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Israel may need tax hike to cut virus-swollen debt, Bank of Israel says

Pandemic spotlights absence of economic safety net that can be rolled out quickly when needed, central bank says, and lack of adequate data infrastructure for targeted assistance

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

Bank of Israel Governor Amir Yaron, speaking at the Eli Hurvitz Conference on Economy and Society organized by the Israel Democracy Institute, December 17, 2019 (Michal Fattal)
Bank of Israel Governor Amir Yaron, speaking at the Eli Hurvitz Conference on Economy and Society organized by the Israel Democracy Institute, December 17, 2019 (Michal Fattal)

Israel may have to raise taxes to curb debt levels that have ballooned due to the coronavirus pandemic, the Bank of Israel said in a summary of its 2020 annual report on the economy published on Wednesday.

“To finance debt, which has swelled… it could be that the need will arise in due time also to raise tax rates,” the summary of the report said. The central bank is scheduled to hold a press conference on April 6 to present the full report.

Fiscal policy must adapt itself to a post-pandemic economy “and be conducted in an orderly manner” with long-term priorities, in order to maintain credibility, the Bank of Israel said.

A state budget for 2021 is essential in order to boost growth, and must especially invest in human capital, public transportation and communications infrastructure, energy and the environment, the report said.

Israel has been without a budget since 2018 due to political instability and is now exiting from a fourth round of elections in two years without a clear winner in sight.

People shop at the Givatayim Shopping mall on February 21, 2021, after it reopened following a few weeks of lockdown. (Miriam Alster/Flash90)

“The lack of an approved budget for such a long period impairs the capacity to budget many items and set clear priorities,” the report said. “This further emphasizes the need to approve a budget for 2021 and preserve the institutional frameworks essential for fiscal policy management and to establish its credibility over time.”

Israel’s gross domestic product contracted by 2.5% in 2020 due to the pandemic, with enforced social distancing to keep the virus at bay shuttering businesses and economic activities. Unemployment shot up to its highest level in at least 50 years, to an average of 15.7% for the year, compared to a record low level of 3.8% in 2019. Private consumption dropped by 9.5%, and GDP per capita by 11%. The government deficit ballooned to 11.6% from 3.7% in 2019, and the debt to GDP ratio surged to 72.6% from 60% in 2019.

The crisis was the fiercest one to shake the nation in the past 20 years, and when compared to the crises of 2001-2003 and 2008-2009, “the contraction in GDP in 2020 was sharper than in any corresponding period of time in previous crises, and the negative quarterly growth rates recorded during the year was unprecedented,” the report said.

The businesses that suffered most during the pandemic were the manually intensive, lower paying ones, and those that necessitated physical presence. Unemployment levels were highest among those with lower pay and lower education.

Israelis enjoy takeout coffee at cafes in Tel Aviv, which were opened today, as Israel exits a 3rd lockdown due to the COVID-19 coronavirus pandemic. (Miriam Alster/Flash90)

Unemployment will decline as the economy recovers from the crisis, the report said, but will likely remain much higher than in 2019, before the crisis struck. This could be because businesses have become more efficient and can make do with fewer workers; because of changes in the structure of the economy; or because those who were furloughed or unemployed for a long time find it hard to get back to work.

Training the workforce, i.e., human capital, to adapt to changes in the economy will help address this fallout from the crisis, the report said.

During the crisis the government compensated citizens for their losses, e.g., grants and unemployment benefits for those who were furloughed, which were extended until June 2021.

A hairdresser wearing a face mask does hair extensions to a customer at a hair salon in Tel Aviv on February 7, 2021 as Israel exits a 3rd lockdown due to the COVID-19 coronavirus pandemic.(Miriam Alster/Flash90)

Now, as the nation emerges from the crisis, these programs should be stopped or cut back, so that they don’t disincentivize going back to work or prop up businesses that wouldn’t survive on their own. These policies should be scaled back in parallel with the economic recovery, the report said.

Safety net and data needed

In addition, the crisis has highlighted a lack of a broad economic safety net that can be rolled out quickly when crises hit, along with a lack of an adequate data infrastructure to design and implement effective targeted assistance programs.

“Dealing with these weaknesses is important for improving preparedness for a future crisis,” the report said.

With the exit from the crisis, the need to focus on the basic problems of the economy, especially productivity, will rise once again on the agenda of policy makers, the report said.

Low productivity in some sectors and inequality are two issues that need to be addressed. Some of these problems have even sharpened during the crisis, like the wage gap between educated and less-educated workers. As businesses and workplaces increasingly turned online, those with not equipped with skills for online activities were hurt the most in the crisis, as they could not work from home.

“All of these emphasize the importance of improving the education system and reducing the gaps within it,” the report said. In addition, increasing investment in the economy and in particular in infrastructure, “above all in public transportation” and communications are also needed to increase productivity.

An ongoing challenge of maintaining a rate of construction starts that matches the needs of the population over time is also set to come back to the fore, the report said.

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