Israel Finance Ministry, Yearly Pension Plan Report

PUBLIC FINANCE

General

The public sector in Israel is defined by Israel's Central Bureau of Statistics as the central Government, the Bank of Israel, and the National Institutions. The public sector does not include the local authorities or Government Companies. The Government's annual budget covers the expenditures and revenues of the Government only, and does not include the accounts of National Insurance Institute, the National Institutions, the Bank of Israel, or surpluses and deficits of Government authorities, such as the Post Authority, the Airports Authority, and the Ports and Railways Authority.

The Budget Process and Deficit Reduction

The Government's fiscal year ends December 31. The Government's annual budget process is generally initiated in June by the Budget Department of the Ministry of Finance, which coordinates budget discussions with the various Government ministries. During Septemberand October, the details of the budget are finalized within the Government. No later than 60 days before the end of the year, a budget bill, together with supporting information, is required to be submitted to the Knesset for its approval. At the time the Government submits the annual budget to the Knesset, it is required by law to submit a three-year projected budget, which is non-binding and therefore does not require Knesset approval. No later than the end of the year, after discussions with respect to the proposed annual budget before the Finance Committee of the Knesset by the responsible Government Ministers and officials, the annual budget law is required to be approved by the Knesset.

In response to persistent budget deficits, the Knesset passed the Deficit Reduction Law in 1992. This law required that the targeted domestic budget deficit (excluding credit granted by the Government), as a percentage of GDP, decrease each year during the period 1993 through 1997, as compared to the targeted domestic budget deficit (excluding credit granted by the Government) for the preceding year. The amount of the year-to-year decrease was not specified. However, in 1996, the Government submitted a new Deficit Reduction Law, which was approved by the Knesset in January1997, with specific targets for the total deficit for each year until 2001, rather than for the domestic deficit only as under the previous law. According to the new law, the targets of the total budget deficit (domestic plus external), excluding credit granted by the Government, as a percentage of GDP are 2.4% for 1998, 2.0% for 1999, 1.75% for 2000 and 1.5% for 2001. Unless the Knesset approves an increase in budgeted expenditures, no ministry in the Government can spend any amount in excess of its budget. However, budgeted amounts that are not spent by the Government in any given year may, upon notice to the Finance Committee of the Knesset, be spent in the following year. The deficit target established pursuant to the Deficit Reduction Law refers to the budget as proposed by the Government, rather than actual expenditures and revenues. Therefore, no adjustment to Government expenditures is required by law if the actual deficit exceeds the targeted deficit because Government revenues or the actual GDP is less than anticipated. The Government finances its deficits through a combination of internal and external indebtedness and proceeds from privatization. See "Public Debt."

From 1992 through 1996, the domestic deficit, excluding net allocation of credit, was 4.9%, 2.4%, 2.1%, 3.2%, and 4.6% of GDP, respectively, in comparison with domestic deficit targets of 6.2%, 3.2%, 3.0%, 2.75%, and 2.5%, respectively. In 1997, as stated, the Government decided to replace the domestic deficit target with a total-deficit target. The total deficit, excluding net allocation of credit, as a percentage of GDP was 2.8% in 1997, and 2.4% in 1998, exactly in line with the Government's targets for these years.

The total budget deficit for the years 1995 and 1996 was affected by a delay in receiving a $948 million grant from the United States which was expected to be recorded in Israel's 1995 fiscal year, but was not received and recorded until 1996 because of a delay in the approval of the U.S. Federal Government budget. In 1996, Israel received $2.148 billion in economic grants from the United States instead of $1.2 billion, while in 1995 Israel received only $0.252 billion in such grants.

The following tables set forth the Government deficit and its financing on a total and domestic basis. Domestic expenditures constitute all expenditures by the Government made in Israel. Domestic revenues constitute all taxes raised in Israel. The Government accounts for domestic expenditures and revenues as a method of measuring the influence of the Government on the domestic economy. Tables 25 and 26 present the gross budget figures, including revenue-dependent expenditures and contributions from the budget to NII; Table 28 presents the budget net of these expenditures.
Table No. 25

The Budget Deficit And Its Financing
(in thousands of NIS at current prices)

