The broad budget cuts that were approved in the Knesset on Sunday reveal that the Finance Ministry has yet to change its pre-October 7 worldview. The motivation for reducing the deficit is clear, but it’s doubtful that the widespread cuts will achieve that goal. A little more than a year ago, the International Monetary Fund declared that budgetary cuts do not improve national debt. Yet the damage caused by budget cuts is certain. Israel’s crumbling public services have suffered from underfunding for years, and additional cuts will only worsen the situation. The harm won’t be felt only as relates to the security and welfare of Israeli citizens, but also regarding economic growth for years to come.
The cuts, consisting of about 1 billion shekels ($270 million), are intended to finance the extended stay in hotels for Israelis who have been evacuated from the areas bordering Gaza and Lebanon. Half of that money comes from funds that had been set aside for a collective agreement with schoolteachers, and the other half from broad cuts to government offices. Even though the sum amounts to only 0.05% of Israel’s GDP, Prime Minister Benjamin Netanyahu and the Finance Ministry have insisted that these sorts of cuts reflect their intentions for the 2025 budget. Very large sums are at stake given the expenses caused by the war and the need to increase security spending in the long terms.
IMF: Budget Cuts Don’t Improve National Debt
The problem is that the budget cuts have little chance of successfully improve Israel’s national debt. In a study that was published last April, the IMF stated that on average, budget cuts don’t lead to the long-awaited reduction of debt. The reason, the researchers explain, is the negative effects of budget cuts on economic growth. The economic slowdown reduces the state’s revenue from taxes, increases its spending on welfare, and most important of all, decreases its GDP. Seeing as public debt is measured in relation to GDP, a decreased GDP means higher debt.
The fact that the Israeli economy is in a slowdown because of the war only makes the situation worse. According to the study, the negative influence of reduced spending is especially strong during periods of economic slowdown, leading to a failure to reduce debt. In the first quarter of 2024, the Israeli economy shrank by 0.13% compared to the equivalent quarter in 2023.
Impoverished Public Services
Government spending is set to increase overall due to war costs, even as civilian budgets are cut. But the state of social services in Israel is very bad. According to a study by the Arlozorov Forum, Israeli government civilian spending would have to increase by 171 billion shekels ($47 billion) in order to reach the OECD average.
The takeaway is that Israeli infrastructure, education, welfare, health care, and other public services are on the verge of collapse. These systems are vital for the wellbeing of Israeli citizens and for the long-term growth of the Israeli economy. For years, the Bank of Israel has pointed to the dearth of investment in physical and human capital in Israel and to the negative influence that has on productivity and growth. At the beginning of the year, Nobel Prize-winning economist Joseph Stiglitz said that public investment in research and development, education, and health care has a high yield. He made that comment in a speech encouraging taxing the rich in order to increase government spending.
The Alternative: Taxation and Taking On Debt
Netanyahu has two alternative sources of funding available: taxation and taking on debt. Given the economic slowdown and the budgetary insufficiency of the public sector, both of those are preferable to the austerity policy that has ruled the day for the past 20 years, and a combination of the two is even better. Last December, the Arlozorov Forum published a report presenting policy alternatives to fund the war effort, increase the security budget, and strengthen public investments.
Taking on additional debt to fund the war and strengthen public services is possible because Israel’s current level of debt is relatively low and because broadening government investment will accelerate growth. Israel’s public debt is still much lower than the average among developed countries and could stand being increased. In 2023, which includes the war in the year’s final quarter, public debt amounted to 61.8% of Israel’s GDP. By comparison, the average public debt in the Eurozone amounts to almost 90% of GDP, the average public debt among developed nations amounts to 111% of GDP, and the average public debt among G7 countries (the world’s largest developed economies) amounts to 126.1% of GDP.
The 1 billion shekels ($273 million) being discussed is a minimal amount, which would add about 0.05% of the GDP to Israel’s debt (according to 2023 GDP), but the big question is about the 2025 budget. The Finance Ministry is discussing a budgetary increase of about 20 billion shekels ($5.5 billion), much less than the 60 billion shekels ($16 billion) that the Defense Ministry is requesting. According to 2023 number, 60 billion shekels is more than 3% of Israel’s GDP.
But a larger budget, if managed correctly, will speed up growth. Economic growth increases tax revenue and reduces the debt-to-GDP ratio. According to a study published at the beginning of the month in one of the leading economic journals, military spending positively influence employment, consumption, work productivity, and business creation.
The other source is taxation. Israel’s tax burden is low by international comparison, which explains its inability to increase public investments without increasing the deficit. According to the Arlozorov Forum, Israel’s public revenue amounted to almost 38% of the GDP in 2022, compared to an average of 41.4% in OECD countries and an average of 48.7% in countries similar to Israel. This is why countries similar to Israel have much higher levels of public investment than Israel despite maintaining a similar debt-to-GDP ratio (about 60%). Getting to the OECD average would mean adding more than 60 billion shekels ($16 billion) to the budget each year. The revenue gap in terms of the average among countries similar to Israel amounts to amount 200 billion shekels ($55 billion).
The massive lack of public investment, both civilian and military, is not in doubt. The Arlozorov Forum’s study clearly shows that moderate increases in debt and taxation can provide not just for increased military spending, but also for increased public investments. Israel can’t protect its citizens, secure their welfare, or maintain healthy economic growth without changing the Finance Ministry and Prime Minister’s Office changing their approach.
