On the Cusp of the Second Year of the Two-Year Budget for 2011-2012

1. On the Cusp of the Second Year of the Two-Year Budget for2011-2012 December 2011 1

2. The People Demand, The Government Digs in During the debate on the 2011-2012 budget, the Adva Center contended that a two-year budget would be detrimental to democracy in Israel. Last summer’s protest illustrated the point, as hundreds of thousands of Israelis marched for social justice. Under normal conditions, the Cabinet and Knesset would have felt obliged to respond to that demand by increasing the 2012 budget. However, their hands were tied, as the ceiling of that budget was fixed in December 2010. The popular demand for social justice was met head on by a different message. The Trajtenberg Commission, charged with formulating a response for the government, stated: “The first decision was not to increase the budget.” 2

3. The Economic Picture Changed,But the Budget Was Already Cut and Dried Another objection voiced against a two-year budget was that frequent changes in the economic arena require frequent re-examinations of fiscal policy. The present forecast for 2012 is a shrinking of economic activity, due to the prevailing financial and economic crisis in Europe -- one of Israel’s major export destinations. This situation calls for a re-examination of fiscal policy. However, the 2012 budget was finalized back in December 2010. Thus, last year’s political “success” in obtaining Knesset approval for a two-year budget now limits the ability of the Knesset to legislate a fiscal response to two new developments – the social protest, on the one hand, and the European crisis, on the other.

4. The Protest Came Against the Background of Serious Economic and Social Problems The protest brought to the fore the following situations: • Stark inequality – a large stratum of poor families, a thin stratum of very wealthy families, and in the middle – a shrinking middle class; • The deterioration of vital public services, like education, health, housing and social security and their subjection to “market forces”; • A macro-economic policy that encourages economic growth that is inequitable, the concentration of capital in very few hands, the concentration of investments in a small number of economic sectors – all in the center of the country, and the economic and social exclusion of large portions of the country and citizenry. • State passivity, justified by the contention that such matters should be left to free market forces. • מדיניות מקרו-כלכלית המעודדת צמיחה בלתי שוויונית, ריכוז ההון בידי מעטים, ריכוז ההשקעות במספר קטן של ענפים במרכז הארץ, והדרה כלכלית וחברתית של אזורים וקבוצות רחבות בישראל; 4. פסיביות מדינתית אל נוכח כל אלה בנימוק של "שוק חופשי".

5. It All Started in 1985 The foregoing problems call for a reconsideration of the 3 macro-economic principles established in the framework of the emergency stabilization program of 1985: (1) economic growth is the main macro-economic goal; (2) economic leadership is to be transferred from the public sector to the business sector; and (3) the functions and budget of the state are to be retrenched. The 1985 doctrine allowed Israeli business groups to come into their own; at the same time, it limited the beneficiaries of economic growth, led to increased inequality, and resulted in debilitated social services. Moreover, the 1985 doctrine weakened the legitimacy of the state as an initiator of processes that could lead to more universalistic social and economic development. As a result, many Israelis find themselves on the margins of economic growth, excluded by both the business and the public sectors.

6. The Social Protest and the Trajtenberg Commission The Trajtenberg Commission did not challenge the 1985 doctrine. Rather, it emphasized the importance of “fiscal responsibility, which Israel achieved thanks to 25 years of hard work.” There is no denying the importance of fiscal responsibility. However, since 1985, that term has served as a cover-up for government inaction. While it is true that the Trajtenberg Commission recommended that in addition to its macro-economic goals, the government should adopt other, measurable social goals, among them increasing employment and decreasing poverty and inequality, it failed to delineate those goals; more importantly, it failed to recommend practical steps and timetables to achieve them.

7. Regarding Education, Trajtenberg Was Good – But Not Good Enough The Trajtenberg Commission did submit many good proposals, mainly in the area that it set as its top priority: Lowering the high costs of raising children incurred by the middle class. All parents need early childhood education services, and especially those in the middle class, who may not be able to afford private services but fear they may not find a place in the publicly subsidized preschools. Yet, urgent needs in the area of education do not end with early childhood. For example, more than 50% of high school seniors fail to obtain matriculation certificates. The Commission did not set any goals for secondary education.