	Actual 1995	Actual 1996	Actual 1997	Original Budget 1998	Original Budget 1999
Revenues and Grants
Tax revenues	84,402,419	95,838,616	109,269,000	124,475,000	129,880,000
Non-tax revenues	23,803,100	24,297,358	28,867,495	29,882,574	33,515,310
Foreign grants	5,126,370⁽¹⁾	12,985,450⁽¹⁾	11,386,620	11,070,000	11,808,000
Total	113,331,889	133,121,424	149,523,115	165,427,574	175,203,310
Gross Expenditure and Lending
Current and capital expenditures	58,432,676	67,731,791	74,082,287	75,703,083	78,935,459
Transfer payments and subsidies	40,337,209	49,454,044	53,325,417	60,846,653	63,377,352
Interest payments and commissions⁽²⁾	18,937,284	20,698,105	22,413,452	24,077,103	23,863,908
Loans	3,555,326	4,506,763	3,609,791	4,490,517	5,244,494
Other expenditures	2,814,764	3,218,351	3,770,543	8,592,735	11,879,591
Total	124,077,259	145,609,054	157,201,490	173,710,091	183,300,804
Surplus (Deficit)	(10,745,370)	(12,487,630)	(7,678,375)	(8,282,517)	(8,097,494)
Financing
Foreign borrowings⁽³⁾	9,396,927	9,486,423	4,541,847	10,980,000	9,676,000
Foreign loan repayments	5,484,682	6,036,217	6,103,736	8,980,000	8,792,000
Foreign financing (net)	3,912,245	3,450,206	(1,561,889)	2,000,000	884,000
Domestic borrowings	24,206,238	34,006,205	2,043,201	33,462,517	32,495,494
Domestic loan repayments	17,766,371	26,083,223	27,259,426	31,480,000	29,872,000
Domestic financing (net)	6,439,867	7,922,982	783,775	1,982,517	2,623,494
Proceeds from Privatization	1,798,184	349,444	8,466,578	4,300,000	4,590,000

	Actual 1995	Actual 1996	Actual 1997	Actual 1998
Cash Balance of the Government (at end of period)
Deposits in NIS	3,880,000	(1,498,000)	(5,405,000)	(4,531,000)
Deposits in foreign currency included in budget	1,916,000	4,911,000	5,894,000	7,184,000
not included in budget	581,000	2,432,000	6,739,000	13,399,000
Total deposits in foreign currency	2,497,000	7,343,000	12,633,000	20,583,000
Total	6,377,000	5,845,000	7,228,000	16,052,000

____________________

(1) A $948 million grant from the U.S. Federal government was received in 1996, instead of 1995, due to delay of the approval of the FY 1996 U.S. Federal budget.

(2) Interest payments and commissions are net of amounts attributable to indexation of NIS-linked Government bonds and that portion of the interest payments on shekel loans attributable to inflation for the year of payment. Those amounts are included in the capital expenditures portion of the budget as domestic loan repayments.

(3) Excludes proceeds borrowed under the U.S. loan guarantee program which are not used for budget financing.

Source: Ministry of Finance.

Table No. 26

The Domestic Budget Deficit And Its Financing
(in thousands of NIS at current prices)

	Actual 1995	Actual 1996	Actual 1997	Original Budget 1998	Original Budget 1999⁽¹⁾
Revenues and grants	105,658,509	117,448,900	134,491,433	150,761,423	156,572,280
Gross expenditure and lending
Current and capital expenditures	53,201,473	60,310,852	65,655,382	67,062,395	69,561,577
Transfer payments and subsidies	40,337,209	49,454,044	53,325,417	60,846,653	63,377,352
Interest payments (including credit subsidies)	14,103,115	14,720,441	16,923,556	17,917,103	18,158,908
Loans	3,555,326	4,506,763	3,609,791	4,490,517	5,244,494
Other expenditures	2,809,797	3,215,857	3,769,344	8,040,575	10,877,591
Total	114,006,920	132,207,957	143,283,887	158,357,243	167,219,922
Domestic surplus (deficit)	(8,348,411)	(14,759,057)	(8,792,454)	(7,595,820)	(10,647,642)
Financing
Domestic borrowings	24,206,238	34,006,205	28,043,201	33,462,517	32,495,494
Domestic loan repayments	17,766,371	26,083,223	27,259,426	31,480,000	29,872,000
Domestic financing (net)	6,439,867	7,922,982	783,775	1,982,517	2,623,494

____________________

⁽¹⁾ As approved by the Knesset in February1999.

Source: Ministry of Finance.

