As politicians dither, Treasury prepping alone for NIS 25 billion cut to 2025 budget
Amid expectations for a delay in governmental approval of next year’s fiscal plan, Finance Ministry officials working on tax hikes and spending cuts to avert more rating downgrades
Sharon Wrobel is a tech reporter for The Times of Israel.
The Finance Ministry is preparing for a series of spending cuts and tax hikes to make NIS 25 billion ($6.6 billion) in fiscal adjustments to next year’s budget that have become necessary due to war costs, as the discussions with the government on the 2025 state finances have stalled.
Faced with a credit rating downgrade by Fitch and as the state deficit this year continues to widen amid growing military and civilian spending, with Israel’s war against Hamas in the Gaza Strip in its 11th month, the government has come under increased pressure to maintain fiscal responsibility and credibility.
Late on Monday, Fitch cut the country’s credit rating by one notch to A from A+ expecting the “conflict in Gaza could last well into 2025,” while maintaining a negative outlook on the economy citing heightened geopolitical risks and the impact of military fighting on multiple fronts on public finances.
Finance Minister Bezalel Smotrich in June started off with two-day “marathon talks” to help draft the 2025 budget outline, and in July Prime Minister Benjamin Netanyahu and senior economic officials, including Bank of Israel Governor Amir Yaron and Smotrich, held their first high-level meeting on the state finances for next year. However, until now the government has not convened to announce a deficit ceiling for 2025 or made progress in passing a draft budget outline as planned.
That’s as Israel’s right-wing coalition government is expected to be bogged down in rifts over the approval of politically tough spending cuts and tax hikes necessary to deal with a fiscal hole in 2025 of an estimated NIS 30 billion ($8 billion).
In response to the downgrade, Finance Ministry Accountant General Yali Rothenberg called on the government to create as much certainty as possible for the Israeli economy, investors, and credit rating agencies by acting swiftly to formulate a responsible state budget for 2025.
“We will pass a responsible [2025] budget that will continue to support all the needs of the war, while maintaining fiscal frameworks and promoting growth engines,” said Finance Minister Bezalel Smotrich following Fitch’s action.
Meanwhile, Finance Ministry officials have been working on a package of spending cuts and tax measures without the political echelon to help tackle the fiscal shortfall. The emergency plan includes merging the two lowest income tax brackets of 10 percent and 14%, according to an internal initial draft document seen by The Times of Israel. The step would affect the low-earning working population that currently pays a minimum rate of 10 percent and would be taxed according to the 14% income bracket.
The Treasury is proposing to align the higher state child allowances that are currently paid for a sixth and seventh child to the amount paid for the first five children. In addition, Finance Ministry’s officials seek to freeze a number of planned tax changes and benefits for 2025 to prevent an automatic increase in government expenditure from January 1. Those include real estate tax rates, National Insurance benefits, and the adjustment of the minimum wage to the average wage in the economy.
Other measures, which have been previously proposed but have not been passed, include the cancellation of a tax waiver on personal imports purchased online from abroad with a value of up to $75, lifting the VAT exemption on inbound tourism, and the levy of VAT on foreign digital services, also known as the “Netflix tax.”
The state budget for 2025 was sought to be approved by the Knesset by the end of this year so the austerity measures to help reduce the deficit and fund war expenditures can come into effect in January. Failure to pass the budget by March 31 of a given year will result in the dissolution of the government and a snap election.
Economists have been warning in recent weeks that a repeated postponement or delay in the drafting and passage of the 2025 budget will undermine Israel’s fiscal credibility and is likely to lead to further downgrades by credit rating agencies and fuel uncertainty among investors amid fears of an escalation on the northern front to an all-out-war with Hezbollah and Iran.
Back in April, S&P joined Moody’s Investors Service in cutting Israel’s sovereign credit rating by one notch citing regional tensions with Iran and expectations of a longer than previously estimated war with Hamas, which broke out in the aftermath of the October 7 onslaught by the terror group on Israel’s southern communities.
S&P kept its negative outlook on the Israeli economy, which opens the door for more downgrades down the line as the country could face higher military and civilian war spending, and as global market sentiment turns sour.
In July, the fiscal deficit climbed to 8.1% and was for a fourth month above the 2024 annual government budget ceiling of 6.6%, as war costs since the outbreak of the fighting triggered by the October 7 Hamas onslaught ballooned to NIS 88.4 billion ($23.5 billion). Israel posted a budget deficit of 4.2% in 2023.
Economists expect the deficit at the end of the year to reach between 7% and 7.5% of GDP, without an escalation of the security situation. Fitch projected that the deficit will probably reach 7.8% of GDP in 2024.
“It seems less important to the market if the deficit reaches 6.6% this year or a little more (7%-7.2%),” Leader Capital Markets chief economist Jonathan Katz. “The big challenge is expected to be the 2025 budget which will require large fiscal adjustments to reduce the deficit to a ‘reasonable’ level (Bank of Israel recommends 4%), which is expected to be difficult to implement for political reasons.”
“Meanwhile, the government has not yet convened to discuss the budget framework,” Katz noted.
