Cabinet approves austerity plan in bid to fend off economic decline

Israel's cabinet approved a package of tax hikes and spending cuts on Monday aimed at reining in the budget deficit, which analysts say will give the Bank of Israel room to resume monetary easing to support a weakening economy.

Ministers voted 20-9 in favor of the measures in a victory for Prime Minister Benjamin Netanyahu, who has been under pressure from the central bank to maintain credible fiscal policies at a time when the economy is slowing and tax revenues are falling short. He also hoped to avoid drastic measures that could upset a public already angered by the high cost of living.

"This is a responsible step to protect the Israeli economy and jobs for its citizens," Netanyahu said after the vote that was opposed by two of the five coalition partners — the ultra-Orthodox Shas and the centrist Independence.

Israel's economy weathered the global economic crisis well until a year ago when exports began to slow as a result of a downturn in Europe and the United States — Israel's two largest trading partners. Exports account for about 40 percent of Israel's economic activity.

"Over the last three years, we have been in the midst of a global economic crisis and we succeeded in preserving Israel's economy and protecting Israeli jobs. In this regard, we are the exception. Now we need to understand that not only is the global crisis not improving, it is only getting worse, and the worse it gets, the more steps we need to take in order to continue protecting Israel's economy. The measures we are taking are well thought out and very difficult," Netanyahu said at the meeting.

The new measures include raising income tax by 1 percentage point on monthly salaries exceeding the national average of 8,881 shekels ($2,198) in 2013. Taxes on monthly salaries of over 67,000 shekels will go up 2 percentage points. Income tax rates in Israel range from 10% to 48%.

Value added tax is also set to rise to 17% from 16% on Aug. 1, most government ministries' budgets will be trimmed by 5% and the tax authority will be cracking down on tax evaders to collect billions of shekels. Finance Minister Yuval Steinitz also ordered immediate tax hikes on cigarettes and beer, which went into effect last week.

The Finance Ministry said the measures would add a total of 14.4 billion shekels to state coffers next year.

The Knesset will debate the steps next week.

Economists forecast economic growth of around 2.5% this year, slowing from 4.8% in 2011 and resulting in a tax revenue shortfall that will push the budget deficit closer to 4% of gross domestic product. That would be well above an initial target of 2%.

The government last month opted to raise the 2013 deficit target to 3% of GDP from 1.5%, leading Bank of Israel Governor Stanley Fischer to warn that interest rates may have to rise since fiscal loosening is inflationary. Without the new austerity measures, economists say the deficit could reach 5% to 6% of GDP.

Netanyahu and Steinitz have defended the austerity steps as crucial to preventing the economy from deteriorating and requiring more severe measures in the future.

Prior to the vote, Netanyahu told ministers that governments — in a reference to some European countries — that did not act promptly and responsibly caused great harm to their citizens in the form of crumbling social systems and mass unemployment.

"We will not allow that to happen ... We need to act responsibly," he said, stressing that populist measures that involve large public spending lead to economic collapse.

Steinitz also addressed the issue, saying that "these measures are not fun, and they're not pleasant for me either, as finance minister. But any intelligent person understands that we are doing this to protect Israel's economy. These measures are the Iron Dome of our economy. It is a courageous and vital move that will prevent Israel from economically collapsing. The government's decision signals to the world that we are handling our economy responsibly."

Still, details of the plan have dominated the news in recent days, with commentators, opposition leaders and some government officials criticizing the government for attacking the middle class at a time when the public has been protesting the high cost of living.

Welfare Minister Moshe Kahlon, a member of Netanyahu's Likud party, voted against the plan. "My heart wouldn't let me vote in favor when I know there are people making 2,100 shekels ($519) a month and this deducts another 70 shekels from it, which is their budget for chicken and vegetables," he told reporters.

Netanyahu said the measures would help put more money in the pockets of the poor although some officials believe the economy will suffer more under the weight of higher taxation.

Rejecting claims that the measures would particularly hurt the weaker class, Netanyahu said that "we are talking about a one percent increase in income tax, mainly for the middle and upper class; we are talking about an additional tax on the wealthy; we are talking about a half percent tax on employers and a one percent VAT increase. It is not easy, but it is not impossible. We will charge more from those who have more, and less from those who have less."

One of Netanyahu's few supporters is Fischer, who on Sunday called the fiscal steps "brave and essential" to improve Israel's budget situation.

Last week, the Bank of Israel held its benchmark rate at 2.25%, after cutting it in June for the first time in five months, with some analysts citing concerns over the budget as a key reason for the central bank staying on hold.

"If progress is made toward improving fiscal prospects, the Bank of Israel will likely cut its base rate 25 basis points to 2.0% at its next meeting" on Aug. 27, said Barclays Capital emerging markets economist Daniel Hewitt.

Crime and punishment

Against the backdrop of the austerity measures, an intense confrontation erupted Monday between Netanyahu and Steinitz on one side and Defense Minister Ehud Barak on the other. The disagreement led Barak to oppose the austerity plan, which in turn sparked "punishment": the Defense Ministry budget cut jumped from 18 million shekels to 100 million shekels.

Barak came out strongly against the austerity measures, saying "I reject outright any comparison [between Israel and] Greece, Spain or Ireland. Those countries were dragged down by factors that are completely irrelevant to our case — mainly the irresponsible fiscal behavior of individuals, corporations and governments in a situation where the currency is not limited to the nation."

"Even under the complex circumstances of a global economic crisis," Barak continued, "it is essential, and entirely possible, to protect the economy without decimating the human fabric that carries it — the average citizens who go to work and pay taxes."

Initially it was predicted that Barak's party, Independence, would be split on the austerity measures, with Industry, Trade and Labor Minister Shalom Simhon (whose budget would be cut by 70 million shekels), and outgoing Homefront Defense Minister Matan Vilnai voting against, and Barak voting in favor along with Agriculture and Rural Development Minister Orit Noked. But at the last minute, apparently due to political considerations, Barak decided to rescind his support on the grounds that the measures constituted "a misguided economic decision that could deepen the recession."

Immediately following the cabinet meeting, Steinitz told the prime minister that he found it unacceptable that a minister who voted against the austerity plan would be partially exempt from the across-the-board ministry budget cuts. Consequently, it was decided to cut 100 million shekels from the defense budget.

In response to Steinitz's announcement regarding the defense budget cut, one of Barak's associates said that "this is the Finance Ministry behaving childishly and 'punishing' the country's security."

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