Taxation and Tax Revenues

In 1998, Israel's total tax burden, representing the total tax revenue, including National Insurance fees, health tax and municipal taxes, reached 40.4% of GDP, as compared to 40.8% in 1997. The decrease in tax revenue in 1998 was mainly due to the slow-down in economic activity in Israel through 1998, including a decrease in imports of goods subject to high levels of duties.

Israel has a progressive personal income tax with a top rate of 50%, supplemented by a 15% National Insurance fee (including the health tax) and a 36% corporate tax rate.

Indirect taxes consist primarily of a 17% VAT. Imports from the European Union and the United States are duty free, whereas customs are applied on imports from other countries. In addition, a high purchase tax is levied on durable goods, fuel and cigarettes.

In 1997, further changes to the tax system were adopted to integrate Israel more firmly into the global economy. As part of this policy, custom duties on imports continued to decline. Decisions taken under GATT in 1994, with respect to reducing duties on agricultural products, went into effect on January1, 1996. Free trade agreements with Canada, Slovakia and the Czech Republic were signed in 1996, lowering custom duties on imports from these countries as of January1997.

On January1, 1995, a double taxation treaty with the United States went into effect. This treaty governs the income taxation of residents of the United States or Israel, as the case May be, who conduct business or otherwise derive income in the other country subject to the treaty jurisdiction. Among other things, the treaty provides for reduced rates of withholding tax on certain nonbusiness income, such as dividends, interest, and royalties, which is sourced in Israel and derived by a resident of the United States. The treaty provides rules for the avoidance of double taxation through a foreign tax credit mechanism, and allows for the resolution of disputes arising under the treaty through a mutual agreement procedure involving the governing taxing authorities.
Table No. 27

Budgeted Taxes and Other Compulsory Payments
(in millions of NIS at current prices)

	1995	1996	1997	Original Budget 1998 ⁽¹⁾	Original Budget 1999 ⁽¹⁾
Income tax	38,692	41,046	51,336	58,145	58,300
Property, inheritance and other taxes	7,048	9,750	7,945	9,680	10,790
Customs, excise and sales tax	11,735	13,629	14,857	16,730	16,350
Value added tax.	24,676	28,447	31,649	35,760	35,740
Revenue stamp, license and registration fees	2,251	2,968	3,182	4,160	4,230
Total	84,402	95,839	109,269	124,475	125,410

____________________

(1) As approved by the Knesset .

Source: Ministry of Finance.

Table No. 28

Government of Israel Statement of
Net Expenditures (Excluding Capital Expenditures)
(in millions of NIS at current prices)

	1995	1996	1997	Original 1998 Budget	Original 1999 Budget
Government Expenditures:
Government administration.	8,746	10,735	11,810	13,143	13,732
Local authorities	2,894	3,246	3,589	4,073	3,956
Defense.	25,740	30,723	33,619	32,770	34,322
Social services	40,778	49,866	54,666	61,660	64,650
Economic services	8,106	8,988	8,495	9,739	9,599
Interest payments	18,574	20,403	22,226	23,800	23,836
Credit subsidies	365	297	189	278	29
Reserves	-	-	-	4,176	7,417
Total expenditures (other than capital expenditures)	105,203	124,257	134,674	149,641	157,540
Development and Capital Account Expenditures:
Development expenditures	34,704	45,932	46,729	56,587	56,258
Repayments of debt	26,070	35,349	37,135	44,940	43,405

____________________

Source: Ministry of Finance.

Government Budget for 1999

The State budget for 1999 is NIS215 billion-0.8 percent lower in constant prices than the original 1998 budget. Government expenditures, excluding debt service (principal), is NIS183.3 billion, 1.4% higher in constant prices than government expenditures (excluding principal) in the original 1998 budget. Budget expenditures (excluding principal) are 46.5% of the forecast 1999 Gross Domestic Product.

The main changes in expenditures in the 1999 budget, relative to that of 1998, are a 9% decrease in repayment of debt principal (because of the structure of the debt-repayment schedule), a 2% increase in civilian consumption, mainly because of budget supplements for social-affairs ministries, and a 1.9% increase in defense consumption.

Estimated State tax revenues in 1999 will increase by 2.9% in real terms relative to 1998 because of GDP growth, legislative changes, and enhanced collection efforts. The total deficit, excluding net allocation of credit, is expected to be NIS8 billion, and is expected to decline from 2.4% of GDP in the 1998 budget to 2.0% of GDP in the 1999 budget. The total deficit in the 1999 budget is composed of a domestic deficit of 2.6% of GDP, and a surplus in government activities abroad of 0.6% of GDP.