8. Free Education from the Age of 3Not Here Yet Free education from the age of 3 is an excellent idea, as all parents of small children can benefit from it. In contrast, free higher education is less universally beneficial, as only a minority of Israelis (less than 30%) go on to college. The problem is that a law mandating free education from the age of 3 has been on the books since 1984 but has not been implemented due to its cost. The Ministry of Finance postpones implementation from time to time, in the framework of the Budget Arrangements Law. In the last week of December 2011, Prime Minister Binyamin Netanyahu announced that he would not approve any reductions in the Defense budget -- from which the funding was to come for free early childhood education. עד מועד כתיבתו של מסמך זה, הממשלה לא התכנסה לאשר את המלצת ועדת טרכטנברג בדבר חינוך חינם מגיל 3.

9. Update: In January 2012, the Cabinet Pulled a Rabbit out of a Hat, Approving Free Education for All Children from the Age of 3 • Funding is to come from a 4% budget cut in all ministries; • The same decision increased the defense budget; • It is unclear how new kindergartens and day care centers are to be built before the target date – September 2012. • But we are all for it.

10. Trajtenberg was Good on TaxationBut Not Good Enough The main recommendation of the Trajtenberg Commission in the area of taxation was to end the income and corporate tax cutting program initiated in 2003 and renewed in 2010. That was a desirable step, for which many had advocated, including the Adva Center. However, the Trajtenberg Commission did not challenge the long-term process by which Israel has been distancing itself from the tax model prevalent in Western Europe (especially the Scandinavian countries), which collect relatively high taxes that enable them to provide quality public services for everyone. Israel’s present tax model is closer to the U.S. one, which has relatively low taxes but whose social services more often than not involve payments that not everyone can afford. We interpret “social justice” as calling for high-quality social services for everyone.

11. Taxing the Rich: Limited Liability Not all the Trajtenberg Commission’s tax recommendations were adopted: The Cabinet and Knesset approved the following recommendations, among others: a temporary (until 2014) end to the tax-cutting program begun in 2010 and slated to extend through 2016; raising the top marginal tax rate to 48% from 44%; increasing corporate taxes from 24% to 25%; giving fathers of children up to age 3 two tax credits. The recommendation to impose an additional 2% tax on high incomes (above NIS one million) was rejected. The Trajtenberg Commission also decided not to impose an inheritance or estate tax, out of fear that these taxes might make Israel less attractive to affluent Jews living abroad.

12. What Can the Knesset Do This Year? Given that the 2012 budget was approved in 2010, during its present session the Knesset limited its business to deliberation of the Trajtenberg Commission recommendations approved by the Cabinet. The Knesset can definitely do more than just approve the Trajtenberg Commission recommendations. Firstly, the temporary order that made it possible to pass a two-year budget does not prevent the Knesset from holding deliberations, in the plenary as well as in committee, on government outlays in 2011. The Knesset can also ask the chief financial officer of the Finance Ministry for expenditure reports for the first two quarters of 2011 and for an estimate for the third quarter.

13. The Budget Adjustments Secondly, the temporary order states that before 2012 “the Cabinet is to present a proposal for the use of the budget adjustments to the Knesset Finance Committee in 2012.” Moreover, the temporary order states that “details regarding the budget adjustments, the proposal for their use and allocation are to be legislated.” That is, the budget adjustments need to be approved by the Knesset plenary in three readings. This constitutes an opening for a full debate not only on the budget adjustments but on the entire budget for 2012.

14. The Knesset Fell Down on the Job However, the Knesset was not even aware of thetemporary order stipulation concerning the budget adjustments until the first week of December 2011. The Finance Ministry did not mention it. The moment the issue was brought up, the Finance Ministry asked for a postponement until January 31, 2012. The problem is that by January 31, the 2012 budget will already be in use and it will be very difficult to make changes.

15. Erosion in Central Government Outlay Per Capita, 2001-2012 The 2-year budget was a ploy to limit outlays in 2011 and 2012, one of many taken since 1985. During the past decade, the per capita outlay of central government decreased by 8.5%: • In 2001, it was NIS 33,100; • In 2010, it was NIS 30,304. • The international credit raters praise the policy of cutting budgets; however, inside Israel it creates disparities and under-funding. • Looking ahead to 2012, we present a picture of some of the major budget lines.

