IMF Warns Israel’s Deficit Will Exceed Budget, Debt Ratio to Surge Due to Security Costs

The International Monetary Fund (IMF) released its economic review and recommendations for Israel following a visit by its delegation in February. The IMF projects Israel’s government deficit will reach 5.3% of GDP this year, surpassing the 4.9% forecasted in the state budget. Additionally, the debt-to-GDP ratio is expected to rise from about 70% to approximately 74% within four years, primarily due to elevated defense spending.

The IMF advises reducing the government deficit to around 2.5% over the next three years to bring the debt ratio down to about 60% by 2040, similar to pre-October 7 levels. To achieve this, the organization recommends increasing budget revenues, noting that Israel’s civilian and infrastructure expenditures are low compared to OECD countries. Suggested measures include eliminating the lowest income tax bracket (10%) by merging it with the next bracket (14%), which the IMF believes will mainly affect higher earners without increasing marginal tax rates. The IMF also calls for reassessing tax exemptions such as VAT on fruits, vegetables, and tourism services, tax breaks on savings funds deemed "irrational," and corporate tax exemptions.

The report highlights the complexity and inequality in Israel’s tax system, urging simplification and fairness improvements. On government spending, the IMF recommends directing funds toward growth-supporting programs like education and integrating Haredi and Arab populations into the workforce. It warns that rising defense costs, higher public debt, and reduced labor supply will hamper medium-term growth prospects, exacerbating structural weaknesses related to labor participation and skill gaps in minority communities.

The IMF cautions that continued increases in defense spending could crowd out investments in human and physical capital, widening Israel’s per capita output gap with advanced economies. Recommended reforms include expanding labor supply, boosting productivity through reforms and infrastructure investment, and maintaining Israel’s competitive edge in high-tech and AI sectors. Regarding monetary policy, the IMF urges the Bank of Israel to maintain a moderate approach but notes significant risks due to banks’ exposure to real estate amid sector weakness, particularly in Tel Aviv’s property market.