Level of the Budget

The 1998 State budget is NIS 207.4 billion.

The budget, including revenue-dependent expenditure, is NIS 215.3 billion.

Expenditure not including debt servicing (repayment of principal) is NIS 173.3 billion.

Budget expenditure represents 46.3%^* of the projected 1998 Gross Domestic Product.

Budget Goals

The Government stationed one central goal at the forefront of the budget proposal for 1998: returning the economy to sustained growth based on expansion of the business sector. Such growth will gradually lower the unemployment rate.

In 1990-1996, Gross Domestic Product grew at an annual average rate of 5.5 percent. In 1997, GDP is expected to grow by only 2 percent.

To extricate the economy from its slowdown and place it on a trajectory of sustainable growth powered by the business sector, the Government resolved to adopt a broad program including ten major fields, the treatment of each will create more convenient conditions for the business sector to attain sustainable growth:

1. Fiscal policy.

2. Monetary policy.

3. Expansion of infrastructure investments.

4. Enhancement of competitiveness.

5. Elimination of governmental barriers.

6. Labor market.

7. Growth-supportive capital market.

8. Privatization.

9. Liberalization in the foreign-currency market.

10. Downsizing and streamlining of the public sector.

1. Fiscal Policy

To restore a sustainable growth trajectory based on expansion of the business sector, the Government wishes to downscale its involvement in economic activity, focusing on three respects:

Continued gradual reduction of the share of the deficit in GDP.

Reduction of government expenditure relative to GDP.

Avoiding increases in tax rates.

Continued Gradual Reduction of the Share of the Deficit in GDP

Restraining the budget deficit is an important way to create growth-conducive conditions. A lower deficit will allow the business sector to raise capital for its investments at lower cost, making investments more lucrative. Furthermore, a more moderate deficit helps attain price stability, which is an important condition for growth in the business sector.

As stipulated in the Deficit Reduction Law, the total government deficit (not including credit) is to decrease from 2.8 percent of GDP in 1997 to 2.4 percent in 1998.

To meet this target, the Government had to reduce the budget base by NIS 2.3 billion.

By cutting the deficit and funding much of the deficit with privatization revenues (sale of State-owned companies and banks), it becomes possible to reduce the share of government debt in GDP.

The Israeli economy is noted for exceptionally high national debt relative to product (101 percent as against a maximum of 60 percent under the Maastricht Treaty). This trend will alleviate the Government’s future burden of interest payments and allow greater flexibility in setting priorities in the State budget.

Reduction of Government Expenditure Relative to GDP

Reducing the share of public expenditure in GDP is a vastly important prerequisite for growth of the business sector. Since the public sector and the business sector compete for the same production factors, the smaller the public sector is, the better off the business sector becomes. Israel’s share of government expenditure in GDP is higher today than the accepted level in Western countries; hence the importance of bringing this variable down.

The budget proposal for 1998 embodies a decrease in the share of the budget in GDP from a planned level of 47.3 percent in 1997 to 46.3 percent in 1998.

2. Monetary Policy

To elevate the economy to a trajectory of sustainable growth, coordination between fiscal and monetary policy is needed. Consequently, the Government has adopted the following guidelines in monetary policy:

To advance toward the economy’s growth potential, estimated today at 5 percent per year.

The 1998 inflation target will be 7-10 percent.

The inflation rate should continue to decline gradually, toward the attainment of long-term price stability in the sense accepted in industrialized countries.

The business sector should account for a larger share in employment.

The monetary policy will strive to achieve a balance between several macro-economic targets. If the monetary policy proves incapable of attaining all the targets concurrently, the Government will prioritize the targets.

3. Expansion of Infrastructure Investments

Infrastructure investments affect the economy’s long-term growth rate. A modern and efficient infrastructure is an essential condition for growth of the business sector.

Total infrastructure investment, including development of the electricity, communications, ports, water, sewage, and transportation systems, was NIS 11 billion in 1996-1997. Most of the expenditure was made by non-budgeted agencies (State-owned corporations and statutory authorities).

Infrastructure investments are expected to take a vigorous leap forward in 1998, rising by NIS 2.1 billion to NIS 13.1 billion. This 20 percent increase is meant to invigorate infrastructure activity and support an acceleration of growth. Within the State budget, the high level of infrastructure investment achieved in the past few years will be maintained.

Noteworthy among the planned infrastructure investments in 1998 are Project Terminal 2000 (the Ben Gurion airport terminal project which is under construction) and the Cross-Israel Highway, which will be built by the private sector.

The State also intends to create a legal framework for the formation and activation of water and sewage corporations, railroad projects funded by the business sector, and regulation of the natural-gas industry.

4. Enhancement of Competitiveness

The extent of competitiveness in various products and services is a contributory factor in the rate of price increases. Prices of competitive products and services tend to rise more slowly over time than those of noncompetitive items. Analysis of the Consumer Price Index over a period of nearly a decade, shows that the prices of noncompetitive products and services rose by 32 percent beyond the Consumer Price Index, while those of competitive products and services decreased by 13 percent.

