Israel Faces Tax Hikes and Service Cuts Post-Election Amid Defense Spending Surge

Israel is heading towards a challenging fiscal future, with experts warning that increased defense spending due to ongoing conflicts will inevitably lead to higher taxes and reduced public services for citizens. The next government will face a massive challenge in managing the economy, which, despite appearing stable with growth, is not translating into improved living standards for many Israelis. The current situation is deemed unsustainable, with experts divided on the solutions and who should bear the cost.

Before the current government took office in 2022, Israel's economic starting point was strong, with low debt and revenues exceeding expenditures, bolstered by years of building financial reserves. However, this masked a long-standing issue: a gap in living standards compared to developed nations, which Israel has failed to close despite its high-tech boom. The purchasing power of the average Israeli worker has lagged behind that of their counterparts in developed countries. This disparity is also evident in public services, with pre-war civilian spending on education, health, welfare, and infrastructure already below the average for developed nations. This forces citizens to pay out-of-pocket to supplement services, effectively paying twice.

The October 2023 war dramatically altered the fiscal landscape. Defense budgets, around NIS 60 billion in 2022, are projected to reach nearly NIS 160 billion by 2026. The Netanyahu government's approach to funding this increase has drawn criticism, relying on broad budget cuts to other ministries, tax hikes, and increased national debt, while continuing to allocate significant coalition and sectoral funds. Despite these pressures, Israel's macroeconomic data suggests an economy that has remained resilient, largely due to the pre-war financial cushions. However, the growing share of defense and interest payments in the national budget (from 29% in 2022 to an estimated 37% in 2026) leaves less for essential services.

Experts identify four key challenges: the erosion of social services, leading to longer waits for medical care and education, and increased traffic congestion, which citizens will have to fund privately or endure poorer services; the disconnect between economic growth and citizens' wallets, with the purchasing power of an hour's work significantly lower than the OECD average, meaning Israelis must work more to afford the same goods; the need to adapt education and training systems to the modern labor market, particularly for Haredi and Arab communities, to avoid future unemployment and economic strain; and a crisis of public trust in the government, exacerbated by perceived unfair budget allocations, leading to a reluctance to pay higher taxes without assurance of proper use.

Disagreements persist on how to address these issues. Some advocate for canceling tax exemptions and improving tax collection and budget efficiency, including in defense. Others propose expanding the tax base and increasing tax rates, particularly on non-wage income, to align with OECD averages. The latter approach suggests that even with tax increases and cuts to non-growth-promoting expenses, a decline in civilian services is still likely. To restore public trust, experts suggest initial steps like reducing class sizes, implementing long-term care insurance, or setting tangible goals such as narrowing the purchasing power gap with the OECD. Ultimately, Israel faces challenging years ahead, requiring a strategy of "mitigation and adaptation" to minimize damage and adjust to the new reality, while carefully considering tax policies that do not disproportionately burden those who generate the most revenue.