16. Per Capita Central Government Expenditure, 2001-2012 NIS 2010 Prices

17. Per Capita Social Service Expenditures: A Decade of Budget Cuts Not Yet Recovered The years of the second intifada – 2001-2004 – saw budget cuts in all ministries except Defense. In 2001, the per capita social service outlay was NIS 12,488; in 2004 it was NIS 11,309, a reduction of 9.5%. Since that time, the per capita outlay has been on the increase. Still, in 2010 it totaled NIS 11,865, or about 5% lower than in 2001.

18. Per Capita Social Service Expenditure 2001-2012NIS, 2010 Prices

19. Which Social Service Budgets Increased? The budget of the Ministry of Education increased, due to new collective wage agreements with elementary and high school teachers involving salary increases. Another reason for the increase in the national budget for Education was the need to build new classrooms, after a decade of budget cuts in the investment budget. The investment budget of the Ministry of Health also increased, following a decade of budget cuts.

20. The Defense Budget: The Budget First Approved Does Not Reflect the Real Expenditure The Trajtenberg Commission recommended a cut of NIS 2.5 billion in the 2012 Defense budget to pay for free education from age 3 and other social service recommendations. The Ministry of Defense objected. Defense outlays are usually higher than the budget approved during the budget debate. The following table points to the difference between the sum that the Knesset originally approved for the Defense Ministry and the total expended on Defense. The latter includes outlays for secret services. Assuming that secret service outlays are stable, the jumps represent increases in budget allocations for the Defense Ministry.

21. Budget of the Ministry of Defense and Total Defense, 2001-2010: Budget Originally Approved by the Knesset and Actual Expenditure

22. The Defense Budget and the Absence of a Political Settlement with the Palestinians Israel pays a heavy price for the absence of a political settlement with the Palestinians. During the last 20 years, it experienced two intifadas and a disengagement from the Gaza Strip. There was also the Second Lebanon War and the “Molten Lead” Campaign. In the 21 years between 1989 and 2010, the Ministry of Defense received budget increases earmarked for hostilities in the amount of some NIS 55 billion.

23. Additions to the Defense Budget for Hostilities Connected with the Palestinian Conflict and the Second Lebanon War, 1989-2010 In NIS billions, 2010 Prices

24. Education: After a Decade of Cuts, the Budget for Teaching Hours Returned to its 2001 Level Between 2001 and 2006, Israeli schoolchildren lost teaching hours costing NIS 7.9 billion (calculated on a per capita basis), following budget cuts. During the years 2007 and 2008, as the first stage of the wage agreement for elementary teachers was instituted, the budget for teaching hours began to grow. In 2010, the per capita budget for teaching hours was slightly higher than it had been in 2001. This is a positive development.

25. Per Student Budget for Teaching Hours, 2001-2010 In NIS, 2010 Prices

26. The InvestmentBudget of the Ministry of Education Increased The investment budget, which finances the construction of schools and classrooms, decreased between 2001 and 2004 by 60%. In 2007, a 5-year program to build 8000 classrooms between 2007 and 2011 was instituted, leading to larger budgets. Still, there is a shortage of classrooms in Israel, making it difficult for many schools to implement a long school day.

27. Ministry of Education Investment Budget, 2001-2012In NIS Millions, 2010 Prices

28. Erosion of the Per Student Budget for Higher Education, 2001-2012 Between 2001 and 2004, Israel’s system of higher education lost an accumulated sum of NIS 2.2 billion (on a per student basis). The result: fewer lecturers and teaching assistants, larger classes and reduced investments in laboratories and libraries. In August 2010, an increase of NIS 7.5 billion, to be spread over six years, was approved for higher education. This is a positive development, even though it is not enough to make up for lost revenues.

29. Higher Education Budget, Per Student, 2000/2001-2011/2012 In NIS, 2010 Prices

30. Erosion in the Ministry of Health Budget, 2001-2010 In 2010, the budget of the Ministry of Health (not including funding of the National Health Insurance Law and the investment budget) was 96% of its value in 2001. Among others, this budget includes three very important services: long-term health care, mental health care and public health services.

