Bank of Israel chief says don’t cut taxes, raise services

Karnit Flug laments low rate of social spending, significantly under OECD average

Shoshanna Solomon is The Times of Israel's Startups and Business reporter

Finance Minister Moshe Kahlon (right) with Bank of Israel Governor Karnit Flug, June 3, 2015. (Yonatan Sindel/Flash90)
Finance Minister Moshe Kahlon (right) with Bank of Israel Governor Karnit Flug, June 3, 2015. (Yonatan Sindel/Flash90)

Bank of Israel Governor Karnit Flug said it would be wiser for the government to spend any excess revenue from taxes on improving social services rather than cutting taxes.

“There is room for improvement of our social and public civilian services and I would like to see more efficient spending in that area,” Flug said at a briefing on Sunday with journalists at the Jerusalem Press Club. “We don’t need an extra short-term stimulus of the economy.”

Flug’s remarks came as Finance Minister Moshe Kahlon said at the end of January that he would consider an additional tax cut this year if tax revenues continue to exceed expectations.

Because Israel’s economy is strong and is “pretty close to full employment,” Flug said she would prefer that any additional resources be spent, for example “on speeding up infrastructure.”

Israel’s economy grew 3.8 percent in 2016, beyond the growth of most global economies and beyond projections. Unemployment levels at the end of 2016 were at a record low of 3.8 percent, and participation in the labor market rose to 80%, a record high, Flug said.

Israel’s civilian spending, including in health and education, is among the lowest in developed countries. The nation’s civilian public expenditure as a percentage of GDP in 2015 was 29.8%, well below the OECD average of 41.8%.

“Overall public expenditure in Israel is significantly lower than in most advanced economies and that is in spite of the fact that we have a high defense spending and a still-high interest rate on the historical debt,” Flug said. “So what is left for civilian public spending is actually very, very modest.”

This is reflected, she said, in the education system, which is not “ensuring high enough standards for our kids,” the “very overcrowded” health system, and the welfare system, which is “very tight, I would say stingy.”

In some cases the low social spending “is clearly detrimental to growth,” she said. “A country that relies on high tech and human capital, in order to maintain this competitive advantage, has to do better in the educational system and the area of infrastructure.”

The government must also make sure the additional revenue is here to stay before deciding to cut taxes, Flug said.

Flug also hinted the Bank of Israel will continue intervening in the market, when necessary, by buying dollars to keep the shekel in check.

“Our currency appreciated substantially over the last two to three years,” Flug said. “We do not try to offset the fundamental economic forces that affect the currency but we are operating in an environment where some of our trading partners are pursuing an extremely expansionary policy, both in terms of negative interest rate and quantitative easing. Obviously, we have to take that into account in our policy and that is what we do.”

Last week, in an interview with Bloomberg News, Barry Topf, a former director of market operations at the Bank of Israel who helped design the central bank’s foreign currency intervention program, said the dollar purchases that initially helped Israel weather the global financial crisis may now be hurting the economy by distorting prices. Topf suggested the Bank of Israel should scale back the program significantly, after the country tripled its foreign exchange reserves in less than a decade.

The bank’s dollar purchases, to curb the gains of the shekel, have swelled its foreign currency reserves, which surged to almost $100 billion in 2016 from less than $30 billion eight years earlier, Bloomberg said. The shekel has gained 39 percent against the dollar since 2008.

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