In each of the past three years, the annual growth rate of GDP slowed relative to the previous year. Therefore, the Government decided to take a series of measures that will create more convenient conditions for enhanced activity by the business sector, thereby accelerating growth and stimulating employment.

Enumerated below are the main measures in the proposed policy for 1999 in three major fields:

Budget framework.

The 1999 budget emphasizes continued gradual reductions of the deficit, government expenditures, and debt measured as a percentage of GDP. It also stresses avoidance of any increase in the tax burden.

Increased infrastructure investment.

The 1999 budget boosts government investments in infrastructure by nearly NIS1 billion relative to the 1998 budget. Most of the increase will be invested in transport (a 30% increase from the original 1998 budget) and in water and sewage (a 15% increase). The expansion of infrastructure investments will help stimulate growth not only by creating added economic activity in the performance of the infrastructure projects themselves, but also by expanding the advanced infrastructure that the business sector needs to develop more rapidly.

Vocational training and changes in the labor market.

The 1999 budget includes NIS100 million for a vocational training program for the 30,000 who are currently unemployed, stressing in-plant training. Furthermore, in view of the shortage of skilled workers in electronics and computers, the Government has decided to initiate a special program that aspires to double the number of university graduates in electronics and computers within four years.

Additional areas of emphasis in the 1999 budget include increasing the defense budget, preparing for tourism in the year 2000, absorbing immigrants, enhancing competitiveness and bringing down prices, and increasing efficiency in the public sector.

Local Authorities

Local authorities in Israel include 63 municipali, 146 local councils, and 53 regional councils. The local authorities are obligated by law to provide a number of basic social services. Local authorities generally finance the provision of such services through local taxes (primarily taxes based on the use of property) and through transfer payments from the Government. In addition, under certain circumstances, local authorities May finance a portion of their activities through borrowings, while less financially sound local authorities may receive supplementary grants from the Ministry of Interior. As of December 31, 1997, the total outstanding debt of the local authorities was approximately NIS 12.4 billion. Transfer payments from the Government are allocated among all local authorities based on fixed criteria and for specific purposes, such as social services or education. The aggregate of the capital expenditures of all local authorities in 1997 was approximately NIS 6.2 billion, most of which was for road construction, public building starts and improvements in sewage systems. The Government currently maintains authority to approve changes in the level of taxes imposed by local authorities.

Social Security System

National Insurance Law. Under Israel's National Insurance Law, the National Insurance Institute (the "NII"), an independent institution, provides a wide range of social security benefits, including old-age pension benefits, unemployment insurance, long-term disability payments, workers' compensation benefits, maternity support benefits, and child support payments. In 1998, total expenditures by the NII were NIS 33.7 billion. The NII funds its expenditures using the proceeds of social security taxes paid by employers and employees, transfer payments from the Government required according to the National Insurance Law, and interest income on deposits representing surplus from previous years. The NII also receives separate funds for non-contributory NII benefit payments, including payments to new immigrants and other payments not covered by social insurance programs. In 1998, the Government's transfer payments to the NII (including Government payments replacing employers' contributions to the NII, pursuant to a Government program intended to reduce labor costs) and the Government's share of the NII provision for non-contributory payments totaled NIS 9.9 billion and NIS 5.26 billion, respectively. These amounts represented 29.0% and 15.6%, respectively, of total NII income in 1998, and together represented 7.3% of the Government budget for 1998. The aggregate amount of Government transfer payments to the NII and the Government provision for NII non-contributory payments in the 1999 budget is NIS 16.6 billion.

Health Care. Israel has an advanced medical system and a ratio of one doctor for approximately every 300 people. Until 1993, the health organization operated by the Histadrut provided health care for more than 70% of the Israeli population. In 1994, as a result of significant deficits experienced by the Histadrut-sponsored health care organization, the Government implemented a recovery program for this organization, after which other health care organizations increased their share of the health care market. Under this program, the Government agreed to make transfer payments to those organizations in an aggregate amount of approximately NIS 2.4 billion in 1994 prices over a multi-year period. In 1994, the Government also enacted new health care legislation which came into effect in 1995, and instituted a new health care fee to fund future health care benefits. According to the law, every resident of Israel is entitled to a wide range of medical benefits. In 1997, the Government enacted legislation in order to enhance efficiency in the health care market. The legislation reflects and expresses some of the structural changes proposed by the Ministry of Finance. These changes are mainly related to the framework of health funds under the national health care law by expanding their flexibility, authority, and responsibilities, thus giving them incentive to make their service more efficient. Additional changes are related to the reduction of systematic redundancies and introduction of reckoning arrangements among agencies in the system, leading to economies and efficiency. The 1998 Government budget provides for Government expenditures on health care of NIS 4 billion, mainly for mental illness, public health, preventive care, and investments in hospitals (which are not included in health services supplied by health funds).

