Central bank chief urges government to rethink spending priorities to reduce war debt
Amir Yaron says government shouldn’t rush to cancel tax hikes imposed on the public; reminds lawmakers that independent institutions are vital for economic growth
Sharon Wrobel is a tech reporter for The Times of Israel
Bank of Israel Governor Amir Yaron on Wednesday urged the government to make changes to the budget expenditure in light of higher defense spending and the need to bring down the country’s debt to help the war-torn economy recover.
“A higher level of defense spending in the foreseeable future, and the need to maintain fiscal responsibility all the more emphasize that adjustments will be needed in the composition of spending, which will require the government to set priorities that are appropriate to the challenges of the economy and which will support sustainable growth and an increase in the standard of living of all segments of the population,” said Yaron in a letter sent to the government alongside the Bank of Israel’s annual report for 2024.
The call by Yaron, who acts as the government’s economic adviser, comes after the coalition approved the 2025 budget on Tuesday. The passage of the budget was seen as a major boost to the stability of Prime Minister Benjamin Netanyahu’s government, as general elections would have been called if the budget had not passed before March 31. Opposition leader Yair Lapid termed the budget “the greatest robbery in the history of the country.”
“The government has taken significant convergence measures this year, mainly on the revenue side, measures that came into effect in early 2025 and that are likely to roughly offset the additional fixed expenses stemming from the war,” cautioned Yaron.
“However, these measures are not enough to ensure a sustained decline in the debt-to-GDP ratio – both because some of them are temporary and because of the expected increase in other structural government expenditures,” Yaron said.
On Jan.1, a series of tax hikes came into effect to bolster state income and fill a fiscal gap amid ballooning defense and civilian expenses during the months-long multi-front war with the Hamas terror group and the Iran-backed Hezbollah group. Among the measures were a hike in National Insurance payments, a freeze of income tax brackets and tax credit points, and an increase in value-added-tax from 17% to 18%. This has left the taxpaying public with less disposable income while consumer prices have been increasing.
“Although we are seeing an improvement in tax revenues and we expect Israel’s debt-to-GDP level to stabilize and possibly come down in 2026 as war spending cools, it will be the right move to wait with considering lowering taxes until we see to what degree the sources of state revenues are persistent,” Yaron said speaking at a press conference in Jerusalem. “We need to be cautious about the improvement in tax collection because some of these additional taxes are temporary such as the VAT increase and the taxation of undistributed profits.”
“As we are still facing a high degree of uncertainty, we need to have buffers,” he added.
Yaron noted that thanks to the fiscal credibility and economic fundamentals Israel has built in recent years, it was possible to temporarily increase the budget deficit and debt level to finance war costs.
“The war once again is a testament to the crucial importance of a relatively low public debt-to-GDP ratio for the economy’s resilience to shocks and its ability to finance extraordinary expenditures,” he said.
Government spending for defense and civilian needs surged significantly due to the war, and as a result the 2024 budget was opened three times for budget additions, mostly related to the ongoing fighting. The sharp increase in spending was financed mainly by increasing the budget deficit, which reached 6.8 percent of the GDP in 2024. The public debt-to-GDP ratio rose to 68% from 62% at the end of 2023.
Moody’s Investors Service warned Tuesday of Israel’s “very high political risks that have weakened economic and fiscal strength.” The rating agency said it expects “significantly higher budget deficits in the coming years, mainly driven by higher defense spending but also lower tax revenues as a result of our lower growth forecasts for the coming years.”
“We now expect the government debt ratio to stabilize later and at a higher level than assumed previously,” Moody’s said. “In our baseline scenario, we forecast the debt ratio to rise to around 70% of GDP over the coming years, compared to our forecast of a decline towards 50% before 7 October 2023.”
Yaron’s criticism and Moody’s warning come amid financial jitters over the renewal of the government’s contentious judicial overhaul and the resumption of fighting in Gaza.
The coalition brought highly controversial legislation for final votes at the Knesset on Wednesday that will greatly increase political control over the judicial appointments process in Israel, and dramatically reduce the influence of the judiciary over appointments to the Supreme Court.
Speaking at the press conference, Yaron reiterated his warning that the existence of strong and independent institutions is vital for the stability and prosperity of the economy.
“There is a direct correlation between strong and independent state institutions and economic growth,” said Yaron. “Hence, if they are hurt, the economy gets hurt as well.”
In the central bank’s annual report, Yaron noted that the war has significantly affected economic activity in 2024, mainly due to supply constraints, primarily a shortage of workers. The economy grew by only 0.9%, and business output decreased by 0.8%.
“The war’s impact on economic activity was primarily due to the decline in labor supply, mainly because of the ban on the entry of Palestinian workers, the recruitment of reservists, and the difficulty for workers in conflict areas to reach their workplaces,” Yaron said. “The increase in the burden of military service, and especially reserve service, will continue to exact a considerable economic toll.”
“Integrating additional populations into military service will mitigate this cost for the economy as a whole and for the army serving population in particular,” he said.
The Times of Israel Community.