Thus, it is immensely important to move products and services from the noncompetitive category to the competitive. Such an action may lower their prices both at the point of changeover and across time; it may also improve service and diversify products and services. The price decrease occasioned by competition makes a substantive contribution to the business sector, which benefits from an improvement in competitive capacity versus its rivals. The Government has resolved to introduce further competition in communications, public transit, aviation, energy products and services, and industrial products, to name only a few.

A more detailed description of the decisions concerning these fields appears in the chapter on “Structural Changes.”

5. Elimination of Governmental Barriers

Beyond the persistent lack of competition in certain industries, the Government itself sometimes infringes on the very possibility of competition by hindering the activities of the business sector. In the final analysis, these constraints harm the business sector and impair its ability to expand. Elimination of governmental barriers, especially those in land policy, will allow the economy to achieve a higher growth rate.

6. Labor Market

Unemployment is being fought mainly through growth-enhancement actions. To complement these measures, several actions in the labor market and the Unemployment Division of the National Insurance Institute are proposed:

Stronger control of foreign workers.

Tougher enforcement of the unemployment law by the Government Employment Service.

7. Growth-Supportive Capital Market

The major function of the capital market is to interface between supply and demand of capital. Demand reflects the wish of individuals and companies to obtain financing, without which companies would struggle to invest in equipment, inventory, and technology, and individuals could hardly pay for products and services that require a high up-front outlay (such as housing and education). Supply reflects savers’ willingness to spread consumption of their income over a period of years.

The Israeli capital market has several structural problems, including:

Lack of long-term institutional investors. Pension funds and life-insurance companies—the pillars of healthy capital markets the world over—do not participate in the market in Israel. This situation is largely the result of arrangements that provide pension funds and insurance companies with subsidized and non-negotiable government bonds.

This subsidy not only impairs the capital market but also inflates budget expenditure by NIS 1.5 billion per year, for the purpose of subsidizing some, not all, pension savers.

The high level of centralization in the capital market, caused by the banks’ control and management of provident and mutual funds.

A tax system that discriminates among different kinds of investors and savings instruments.

To encourage long-term saving, especially for retirement. This measure will be attained by rationalizing long-term investments and unifying the terms in various kinds of retirement saving.

To downscale new pension funds’ investments in earmarked bonds, in order to redirect more money to the negotiable capital market, with regulation provided by the Capital Market Commissioner.

To correct taxation distortions that affect the capital market, which create unjustified propensities in choosing among investment paths.

8. Privatization

The privatization process helps the business sector grow in the following ways:

Management of State-owned companies by the business sector makes the companies more efficient and, consequently, enhances profitability and competitiveness domestically and in world markets.

Privatization makes more resources available to the State. The increase in resources alleviates pressure on the capital market (to fund the deficit) and lowers long-term interest rates.

The sale of State-owned companies on the capital market creates greater negotiability and liquidity in the capital market, enhances the confidence of domestic and international investors, and makes it easier for private firms to raise capital in order to expand their activity ease.

Privatization revenue increased during the first few years of the 1990s and peaked in 1993 at NIS 3.2 billion, 1.7 percent of GDP. Revenue plunged in subsequent years, coming in at only in NIS 0.3 billion in 1996.

In 1997, privatization receipts will attain the unprecedented sum of approximately NIS 8 billion. Among the equities sold thus far are parts of Bank Hapoalim, Bank Leumi le-Israel, Israel Discount Bank, and United Mizrahi Bank, along with shares in Israel Chemicals, Bezeq, and Yozma.

The privatization revenue target for 1998 is NIS 4.3 billion.

9. Liberalization in the Foreign-Currency Market

Since the mid-1980s, important measures have been taken to enhance the suppleness and openness of Israel’s foreign-currency market, with the goal of making this market fully open.

Exposing the Israel financial markets to competition and integrating them into the world money and capital markets will also support the process of business-sector growth.

10. Downsizing and Streamlining of the Public Sector

In its 1998 budget deliberations, the Government also decided to adopt several measures that will streamline government work by eliminating or downsizing units that can be handed to the business sector, eliminating redundancies, and closing unneeded units. These changes are part and parcel of the intention to streamline the public sector and reduce its share in GDP.

1. Immigrant Absorption

The 1998 budget is based on the arrival of 60,000 immigrants during the year. The budget proposal includes an immigrant-absorption plan that invokes both “direct absorption” and various assistance programs, such as housing for needy immigrants and vocational training for immigrants in general.

2. Infrastructure Investment

Although various ministries’ budgets have been cut, investments in transport infrastructure has not been reduced because this program is known to be crucial in the acceleration of growth. The 1998 budget allocates a robust NIS 2.3 billion for transport-infrastructure investment, 65 percent higher than the allocation in 1991.

3. Long School Day

The budget proposal includes an allocation of NIS 420 million for implementation of the school day law in disadvantaged localities and neighborhoods that are designated as such by the Minister of Education with approval of the Knesset Education Committee. Initial lessons from the application of this program will be adduced in 1998.