Pension Funds

Pension funds are the principal instruments in Israel for the accumulation of retirement savings and provision of retirement income. Most workers who participate in a pension fund do so pursuant to a collective agreement between the pension fund, the workers' employer (or a representative organization for such employer), and the representative organization for such workers. These agreements require that the employer and the employee make contributions to the pension fund. At retirement age (or other insurable event), each employee becomes entitled to receive pension payments in amounts determined based upon years of employment since joining the fund and preretirement wages, regardless of the employee's age or state of health. This approach to calculating employee pension benefits, coupled with several other factors, has caused a large actuarial deficit for almost all Israeli pension funds.

In March 1995, in response to the large and rising actuarial deficits of Israel's pension funds, the Government adopted a new policy, including a comprehensive plan of recovery for existing pension funds. The primary elements of the new Government policy are: (1)
the existing pension funds will be closed to new participants, yet existing participants will continue to be covered under the existing plans for the life of such plans, subject to certain limitations on the future accumulation of benefits; (2)
the Minister of Finance is empowered by the Government to draft recovery plans for pension funds in actuarial deficit positions, according to the principles established by the Government; (3)
provided that a pension fund complies with its approved recovery plan, the Government will be responsible for paying pension benefits owed by that pension fund if, and to the extent that, the pension fund is unable to do so; (4)
the Minister of Finance, at his discretion, is authorized to continue and issue special bonds to pension funds in actuarial deficit for an interim period; (5)
new members enrolling in pension programs shall join new, actuarially balanced funds that will operate separately and independently from existing funds, while benefits payable by the new pension funds will be subject to automatic reductions to the extent necessary to eliminate any actuarial funding deficit of such funds; and (6)
the Government will issue special bonds, bearing interest at above-market rates (real rate equal to approximately 5% per annum), to each new pension fund with respect to 70% of its assets, provided the contributions made to any such fund are made with respect to wages not exceeding twice the amount of the average market wage. The portion of the new pension funds' assets that is not invested in special bonds will be invested in the Israeli capital markets. The Government estimates that over the next 80 years, the total cost to the Government of the recovery plan for existing pension funds will be approximately NIS 120 billion, consisting of approximately NIS 30 billion for pension payments that the pension funds will be unable to make, and NIS 90 billion for the subsidy component of the special bonds.

Currently, approximately 95% of all assets held by Israeli pension funds are held in pension funds owned and operated by the Histadrut, and approximately 30% of the workers in Israel participate in these funds. Generally, pension funds are funded through employer and employee contributions and are supported by the Government through significant tax benefits and, since 1995, by the Government's issuance of special non-marketable bonds bearing real rates of 5.05% per an. Since 1995, approximately 70% of the assets of all pension funds are invested in such special bonds (93% prior to 1995). During the period 1992 through 1994, the average annual above-market component of the interest paid on these special bonds (as compared with comparable Government bonds issued in the market) was approximately 2.5%. The spread for existing funds has decreased to 1.4% in 1997 and 1.2% in 1998, while decreasing to only 0.9% in 1997 and 0.7% in 1998 for new funds. Historically, all Israeli pension plans have been managed as non-profit organizations. In recent years however, for-profit organizations have also begun to get involved in the operation of pension funds.

Public sector employees are presently participating in an unfunded Government pension plan mandated by the State Service (Benefits) Law. The actuarial liabilities of the Government with respect to pension benefits payable under this plan were approximately NIS 184 billion as of December 31, 1997. The Government has reached an agreement in principle with the Histadrut which provides that new Government employees will not participate in the existing unfunded Government pension plan, but will instead participate in the new funded pension plans (described above) to which the Government will make contributions on their behalf. The agreement with the Histadrut has been signed, and presently awaits the approval of the Knesset.