan. (NOTE: A local version
of the &Wisconsin Plan8 started operating in the summer of
2005 as part of then Finance Minister Netanyahu,s plan to
encourage movement away from allowances and to a culture of
work. END NOTE).


6. (U) Noticeably absent from the budget were Prime Minister
Netanyahu,s three large planned institutional reforms: that
of the ISRAEL Land Authority, the electricity sector, and the
ports. These will be handled outside the budget framework.
Given their complex nature and the structure of the governing
coalition, most analysts doubt any of the three will be
enacted. Not much is left of the ISRAEL Lands Authority
reform, as it has gone through various changes on the way to
Knesset approval. In terms of the other two reforms )
electricity and ports--there are differing views on their
importance, ability to be executed, and cost effectiveness
given the labor unrest that would take place on the road to
reform.

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TAX REDUCTIONS AND THE PM,S ECONOMIC PLANS
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7. (U) Tax reductions are a central element of Prime Minister
Netanyahu,s economic world view, and were a large part of
his 2003 economic recovery plan as Finance Minister. At the
time, economists felt that such tax reductions were
important, but today some politicians and economists see
Netanyahu as &obsessed8 with tax cuts. The original
2009-2010 economic plan included a section intended to
continue reducing income and corporate tax until 2016,
extending the current tax reform plan that was to end in

2010. This would have brought the highest marginal income
tax to a level of 39 percent in 2016, and corporate tax to 18
percent, compared with their current rates of 46 percent for
individuals and 26 percent for corporate tax. However, from
the time it was announced, this plan had many critics since
Israel,s taxes*particularly its income taxes*are deemed to
be at acceptable levels compared to other similar economies,
and because of the already sharp decline in tax revenues.
For instance, S & P in its July 16 rating update notes that
government revenues are falling in all major categories to a
forecasted 29 percent of GDP in 2009, from an average of 33
percent of GDP over the past five years. The GOI reached a
compromise on taxes whereby there will be additional
decreases of one percent each in 2009 and 2010*instead of
the two percent each year originally proposed. As for
corporate income tax, there will be a one percentage point
decline in 2010 to 25 percent, in accordance with the
previous tax reform plan.


8. (U) In contrast, there were discussions regarding a
drought tax in light of the dire water situation. Since the
agriculture sector has a strong lobby, it was clear early in
the budget process that there would not be additional
concessions from industry. Instead, the GOI decided to
impose a tax on households for using more than a specific
quantity of water based on the number of individuals in the
household. The levy will remain in effect through winter
(rain season),but the quota will then be increased. This
tax is estimated to provide revenues of between NIS 800
million (USD 200 million) to NIS 1.2 billion (USD 300
million) until the end of 2010.


9. (U) Similarly, the GOI proposed to begin collecting VAT on
fruits and vegetables. Though seemingly innocuous, this
proposal drew tremendous attention and criticism throughout
the entire budget process due to the manner in which it was
handled. Particularly troublesome to critics was the lack of
coordination between the Prime Minister,s announcement of
the withdrawal and statements to the contrary by the Ministry
of Finance. However, they viewed the Finance Minister as
handling the confusion graciously*noting his disagreement
with the PM,s decision but ultimately respecting
Netanyahu,s authority.

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COMPETING ROLES OF PM AND MOF
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10. (SBU) Commentators view the budget positively in light of
the current economic situation, if only because it was
necessary to approve the budget in order to execute broader
economic plans. During the budget process, one of the more
problematic issues that surfaced was that the Prime Minister
essentially played the role of Minister for Economic
Strategy, obviating the advisory role of Finance Minister
Yuval Steinitz and his Ministry. Although Finance Ministry
officials provide the PM with a set of proposals and
alternatives, it is clear from the budget process that
politicians made all the key decisions. A Bank of ISRAEL
contact said that it is good to have a Prime Minister who
cares about economic matters, but acknowledged economists,
concerns that the Finance Ministry,s role is now in
question. Though there is still the common memory of Prime
Minister Netanyahu,s strong and effective period as Finance
Minister, he is viewed now as being more concerned about
keeping his coalition together, and not necessarily doing
what is right for the economy. The Finance Minister, on the
other hand, is considered very intelligent and capable, but
weak compared to Netanyahu, which does not bode well for the
Finance Ministry.


11. (SBU) However, Netanyahu has also lost support through
the process. Ha,aretz,s economic commentator, Nehemia
Strassler, was an avid supporter of Netanyahu during his
tenure as Finance Minister, approving of the reduction in
taxes, fiscal consolidation, the change in culture from
allowances to work, privatizations, and structural reforms
which were all part of Netanyahu,s economic recovery plan.
However, now, in a July 17 opinion piece in "Ha'aretz,"
Strassler was critical of how the budget and budget
department of the Ministry of Finance were handled, and
called the budget fat and wasteful. Strassler said this
reflected Netanyahu,s weak leadership. A former Ministry
of Finance official, now in the private sector, also
expressed concerns to Emboffs about the Government,s
economic credibility. He noted that this is particularly
problematic given that the government is only in its first
year, and questions its future stability. There are also
concerns about hidden concessions that might have been given
to the Histadrut labor union as part of the package deal.

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FINALLY A BUDGET... BUT FEARS OF INFLATION
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12. The Ministry of Finance likes to emphasize that the
budget and economic plan included components aimed at helping
the economy pull out of the recession, assisting economy
recovery and providing social assistance. The June CPI
figures were released immediately following the budget
approval, contributing to further doubts about economic
plans. The increase of 0.9 percent was a surprise to most
economists, and this could have been a statistical fluke,
there are indications that CPI will continue to be high, due
to the one percent increase in VAT, the drought tax, and
increases in taxes on cigarettes, gasoline and alcohol.
These increases are not necessarily inflationary and some may
be temporary. However, they do pose an additional burden for
weaker sectors of the economy. Given this, there are
projections that the Bank of ISRAEL will likely raise
interest rates sooner than they might have
otherwise*dampening some of the effects of economic recovery.

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COMMENT
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13. (SBU) This budget and the accompanying arrangements bill
are a pale reflection of the "shock and awe" economic policy
reforms Netanyahu's economic advisors promised Emboffs in
conversations before the Israeli elections. However, given
the realities of coalition politics and global recession, it
will buy the government time to build support for a more
focused fiscal policy in 2011.

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