4. Greater Assistance for Disadvantaged Population Groups

The budget proposal provides greater support for disadvantaged population groups.

In this context, the budget for population groups in distress (administered by the Ministry of Labor and Social Affairs) was increased by NIS 150 million relative to the 1997 budget. This population includes the disabled, the elderly, children at risk, and the mentally retarded, to name only a few. The matter of children at risk will be given special attention in 1998.

5. Income Tests for National Insurance Child Benefits

Expenditures through the Children’s Division of the National Insurance Institute were NIS 5.7 billion in 1997.

These transfer payments accrue to all households with children, including the most affluent ones. This frustrates the very purpose of transfer payments—improvement of national income distribution.

The Government has resolved to ask the Knesset to amend the law to reduce some of the benefits for the first and second children of persons of relatively high income (above NIS 7,000 per month) who have up to three children.

6. Treatment of Unemployment

The Government has resolved to adopt an NIS 120 million assistance plan to deal with the unemployment and appointed a committee of directors-general to tender recommendations concerning its implementation. The plan will include vocational training, high-school equivalency, replacement of foreign workers by Israelis, essential temporary jobs, assistance for small business, and subsidization of transport for more distant areas.

The Government will also spend NIS 300 million in 1998 to implement alternatives to the Encouragement of Capital Investment Law—a budget increase for the marketing promotion fund, in-plant training in development towns, a budget increase for the Chief Scientist, expansion of the small-business promotion program, and projects facilitating rapid development in localities in national priority areas where relatively high unemployment rates prevail.

7. Structural Changes in the Health System

The budget proposal includes an expenditure increase of NIS 500 million for various health-system purposes, including expansion of the package of insured health services to reflect population growth and demographic changes.

The Government also proposes a series of structural changes in the health system to enhance efficiency by shifting internal resources toward improvements in matters of higher priority. The proposed changes include an expansion of the health funds’ flexibility, authority, and responsibilities, thus giving them a motive to make their service to members better and more efficient. These changes will be monitored and approved by the Minister of Health. Additional proposed changes are related to the reduction of systemic redundancies, introduction of competition in the pharmaceuticals market, and introduction of reckoning arrangements among agencies in the system, leading to economies and efficiency.

8. Structural Changes in Municipal Government

The budget proposal includes an NIS 500 million recovery plan for municipal authorities. Authorities that present a balanced budget for 1998 by means of efficiencies and maximization of revenue collection will be included in the program. However, municipal authorities whose deficits exceed the legally stipulated maximum will be replaced by appointed committees, under which financial rehabilitation actions will be taken.

ANALYSIS OF THE DRAFT BUDGET

Expenditure

Most of the real changes in expenditure, in the draft budget for 1998, are presented below in comparison with the original budget for 1997:

Total expenditure, including pay-off of principal in repayments of debts, will increase by about 2.3%, an increase which derives first and foremost from a 12% increase approximately in pay-off of the principal and from an increase in the interest budget of about 1%.

Transfer payments to individuals, to institutions and to local authorities will be maintained at their real level - with distinction between transfer payments to the local authorities which increase by about 5% in the wake of the arrangement of covering of deficits effected with the local authorities, and a decrease in transfer payments to individuals which derives mainly from changes decided by the Government - selectiveness in transfer payments in the children's branch and maintaining of the real level of the other transfer payments.

Direct investment in infrastructure is maintained at the real level.

Interest payments will increase by about 1%. This low rate of increase derives from two opposing movements, the increase in the size of the government debt on one hand, the decrease in interest on the other.

Repayments of principal will increase by about 12%, mainly because of the flow of repayments of the principal for loans taken by the Government in the past, and in light of the shortening of the average term for redemption of the loan.

Credit Allocation will be reduced by about 20%, following the adjustment of the budget data to the forecast execution.

Revenues

It is estimated that State tax revenues in 1998 will show a real increase of 3%, in comparison with the revenue actually anticipated in 1997.

The anticipated revenue increase derives from growth of the GDP, from legislative changes and from increased tax collection (for details, see Part 4 below).

State Budget Deficit

The total deficit, without allocation of credit, will decrease from 2.8% of the GDP in the 1997 budget, to 2.4% of the GDP in the 1998 budget, and will stand at NIS 9.2 billion. The total deficit will stand at NIS 8.3 billion.

The domestic deficit, without allocation of credit in the 1998 budget year, will be NIS 8.4 billion, namely 2.2% of the GDP. The foreign deficit, without allocation of credit, will be NIS 0.8 billion, namely 0.2% of the GDP.

Financing of the Total Deficit*

Billions of NIS

* The different elements of loan financing are interchangeable.

The Budget Deficit and How It Is Financed

(NIS Thousands)

* Overseas and domestic funding may be exchangeable.

Gross Expenditure by Economic Classification

(not including Bank of Israel)

(NIS Thouands)

Revenues and Borrowing

(not including Bank of Israel)

(NIS Thouands)