31. Ministry of Health Budget, 2001-2010 Per Capita, Age-Adjusted 2001=100

32. Following Prolonged Erosion: Growth in the Investment Budget of the Ministry of Health Between 2001 and 2004, the Ministry of Health investment budget was drastically reduced, followed by a trend of slow growth, including a significant jump in 2010. This is against the background of a situation in which in certain areas of the country, especially the South, there is a shortage of hospitals and hospital beds, while in other areas hospitals are in need of renovation.

33. Ministry of Health Investment BudgetIn NIS millions, 2010 Prices

34. Social Security Transfer Payments are Less Effective than in the Past in Reducing Poverty The drastic budget reductions made between 2001 and 2004 led to a significant rise in the poverty rate in Israel, from 17.7% at the start of the decade to about 20% at the end. In addition, transfer payments are less effective than they were in the past in reducing poverty: In 2002, they reduced poverty by 57%; in 2010, by only 39.2%

35. Poverty Rate among All Families in Israel, 2001-2010 After transfer payments and direct taxes 35

36. Continuous Decrease in Central Government Budgets for Local Authorities Central government budgets for local authorities have decreased considerably. In 2001, they were NIS 5.34 billion; In 2010, they were NIS 3.86 billion; For 2011 and 2012, they were set at NIS 3.7 billion per year. The result is damage to the services for which the local authorities are responsible, especially in areas with limited local resources.

37. Central Government Budgets for Local Authorities, 2001-2012 In NIS billions, 2010 Prices

38. The Central Government Investment Budget for Local Authorities is No More The largest cut for local authorities was in investment budgets. In 2001, the central government transferred NIS 578 million to local authorities for development; In 2010, it transferred NIS 0.9 million; In 2011-2012, this budget disappeared from the books. The result: Local authorities, whether strong or weak, are left to their own devices when in comes to development.

39. Central Government Budgets for Local Development, 2001-2012 In NIS Millions, 2010 Prices

40. How Does One Pay for Social Justice? • Since 2003, the policy has been to reduce income and corporate taxes, following the neo-liberal ideology according to which since the state needs to be small, it does not require large budgets. • The Summer 2011 protest movement succeeded in undermining this truism and led to the Trajtenberg Commission’s recommending putting a stop to the tax-cutting program. • Tax revenues are expected to decrease in 2012, in the wake of the European crisis. At the same time, the Defense Ministry insists that its budget cannot be reduced. • Against this background, the option of raising taxes should be considered, in order to prevent another round of cuts in the social services. Last time they did considerable damage.

41. Indirect Taxes Now Exceed Direct Taxes With one hand, direct taxes were decreased; with the other, indirect taxes were increased. In 2011, state revenues from indirect taxes, NIS 104.6 billion, will be greater than revenues from direct taxes, NIS 103.5 billion. This is a change in the trend: For at least two decades, direct taxes have exceeded indirect taxes. Indirect taxes are less progressive than direct taxes: A rich person and a poor person pay the same VAT on a given item, despite their different income levels.

42. Taxation in Israel is Comparatively Non-Progressive, as the Weight of Indirect Taxes is Greater than that of Direct Taxes Even before the present budget proposal, the tax system in Israel was relatively unprogressive, compared with that of other OECD countries. According to the Israel Revenues Authority, Israel’s income and corporate tax rates are among the lowest and its indirect tax rates among the highest. The 2011-2012 budget proposal recommended maintaining the VAT at 16% until 2013, rather than lowering it to 15.5%, as promised.

43. StaS State Revenues from Direct Tax Taxes as a % of GDP, OECD Cou Countries and Israel, 2008

44. State Revenues from Indirect Taxes, as a % of GDP, OECD Countries and Israel, 2008

45. About the Figures Budget figures for 2010 and earlier are actual expenditures, as reported in annual reports of the Chief Auditor of the Finance Ministry. Budget figures for 2011 and 2012 are from the budget proposal for those years. All figures are in constant 2010 prices, based on the Consumer Price Index, unless otherwise indicated. Figures for 2011-2012 are based on a forecasted 2% average inflation rate. All budget calculations are based on net figures and do not include expenditures predicated on income, unless stated otherwise.