A comprehensive plan to reform the Israeli economy

As it has done before each election since the mid-1980s, ICSEP prepared a “100 Day Plan” for a reform of the Israeli economy before the last general election in August of 1999. The purpose of the plan, which was put together by ICSEP experts in consultation with a wide spectrum of knowledgeable and important players in the Israeli economy, was to present the new Israeli government with a blueprint for a few major steps essential for the opening of the Israeli economy and restarting growth.

The premise was that Israeli governments are politically so unstable and preoccupied with sheer political survival that they can not engage in even desperately needed comprehensive reforms, and therefore, one should only offer them a few choice steps that are doable and that can have the most major impact on the economy. Besides being submitted to the Prime Minister, the Minister of Finance, and other high government officials, the plan was also distributed to the policy community, with the intention of opening a public debate and creating support for reform.

The plan focused on two major areas: the widening deficit in the Israeli government budget, and its relationship to its structure; and the dysfunction of the Israeli financial markets that have been in dire need of reform for over a decade now. The plan was also built on the premise that it was to be treated as an addition to our former larger plan, “Obstacles in the Way of Growth and How to Remove Them”, that was far more comprehensive and treated many more areas. The fact that we still could refer to our earlier plan, which was devised before Prime Minister Netanyahu was elected in 1996, is a bitter reminder of the incapacity of Israeli governments to actually implement reforms, even when they are convinced that they are desirable and urgent, and intend to do all that is in their power to bring them about.

The major finding of our plan was that increasing budget deficits are not a function of cyclical developments, although recession is a contributing factor. Ratherr, the major problem is systemic: not the size of a deficit in a certain year, but the development trend on the side of budgetary expenses that constantly increases the deficit – what is known as an automatic pilot. The study found that parallel to a dramatic shrinkage in the expenditures on national security and traditional subsidies, there was an exponential growth in transfer payments. Most of these growing transfer payments are political in nature, and have been transformed into entitlements as a result of coalition agreements between the ruling party and its partners.

An analysis of the budget expenditures shows that one cannot expect further large savings from such budget items as servicing the government debt, expenditures on health and education, and investment in public goods such as infrastructure. Namely, no shrinkage in current expenditures could finance the trend for growth in transfer payments.

As for the income side of the budget, all talk about lowering the tax burden on the population, has been just that – talk. Not only is the burden high, but it is also distorted. People start paying income tax on very low incomes, and reach the high brackets very quickly. Taxes, therefore, are a negative incentive to work. At the same time, there are a large number of people who do not pay any taxes, either because they receive transfer payments, or they receive income from capital which is not taxed as far as households are concerned. So the income side of the budget does not exhibit any potential for growth, and is as distorted as the expenditure side.

Therefore, a comprehensive reform must be made in the tax system. Its base must be widened, while its application should begin at a higher level of income and rates on lower- and middle-income workers should be greatly reduced.

There is also no prospect that budget deficits can be contained unless the problem of the automatic pilot, which increases transfer payments, is boldly confronted, and at the earliest possible date, since any delay can only greatly aggravate the problem.