Israel has a $6 billion buffer. The question is who gets to spend it
The deficit has fallen to 3.3% of GDP as tax revenues surge, giving the government an unexpected fiscal cushion. The Bank of Israel and Treasury officials, however, are increasingly focused on the much larger challenge of financing a defense budget that could reach $61 billion.
Finance officials are currently experiencing what can best be described as a mixed feeling, one that was strengthened on Monday. The government deficit has fallen to 3.3% of GDP, its lowest level since November 2023, even as Israel remains in the midst of a war on several fronts.
The numbers for the first seven months of the year are even more striking: a deficit of NIS 11.5 billion ($3.8 billion), compared with NIS 37.2 billion ($12.4 billion) in the same period last year, a 69% decrease in one year.
The Ministry of Finance notes that budget execution is not evenly distributed throughout the year. January typically sees little spending, while the first months are constrained by the continuing budget. Execution accelerates during the second half of the year, with spending traditionally surging in December. But the gap between the projected deficit and the current figures is large, and it is beginning to worry Treasury officials for a potentially dangerous reason: It could whet politicians' appetite to spend what appears to be a surplus, even though Israel remains deeply in deficit, while the Defense Ministry is also seeking additional funds as the war continues.
The second "problem" for Treasury officials is the source of the surprise: tax revenues. Since the beginning of the year, they have increased by NIS 38.3 billion ($12.8 billion), while expenditures have risen by NIS 12.6 billion ($4.2 billion). In other words, while spending has widened the deficit, tax collection has more than reversed the effect.
Let's be clear: The government is spending money, and a lot of it. In July, it spent about NIS 60 billion ($20 billion), the highest monthly amount since the beginning of the year. Yet the monthly deficit stood at NIS 4.8 billion ($1.6 billion), almost identical to the figure recorded in July last year.
State revenues have increased by about 12% since the beginning of the year, while expenditures have risen by only 3.5% so far. Direct tax revenues rose 17.7% to NIS 212.8 billion ($70.9 billion), while indirect tax revenues increased by about 10% to NIS 130.7 billion ($43.6 billion).
Defense spending since the beginning of the year amounted to NIS 108.2 billion ($36.1 billion), an increase of 12.6%. Spending by civilian ministries stood at NIS 220.1 billion ($73.4 billion), a nominal decrease of 1.3%. Interest payments and payments to the National Insurance Institute increased by 8% to NIS 45.3 billion ($15.1 billion).
But there are numerous technical and timing-related factors behind the figures. The Transportation Ministry was allocated an unusually large budget this year, while the year began under a continuing budget and projects were delayed because of manpower shortages during the war. This month, the ministry has already spent NIS 700 million ($233 million) more than in the corresponding month last year, narrowing the gap to about NIS 1 billion ($333 million).
The social ministries have more than NIS 3 billion ($1 billion) in payments waiting to be settled with the National Insurance Institute that have not yet been transferred. Meanwhile, the Ministry of Construction and Housing, which operates something of a closed financial system, recorded income from land sales that was about NIS 2 billion ($667 million) higher than last year, reducing its net spending.
The defense budget opened the year at NIS 112 billion ($37.3 billion), was subsequently increased to NIS 143 billion ($47.7 billion), and was later updated to NIS 158 billion ($52.7 billion). On top of that, there is an additional NIS 15 billion ($5 billion) that the budget commissioner has pledged to allocate based on actual spending.
The main trigger is the size of the reserve forces. Budget planning is based on 40,000 reservists, with spending above that threshold transferred to the Budget Division for approval. This is the division's working method: Budget for the short term and pay as expenses are incurred.
That approach saves money in the short term but creates budgetary surges in the medium term. It also explains why the public debate over the defense budget returns almost every week. More importantly, it reflects a simple principle that has developed since October 7: When the defense budget has effectively tripled within a few years and is not coming down because the government continues to wage war, it becomes difficult to loosen the reins.
This brings the debate back to the central question among economists: What does the surge in tax revenue mean, and is it permanent?
According to calculations by the Accountant General's Department at the Ministry of Finance, part of the increase stems from the taxation of retained earnings, a measure that was initially viewed as a one-off source of revenue but has continued to generate substantial sums. Treasury officials now estimate that the measure has increased the underlying tax collection base itself.
The reason is that self-employed individuals who leave profits in their companies rather than distribute them as dividends can be exposed to an additional tax, which applies to individuals whose annual income exceeds NIS 721,560 ($240,520).
The result has been a sharp increase in withholding and income-tax revenues from the self-employed, rather than simply an increase in collections from large corporations.
The Accountant General's Department also acknowledges strong performance in withholding taxes, essentially taxes collected from employees' salaries. And this is not just a one-month phenomenon. It has become a trend.
That distinction lies at the heart of the debate. If the surge in revenue is temporary, the deficit could reopen in 2027. If the increase has become embedded in the tax base, however, it could represent a structural change in the government's ability to collect revenue.
The Ministry of Finance's chief economist has already revised the revenue forecast upward twice. In June, the forecast was increased by about NIS 7 billion ($2.3 billion) compared with the original budget, following an earlier increase in March when the first budget was prepared.
The chief economist has followed a conservative approach, raising the forecast only when new data made it increasingly difficult not to.
The Ministry of Finance has firmly refused to quantify the size of the positive surprise in the deficit figures, and there is a good reason for that. To politicians and military officials, any amount above the forecast can quickly be interpreted as a budget surplus that is available to spend, even though Israel remains in a significant deficit that could widen as the war continues.
Still, there is a number being discussed, and it is around NIS 19 billion ($6.3 billion). That is large enough to be considered a meaningful fiscal buffer.
And this is where a gap has opened between some Treasury officials and the Bank of Israel.
The governor has presented a path in which defense spending does not fall back to 5% of GDP but instead stabilizes at around 6%-7%. That, in turn, would require fiscal adjustments, either through spending cuts or higher taxes.
The Treasury does not dispute the first part of the assessment. Officials there also estimate that defense spending as a share of GDP will remain above 5% in 2027.
The Budget Division is broadly aligned with the governor. Its officials are contemplating a defense budget of around NIS 183 billion ($61 billion) and are concerned that after three years of budgets at such levels, it will become extremely difficult to bring spending back down.
The Accountant General's Division, on the other hand, is more reluctant to accept the Bank of Israel's call for additional fiscal measures. In its view, imposing additional taxes on the working population to close a deficit that is already shrinking could unnecessarily weigh on growth.
The Accountant General's assessment is that, barring another round of fighting with Iran, Israel could end the year with a deficit below the official target of 4.9% of GDP.
That assessment is not being stated publicly, because the moment it is, budgetary demands from government ministries are likely to follow, with the defense establishment first in line.
The buffer exists, and it is real. The question is whether its use will be determined through an orderly budgetary discussion, or by whoever knocks on the door first, and makes the most noise.
